Landi Renzo (LR.MI) Compounding Risks and Growth

Transcription

1 Europe Italy Auto Parts & Equipment Company In-Depth 68 pages Landi Renzo (LR.MI) Compounding Risks and Growth A Nice Niche Landi Renzo is the world leader in the niche of alternative fuel system kits for vehicles (23% share). Independent industry research estimates the market for gas conversion kits is set to accelerate from 9.9% over the past two years to 18% annually to But it should remain a market of just 8m units in 2012 a drop in the auto sector ocean, likely keeping big names out. Sound Business Model Landi s business model hinges on two main elements: i) a focus on R&D and innovation, and ii) a lean production base. Also very important is its local presence in its key markets via extensive distribution channels. The combination of these elements coupled with the relatively small size of the niche makes Landi s business relatively well protected. Double-Digit Growth to Continue In (CAGR) we forecast sales EBITDA and net profit growth of 21.3%, 24.7% and 26.3%. We see the EBITDA margin topping 23.8% while ROI should be well above 50%. Operating cash flow should reach 9.6% of sales in However, growth will come with political risks, given most of it will be generated in Pakistan, Iran and India. Off To A Slow Start H1 07 results were disappointing, with growth well below the full year guidance given prior to the IPO. In our view the company has to work harder to improve its forecasting ability to regain the confidence of the financial community. However, following the recent de-rating and bullish H2 07 guidance, we think the shares trade near a floor considering attractive long-term prospects. Valuation range Based on DCF and peer valuations, pointing at 4.11 and 3.60 respectively, we reach a fair value of 3.60 per share. Accordingly, we initiate coverage on Landi Renzo, with a Hold/ High Risk (2H) rating and a price target of 3.60 per share. We think that the key driver for the stock price will be the capability of management to deliver on guidance. Hold/High Risk 2H Price (13 Aug 07) 3.33 Target price 3.60 Expected share price return 8.1% Expected dividend yield 2.1% Expected total return 10.2% Market Cap 375M US$513M See Appendix A-1 for Analyst Certification and important disclosures. Landi Renzo (EUR) Year to 31 Dec 2005A 2006A 2007E 2008E 2009E Sales ( M) Net Income ( M) Diluted EPS ( ) PE (x) EV/EBITDA (x) DPS ( ) Net Div Yield (%) Mauro Baragiola mauro.baragiola@citi.com Alberto Checchinato alberto.checchinato@citi.com Citigroup Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Non-US research analysts who have prepared this report are not registered/qualified as research analysts with the NYSE and/or NASD. Such research analysts may not be associated persons of the member organization and therefore may not be subject to the NYSE Rule 472 and NASD Rule 2711 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Customers of the Firm in the United States can receive independent third-party research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access this independent research at (for retail clients) or (for institutional clients) or can call (866) to request a copy of this research. 1 Citigroup Global Markets Ltd

2 For further data queries on Citigroup's full coverage universe please contact CIR Data Services Europe at or Fiscal year end 31-Dec E 2008E 2009E Valuation Ratios P/E adjusted (x) EV/EBITDA adjusted (x) P/BV (x) Dividend yield (%) Per Share Data ( ) EPS adjusted EPS reported BVPS DPS Profit & Loss ( M) Net sales Operating expenses EBIT Net interest expense Non-operating/exceptionals Pre-tax profit Tax Extraord./Min.Int./Pref.div Reported net income Adjusted earnings Adjusted EBITDA Growth Rates (%) Sales EBIT adjusted EBITDA adjusted EPS adjusted Cash Flow ( M) Operating cash flow Depreciation/amortization Net working capital Investing cash flow Capital expenditure Acquisitions/disposals Financing cash flow Borrowings Dividends paid Change in cash Balance Sheet ( M) Total assets Cash & cash equivalent Accounts receivable Net fixed assets Total liabilities Accounts payable Total Debt Shareholders' funds Profitability/Solvency Ratios (%) EBITDA margin adjusted ROE adjusted ROIC adjusted Net debt to equity Total debt to capital

3 Contents Investment Thesis 4 Valuation 6 Group overview 11 The Reference Market 17 Group Strategy 33 Key Global Market Opportunities 38 Financial Forecasts 2006A-2009E 41 Appendix 1: Countries Analysis 52 Appendix 1: Oil Data 58 Appendix A

4 Investment Thesis Landi Renzo (Landi) the world leader in the niche of gas conversion kits for passenger vehicles has been growing sales at 46% per year since 2004 on the back of new product launches, opening manufacturing facilities in main markets and a growing reference market (+9.9% CAGR). Further, growth of this market is forecast to accelerate (+18% CAGR), fuelled by increasing concerns over environmental issues and climate change, the high cost of traditional fuels and growing national and international eco-friendly regulation. Leveraging a business model hinged on strong R&D, a growing local presence in its main markets, strong coverage of its distribution channels and a lean production base, we believe there is still room for growth in the coming years: we estimate 21.3% sales growth and 26.3% net profit (06-09 CAGR) despite a disappointing H1 07 showing little growth on one-offs. Although H1 was a slow start both in terms of market communication and fundamental results we think that there s still room to achieve FY07 targets on the basis of Q3 guidance. Our DCF points to 4.11 per share while peer multiples suggest a range between 3.20 and 3.60 per share. Accordingly, we initiate with a Hold/High Risk (2H) rating and a target price of 3.60 per share. Focused on a fast-growing alternative energy market Market leader with a global footprint Rapidly-expanding group Why the market is expected to boom Investment positives Landi is the global leader with a 23% share of the highly fragmented world market of Compressed Natural Gas (CNG) and Liquefied Petroleum Gas (LPG) alternative fuel systems for vehicles. Although niche markets, these are expected to keep on growing at a healthy pace on the back of rising costs of traditional fuels, increasing environmental (climate change) concerns, stricter emission regulations and attempts to diversify energy supply. Indeed, LPG and CNG are an environmentally friendly alternative to traditional fuels. With sales to over 50 countries world-wide and non-italian sales representing 74% of group turnover (2006), Landi s production structure is increasingly adopting an international manufacturing base: with subsidiaries in seven countries, the group is adding to its Italian and Brazilian (since 2004) production facilities, a manufacturing plant in Pakistan (2007), Iran (2008) and is looking to set up a plant in India in the near future. Landi has experienced 46% sales growth between 2004 and 2006 (CAGR) and EBITDA growth of 84% (04-06 CAGR) and 128% net profit growth (04-06 CAGR) over the same period. This outperformance of Landi s growth over its reference market (market share was up from 13% to 23% in the same period) was mainly due to product innovation and the group s focus on expanding in the faster-growing markets of Pakistan, Iran, Brazil, Germany and Italy. We are forecasting the main drivers of Landi s sales growth to be the Asian markets, representing 39% of our total forecast sales growth to 2009, followed by the Italian market (estimated to hover around 25% of total sales). Whereas growth in western European markets is equally driven by environmental issues and cost consciousness, in emerging markets a combination of factors has been driving the implementation of these alternative fuel systems: reducing both dependency on oil and air pollution in urban areas (e.g. existing taxi and bus fleets have been converted to gas in Pakistan, India and Iran as this is cheaper than renewing the fleet). On top of the public benefits, demand is also driven by consumers seeking lower cost alternatives to petrol. 4

5 Well-run business, with a good model Strong profitability and cash generation What went wrong in H1 07? Valuation Highlighting some risks The group is a well-run business with a consolidated business model based on a strong focus on R&D (in which the group spends 4% of sales per year), a lean manufacturing base (with outsourcing of production of non-core/value added components), an emphasis on quality control and strong relationships with major clients. The combination of these elements makes Landi s business relatively well protected by entry barriers. Thanks to this business model, the group is already delivering circa 20% EBIT margins, cash generation (profit + D&A) of 14-15% of sales annually and a pretax ROCE of 50-60% (post-tax 35%-40%). Our 2009 projections point to CAGRs of 21.3%, 24.7% and 26.3% for sales EBITDA and net profit respectively. We see EBITDA margin topping 23.8% while ROI should be well above 50%. Operating cash flow should reach 9.6% of sales in Although attractive economics, the absolute figures (sales and EBITDA of 247.6m and 58.9m respectively in 2009) are small by auto industry standards. We thus believe that the modest size of the market might be one of the barriers preventing sector gorillas from entering into GPL/CNG niche despite attractive margins and ROI. Although long-term dynamics look attractive, Landi had a disappointing H1 07 mainly due to weaknesses in the after-market in Pakistan and sluggish demand in Brazil for CNG. This was not apparent at the time of the IPO, which suggests that management has limited visibility on revenues and may have to improve internal reporting and controls. Although it has been a slow start, management was very confident of achieving the guidance disclosed for 2007 during the conference call on the 9 th of August especially after a strong July and visibility on new important contracts in Iran. In our view, DCF is the most suitable valuation approach for a company with revenues that are expected to increase by more than 17% CAGR between 2006 and 2012 while enjoying 22-25% EBITDA margins and ROI well above 50%. As a sanity check, we also value Landi using peer multiples, though we think that a peer comparison is hardly applicable due to Landi s niche features. In applying the DCF to Landi estimates, we discounted the free cash flows from using a WACC of 11.4% and a perpetuity growth of 3.0% justified in our view by the high growth of Landi s reference markets. Under such assumptions, we value the enterprise value of Landi at around 420m, or 4.11 per share. Multiples (PE ratio and EV/EBITDA) point to 3.20 per share on 2007 and 3.60 on Based on DCF and peer multiples, we value Landi Renzo at 3.60 per share and accordingly we initiate coverage with a 2H (Hold/ High Risk) rating and a target price of We rate Landi High Risk. Landi s global reference market is small and little information is available. While analysing the company, we relied on information provided by either the company or Frost & Sullivan. Most of future growth is expected to come from emerging markets notably Iran and Pakistan. Major sector players haven t entered into Landi s niche for the time being, considering the modest size of the market. However, should the market grow strongly larger players could decide to enter given i) low barriers to entry (for a major player, whereas barriers for smaller potential entrants are much higher) ii) very high returns on investments and iii) high margins. Other forms of alternative fuel systems can be introduced in the market while attracting more interest from consumers as well as car producers and governments. Although Landi's technologies are considered safe, there might be some resistance to their adoption as: i) LPG kits may occupy a large part of the space in the car boot/trunk; ii) possible difficulties in parking; iii) availability of refueling sites. 5

6 Valuation Although the Landi group has a c.50 year history, it is far from being an established business especially now that the group is increasingly targeting emerging markets and Western countries are increasingly in search of ecofriendly solutions. In our view, DCF is the most suitable valuation approach for a company with revenues that are expected to increase by more than 17% CAGR between 2006A and 2012 while enjoying 22-25% EBITDA margins and ROI well above 50%. DCF requires a host of sensitivity assumptions if applied to high-growth companies exposed to emerging markets like Landi. Nevertheless, we like the DCF approach because it allows us to better understand and value the business model. As a sanity check, we also value Landi using peer multiples, although we think that a peer comparison is hardly applicable due to Landi s niche features. We would like to stress that this valuation section is based on our CIR forecasts while relying on both company guidance and market expectations provided by Frost & Sullivan, which has carried out an extensive analysis of the niche market in which Landi competes on which very little public information is otherwise available. DCF Valuation In applying the DCF valuation methodology to Landi estimates, we discounted the free cash flows from while calculating the terminal value using a Gordon Growth model on 2013 NOPAT assuming that from 2013 onwards capex will match depreciation and no additional working capital will be required. Figure 1. Operating Cash Flows 2007E-2013 E m 2007E 2008E 2009E 2010E 2011E 2012E 2013E Operating cash flows Source: Citigroup Investment Research Given that almost two-thirds of the sales growth to 2013 in absolute terms is due to come from emerging markets, we discounted the flows using a WACC of 11.4%, based on a required yield on equity weighted by sales split as shown in the table above. Finally, we applied a perpetuity growth of 3.0% justified in our view by the high growth of Landi s reference markets. Under such assumptions, we value the enterprise value of Landi at around 420m, corresponding to an equity value of around 460m once IPO proceeds are added back. Hence, our DCF values Landi s share at 4.11 broadly in line with the IPO price of 4.00 per share. 6

7 Figure 2. DCF Valuation m DCF valuation m % PV of future cash flows % PV of Terminal value % Enterprise value % Net debt 41.6 Minorities/surplus assets 0.0 Equity value number of share Treasury shares 0.0% Fair Value per share 4.11 Source: Citigroup Investment Research Whereas the terminal value accounts for around 70% of enterprise value the combined cash-flows estimated for account for just 7% of enterprise value. With such weightings and assumptions, the implied sensitivity to WACC and long-term growth is clearly rather large. Figure 3. Landi Renzo - Valuation sensitivity to changes in WACC and perpetuity growth - per Share WACC Long term Growth 8.00% 9.00% 10.00% 11.00% 12.00% 13.00% 0.0% % % % % % Source: Citigroup Investment Research Peer group relative valuation In valuing Landi Renzo relative to a peer group, the central issue is that there is no clear direct comparable. After analysing several hypotheses, we have compared it to a set of Italian mid- and small-cap companies which are either automotive suppliers (Brembo and Sogefi), or which have similar growth trends (Nice and Saes Getters), or which operate in the engineering segment with similar margins (Sabaf, Interpump, IMA). For the sake of comparison, we have also included Geox a high growth stock which does not fall under any of the above categories but which has a growth profile much closer to Landi. 7

8 Figure 4. Italian Small/Mid Cap (Priced August 8) Price ( ) 2007E 2008E 2009E 2007E 2008E 2009E Sales CAGR EBITDA CAGR Earnings CAGR Piaggio (*) % 8.0% 20.9% Brembo( % 9.5% 16.5% Sogefi % 4.1% 8.2% Interpump % 12.4% 14.1% IMA % 13.3% 20.5% Sabaf % 11.2% 14.0% Guala Closures (*) % 12.5% 17.8% Nice (*) % 20.7% 21.6% Saes Getters % 7.1% 9.6% Peer Group Average % 11.0% 15.9% Landi (*) % 24.8% 26.3% Geox (*) % 27.0% 23.8% Premium (discount) (**) 19% 1% -12% 23% 4% -10% Source: (*) Citigroup Investment Research, Bloomberg (**) Geox not included in the sample (PIA.MI ; 2M); (GCL.MI ; 2M); (NICE.MI ; 2M); (GEO.MI ; 1M) Landi appears expensive on 2007E, fairly valued on 2008E and at discount on 2009, as shown also in the chart below. Figure 5. EV/EBITDA 2009 vs. EBITDA CAGR 2006/2009E IMA Interpump Piaggio Sogefi Brembo Sabaf Nice Guala Closures Saes Getters Landi Source: Citigroup Investment Research, Bloomberg Multiples suggest to us a valuation range of 3.20 to 3.60 per share. 8

9 Initiating with a 2H rating; target price 3.60 Based on our DCF and multiple comparison, we assess a fair value of 3.60 per share. Accordingly, we initiate with a 2H (Hold/ High Risk) rating and target price of 3.60 per share. Stock Performance Landi s shares have been having a disappointing performance since listing at 4.00 per share on June 26. After having traded above the IPO price in the early days of listing, the stock has started to decline while reaching a price as low as 3.29 in early August or % since the IPO. Figure 6. Stock Performance Since IPO on June 26 th /26/2007 7/3/2007 7/10/2007 7/17/2007 7/24/2007 7/31/2007 8/7/2007 LR.MI Mibtel Source: Datastream, Citigroup Investment Research Risks We rate Landi Renzo as High Risk. The risk rating on the stock derives from a number of factors. These factors include an assessment of industry-specific risks, financial risk and management risk. In addition, we consider historical share price volatility, based on the input of the Citigroup Investment Research quantitative research team, as a possible indicator of future stock-specific risks that may potentially cause the shares to deviate from our target price. Landi s global reference market is small and little information is available. While analysing the company, we have relied on information provided by either the company or Frost & Sullivan. On the basis of such information, we have then made forecasts for each of the key markets and continents. Most future growth is expected to be generated by emerging markets notably Iran and Pakistan (where Landi is building local facilities). These two markets are associated with substantial volatility and a certain amount of political risks. 9

10 Future growth also depends on: i) the government pushing alternative fuel systems, ii) oil company deploying capillary network of refueling stations and iii) car producers adopting eco-friendly solutions. The management of Landi Renzo cannot influence any of the three forces. Sector majors haven t entered into Landi s niche for the time being, given the modest size of the market. However, should the market expand sharply big players might decide to enter given: i) relatively low barriers to entry, ii) very high returns on investments and iii) high margins. Other forms of alternative fuel systems could be introduced in the market while attracting more interest from consumers as well as car producers and governments (eg. hybrids cars) while reducing demand for LPG and CNG. There is some risk of product copying by the competition despite existing product patents and a strong drive to make products more technologically advanced. This could contribute to more price competition and an erosion of the group s high profitability and cash generation. Technological advances have done away with most of the dangers, mostly related to the high pressure (of up to 200bar) at which gas is stored, of LPG and CNG systems as far as Landi Renzo products and some of its more advanced competitors are concerned. Nevertheless, lower quality competitor products could still be exposed to the risk of explosion, thereby potentially negatively affecting the overall reputation of alternative gas fuel systems. Although LPG/CNG are considered safe technologies, there might be still some psychological resistance to their adoption (especially in Western Europe) due to: i) LPG (but also CNG) kits occupying a large part of muchneeded boot/trunk space, ii) possible difficulties in parking and iii) availability of refueling stations. Though Landi has been experiencing rapid growth since 2004, it achieved only modest growth rates during its first 50 years (despite being market leader). There is no certainty that, following a short period of sharp increases, the growth rate could return to its historic pace. Management has been with the group for many years. Whereas this is a positive from many points of view, there could be concern that the company might not have the in-house expertise to implement a precise and efficient control and budgeting system while limiting the accuracy of future targets especially those targeting rapid growth in emerging markets. There is some acquisition risk, considering that external growth is one of the avenues company management envisages, either of a new technology, or of a player in an unexplored key market or of a distributor of Landi products. Indeed, the company has little proven track record on making acquisitions, with only one acquisition (that of software division MED) undertaken in , which took several years to turn-around but is now a key element of success of the Landi group. 10

11 Group Overview Group snapshot With 138.7m in sales and an EBITDA of 27.5m in 2006, Landi is the world market leader in the high-growth niche of systems to convert vehicles to run on gas, either Compressed Natural Gas (CNG) or Liquefied Petroleum Gas (LPG). Indeed, this is a lower-cost and environmentally-friendly alternative to petrol and diesel fuels, which is increasingly popular at a time of high oil prices and increasing awareness of environmental issues and climate changes. Figure 7. Landi Renzo products the complete system Figure 8. Landi Renzo products the individual components Source: Company Presentation Source: Company Presentation The group was born during the 1950s in Italy, which at the time was the first market to adopt gas as an alternative to petrol as a vehicle fuel and since then Landi has built on its technological leadership which it defends through significant efforts in research and development. Based in central Italy near Reggio Emilia, Landi designs, produces, customizes and distributes alternative fuel system kits for vehicles allowing them to run on both petrol and gas, either LPG or CNG. Its product range includes pressure reducers, electronic control units and injectors for systems which can be sold as individual components or as complete kits inclusive of the gas tank which Landi does not produce, as it consists of more basic products. Distributing its products in over 50 countries, today over half of its sales are in Europe, Italy absorbs 26%. Southwest Asian markets Iran, Turkey and Pakistan absorb 34% of sales. Future growth is forecast to come from high-growth emerging markets such as these, where conversion of vehicles to gas is seen as a low-cost solution to environmental pollution. For this reason, Landi and the overall market for gas conversion kits have been growing more strongly in emerging countries than in developed ones, where environmental problems have been tackled by imposing increasingly stricter emission rules on vehicles, thereby encouraging a renewal of the existing vehicle (private and public) population. 11

12 Figure 9. Landi Renzo geographical breakdown of sales (2006, 138.7m) Figure 10. Landi Renzo sales breakdown by product category (2006, 138.7m) America 6% Other Asia 6% Rest of the World 3% Other 3% South West Asia 34% Italy 26% Natural Gas Equipment 55% LPG equipment 42% Other Europe 25% Source: Company Reports Source: Company Reports Exposed to both OE and AM segments Landi sells to both Original Equipment vehicle Manufacturers (OEM) and to the After Market (AM), with AM sales representing the largest share of revenues, 70%, and OEM sales the remaining 30%. In the OEM world, Landi has established relationships with car manufacturers, customizing parts for their individual vehicle models. It supplies a wide range of manufacturers including the VW group, Renault, Opel, PSA and Suzuki, all of which are increasingly promoting dual-fuel vehicles (petrol and gas) as part of their product range. Landi also customizes components for individual vehicle models. It sells complete conversion kits in the after market (the AM channel) to distributors and installers, which typically mount the kits on used or zero kilometer vehicles (retro-fitting). In this case it is Landi which certifies the performance and security characteristics of the equipment. Individual components are instead exclusively sold to car manufacturers (the OEM channel) which mount them on some of their models whilst the vehicle is still in the production phase. In this case, it is the OE manufacturer which certifies the performance and security characteristics of the whole fuel conversion system (to gas). Landi is particularly exposed to the OEM segment (this represents 15% of the world market, whilst for Landi it represents 30% of sales), representing an advantage for Landi; growing public concerns and awareness of environmental issues are fueling stronger sales growth to the OE market than to the AM and Landi is set to benefit from this given its higher than average exposure to OEM sales. Indeed, the OEM segment is forecast (Frost & Sullivan estimates, CAGR) to grow at 30% to 2012 versus 15% for the after market, for a total market growth of 18.2%. Also, having developed the components for specific car models in the production phase, Landi has technological advantages also in the aftermarket for kits of those same vehicle models. 12

13 Global leader gradually adopting an international manufacturing base In the overall market for gas fuel conversion kits world-wide, Landi is the global leader with a share of 23%, with a top presence in key markets. Its competitors are mainly Italian manufacturers, with the exception of Fuel Systems Solutions a US company which also controls the second largest player in the Italian market BRC. Landi has subsidiaries in seven countries and production facilities in its main markets: in Italy (2 plants), Brazil and Pakistan (one factory each), a factory in Iran is expected to come on line in late 2007 or early 2008, and distribution facilities in Holland, Poland and China. Figure 11. Landi Renzo group structure and production facilities (1) Remaining 4% stake is owned by local partners. (2) Remaining 30% stake is owned by local partners. (3) Landi Renzo committed to transfer a 25% stake to Iranian company Iran Carburettor. Source: Company presentations The Pakistani plant is due to start production in 2H07, manufacturing parts and systems for the local market where Landi has a 49% share of this market and it is by far the strongest player. The Iranian plant should start production in late 2007 or early 2008, but the group s presence in this market is already well consolidated with a market share of 20%. The Brazilian manufacturing base has been supplying the local market for several years and the group has a 20% market share there. The Italian production base is used both for the local market and as a main production base to sell the group s products worldwide. In both Germany and Italy, the two main markets in Europe, Landi has a market share of above 50% in the CNG market. In the future Landi might consider opening a production plant in India, where there is an opportunity to exploit the expected high growth of the gas conversion kit market. 13

14 Figure 12. Landi Renzo s positioning in its main markets and overall globally Market Market share* Market position Germany (LPG/CNG) 12%/50% #2/1 Italy 35% #1 Brazil 20% #3 Pakistan 49% #1 Russia 18% #2 Global 23% #1 Source: Frost and Sullivan, (*) based on number of units sold Strong sales growth and expanding margins Experiencing ongoing strong growth (H1 07 Apart) Landi experienced impressive growth over the past two years: between 2004 and 2006 the group has more than doubled its sales, increasing its market share from 13% to 23%, raising its profitability from 13.8% to 21.9% at the EBITDA level, with EBITDA growing by 84% and net profit by 128% (04-06 CAGR). This growth came after a few years of relative stagnation: sales hovered at 46m per year between 2001 and 2003, and EBITDA in the three years was 8m, 3.1m and 2.4m respectively. Figure 13. Landi Renzo 2004A-2006A m ( m) 2004A 2005A 2006A CAGR Turnover % % yoy growth 43.1% 50.3% EBITDA % As % of sales 13.8% 21.0% 21.9% EBIT % As % of sales 9.6% 18.3% 19.8% Net profit % As % of sales 5.0% 12.0% 12.0% Cash flow (net profit + D&A) % As % of sales 9.2% 14.7% 14.1% World Market size (m units) % Landi world market share (units) 13% 23% Source: Company data, Frost & Sullivan, and Citigroup Investment Research calculations Market growth rate of 9.9% per year between 2004 and 2006 is forecast to almost double in the coming years Landi s market share up from 13% to 23% More importantly, this growth is expected to continue in the foreseeable future Frost and Sullivan estimates that the growth rate of the combined market of CNG and LPG kits will grow by 18.2% to 2012 in units sold terms ( CAGR), versus a growth of 9.9% per annum between 2004 and Partly, this is due to increasing momentum in the underlying market, pushed by growing concerns for the environment, government incentives which target an increase in penetration of cleaner alternative fuels. This is also thanks to a general effort to diversify sources of energy away from petroleum-based ones, and as consumers look for cheaper ways to fuel their independent means of transportation (more information on the reference market is provided in the next chapter). However, the growth experienced by Landi has also stemmed from two company-specific drivers, as indicated by the increase in market share from 13% to 23% experienced by the group between 2004 and

15 The first important company-specific driver has been new product launches, particularly intense in , that have benefited the group both in terms of market share and also, strongly, in terms of price/mix, thus also boosting margins. The second important group-specific growth driver was the strategy to focus on markets with high growth potential, such as Pakistan, Iran, Brazil, Poland, Germany and Italy, thereby outpacing average growth of the world market as a whole. By establishing subsidiaries in many key markets and developing relationships with OE manufacturers in those countries, Landi was able to post higher-than-average market growth. Indeed, the Brazilian subsidiary started production in , and the group started to benefit from the local production in 2005 Landi products were no longer subject to import duties and the group started to work more intensely with local car manufacturers thanks to its newfound proximity to their production base. By the same token, the Pakistani plant is due to start production in 2H07 and the Iranian one in late 2007 or early Figure 14. Landi Renzo s Market-Specific growth drivers in LPG and CNG (volumes) CAGR CNG LPG Pakistan 18.2% 62.6% Iran 20.6% Germany 416.4% 138.0% Italy 29.1% 6.5% World average 15.5% 6.5% Source: Frost and Sullivan Industrial model based on significant outsourcing of production Resulting in a light tangible asset structure Low capital intensity From the outset in the 1950 s, Landi s business has been based on a light production structure, outsourcing all the phases of production of those components and parts which were not considered strategic, choosing to keep inhouse only the manufacturing of those components which were considered to be the heart of the product. Today, thanks to this philosophy, 60% of operating costs are variable in nature, leaving the group with a very flexible cost structure. This strategy of outsourcing of large parts of the manufacturing has enabled Landi to maintain a light fixed tangible asset base, representing 23-25% of total assets, and has resulted in the group achieving high levels of ROCE. The low investment requirement (both maintenance and growth) which results from this strategy has further strengthened the sound cash generation of the group. 15

16 Figure 15. Landi Renzo Light tangible asset structure and solid balance sheet ( m) Net fixed assets Tangible Intangible Goodwill Financial and other Current assets Stocks Trade receivables Other receivables Current liabilities Trade payable Other payables Net working capital Net capital employed Shareholders' funds Long-term liabilities incl TFR Net debt (cash) Asset rotation ROCE 14.5% 41.7% 47.9% ROCE after tax 8.8% 26.9% 35.3% Net financial gearing 40% 7% 17% Net debt / EBITDA 123% 12% 24% Source: Company reports and Citigroup Investment Research 16

17 The Reference Market Landi s reference market is the global market for alternative fuel systems using LPG and CNG, for which it manufactures both single components as well as complete fuel systems, and where it is the number one player with an estimated market share of 22-24% (2006, Frost & Sullivan). Aside from the presence of two other global players BRC (part of the US-listed US company Fuel Systems Solutions) and Lovato both Italian, this is a very fragmented market, comprising numerous local players which have lower prices but also technologically simpler products. Figure 16. Market Share of LPG and CNG Conversion Kit Manufacturers (World), 2006 Landi 22-24% Lovato 8-10% BRC 16-18% Others 49-51% Source: Company Presentations Figure 17. Environmental Impact of Different Fuels (Greenhouse Gases & Particulate) 100% 50% 0% Diesel Petrol LPG CNG Specific analysis is based on Euro IV Light Duty Vehicles. Source: Company presentations LPG, liquid petroleum gas, is a by-product of oil refining, mainly consisting of a mixture of butane and propane. At room temperature it takes the gaseous form, while at low temperatures or high pressures it takes a liquid form. CNG compressed natural gas, CH 4 is not derived from petroleum but can be found in its natural state in underground reserves and is produced in nature by the decomposition of organic material. It is the real eco-fuel in that, although in its natural form it is considered a greenhouse gas, if burned it produces up to one third of the quantity of CO2 and particulate matter combined (see Figure 17) produced by other fuels, including LPG. Systems using LPG are less expensive (on average 30/40% less, although the price depends on economic conditions in each country; in Europe they cost per kit) and are less sophisticated than those using CNG in that the former may be stored in liquid form at lower pressures than the latter (CNG is stored at 200 bar while LPG is stored at less than 30 bar), thus the storage tank and pressure reducer are less sophisticated. 17

18 Main market world wide, Europe But emerging markets are growing faster Global market for LPG and CNG alternative fuel systems Europe is presently the largest market worldwide for systems employing LPG and CNG as alternative fuels, absorbing 38% of the 2.9m units sold annually (2006 data, Frost & Sullivan). Most of these systems are used to convert used vehicles from petrol fuel to either LPG or CNG, but a rapidly growing portion is being mounted directly on newly assembled vehicles before they leave the assembly line by the OE manufacturers themselves (15% of kit markets and c.30% of Landi s sales). Car dealerships sometime adapt new cars before they are sold. Although still in limited numbers, some municipalities have began to convert public transport to LPG or CNG fuel. Other large markets for these products are Southwest Asia defined as Iran, Pakistan and Turkey representing the second-largest market with 27% of total units sold in 2006, followed by Latin America (15%) and the rest of Asia (13%) which comprises India and China. In these countries, a combination of factors has driven the growing implementation of these alternative fuel systems in these areas: partly it is a need to reduce dependency from oil (CNG is not oil-derived), partly it is a need to reduce air pollution in urban areas (existing taxi and bus fleets have been converted to gas in Pakistan, India and Iran as this is cheaper than renewing the fleet), finally it is in part due to consumers seeking lower cost alternatives to petrol. Figure 18. World market of LPG and CNG kit sales in 2006 (approximate data) Figure 19. World market of LPG and CNG kit sales in 2006 (global split) LPG CNG Latin America 0 448,000 Europe* 450,000 81,000 Russia 345,000 5,000 Australia 75,000 0 Asia 1,000 27,000 SE Asia 299, ,000 Iran 0 147,000 Turkey 265,000 0 RoW 287,000 75,000 Turkey 10% Iran 6% SE Asia 16% RoW 14% Asia 1% Australia 3% Latin America 17% Russia 13% Europe* 20% * Europe is comprised of: Germany, Italy, France, Poland Source: Citigroup Investment Research based on Frost & Sullivan and Company presentation * Europe is comprised of: Germany, Italy, France, Poland Source: Citigroup Investment Research based on Frost & Sullivan and Company presentation LPG is a larger market but CNG is growing faster In 2006, global sales of LPG conversion kits amounted to 1.7m units, 59% of total kit sales (both OE and AM), growing by 6.5% per year from 2004, while annual sales of CNG kits reached 1.2m kits, growing at 15.5% per year in the two-year period. LPG is the predominant gas used in EU countries and in Russia and Turkey. In Italy LPG kit sales represented the majority of sales (73% of total LPG and CNG kits sold); in France, Russia, Turkey and Poland they were the exclusive form of gas used, while in Germany they represented 80% of kit sales. The global LPG industry is extremely fragmented, with a large number of companies operating in different markets around the world. 18

19 Latin American countries instead moved to a wider utilization of CNG, this region holding wide reserves of natural gas and where LPG is almost banned and not used as an automotive fuel. Argentina and Brazil use almost exclusively CNG kits. Thanks to the higher growth in the use of CNG globally, annual sales of kits are forecast to be split 52%-48% in favour of CNG by 2012E, with the main drivers of CNG growth being the markets of India, Pakistan and Iran, as public transportation is being gradually converted to CNG on a mandatory basis in these countries as well as other Asian countries. Figure 20. Global market for LPG and CNG fuel systems for vehicles forecast sales (units) CAGR: 9.9% 2.4 m 2.6m 2.9m CAGR: 18.2% 7.9 m Market growth is forecast to accelerate Forecasts by Frost & Sullivan estimate growth of the market for LPG and CNG fuel systems to accelerate from 9.9% in to 18.2% up to 2012 (CAGR unit sales of LPG and CNG fuel systems) on the back of four main drivers: 1) growing global concern over environmental issues; 2) consumer increasing attention to the running costs of vehicles; 3) resource usage and security of supply; and 4) growing environmentally friendly legislative and regulatory constraints. Figure 21. Global Market Drivers & Restraints E 2008E 2009E 2010E 2011E 2012E Source: Company Presentation STRENGTHS Attention to the running costs of vehicles Growing environmentally friendly legislative and regulatory constraints Development of service station network Growing global environmental issues Low number of CNG stations WEAKNESSES Low understanding of CNG &LPG benefits by population worldwide Insufficient promotion by Industry & Governments Insufficient support of CNG & LPG development by OEMs Source: Citigroup Investment Research based on Company Presentation On top of these, a further driver to the growth in the market for LPG and CNG fuel systems is the increase in the number of service stations where car owners are able to refuel their vehicles, as a consequence of incentives by national governments and local authorities. 19

20 Re-fuelling stations Re-fuelling stations are relatively limited in number if compared to standard fuel stations. Among the reasons of the limited number of LPG/CNG refueling stations, there is their need to be located at a minimum distance away from buildings or populated areas. The distance varies according to factors like the design of storage tanks, but mainly on local rules and regulations. For this last reason, in some cities it is possible to find LPG/CNG refueling stations within city centres. Figure 22. CNG statistics, Source: The GVR (Gas Vehicle Report), March 2007 LPG refueling sites look and operate much like a normal petrol or diesel pump. To fuel up with LPG, the customer simply needs to attach and lock on a bayonet-type connection to the tank nozzle, then push a button to start the flow of gas from the dispenser to the vehicle. CNG refueling stations, having no limits to location, have a double approach: public fuelling stations and private fuelling stations. Public fuelling stations are accessible for anyone who wants to refuel their vehicle, just like a normal gasoline station. Private fuelling stations are generally associated with large fleets (buses, garbage trucks, delivery vans, etc). There are two basic methods of fueling compressed natural gas vehicles: slow-fill and fast-fill. Public fueling stations using a fast-fill system that work like normal stations for gasoline and diesel. NGVs can be fuelled in about the same time or a bit longer than normal liquid fuel vehicles. Slow fill systems take gas directly from the compressor into the vehicle (as opposed to using fuel storage tanks normally associated with fast filling systems). Slow fill systems are typical of fleet fuelling but depend upon the fuel requirements of each fleet and whether or not there is space enough to park vehicles at multiple fuelling points. Often a combination of fast and slow fill systems are installed by fleet operators so that vehicles returning only for a short time can fuel but also those left overnight can be fuelled and be ready for operation the following morning. 20

21 But let us take a closer look at the main three drivers of market growth mentioned above. Environmental drivers Exhaust gases from cars contribute significantly to two major environmental problems: Local air quality as carbon monoxide (CO), nitrogen oxides (NOx), unburnt hydrocarbons (HCs) and particulates (PMs) lead to human ill health (notably respiratory and cardio-pulmonary disease and lung cancer). This is a particular problem in the rapidly growing mega-cities of the developing world. Climate change as the CO2 emissions from transport contribute c. 14% of global greenhouse gas emissions (with this expected to rise both absolutely and relative to other GHG sources). Local air quality As Figure 23 shows, many of the cities in the world face serious problems with their local air quality. (Although the data is old, the fundamental drivers behind the problem remain in place.) Figure 23. Overview of ambient air quality Source: Data assembled by the World Bank from various sources CNG and LPG both have a role to play in reducing the impact of urban air pollution as they reduce CO, NOx, HCs and PMs. Although finding precise figures for the reductions is difficult (as it depends on the comparators chosen and the scope of the value chain selected), the following table is, we think, representative: 21

22 Figure 24. Emissions benefits of replacing conventional diesel with CNG Fuel CO NOx PM Diesel 2.4 g/km 21 g/km 0.38 g/km CNG 0.4 g/km 8.9 g/km g/km %age reduction NB: Medium duty diesel buses, central business district test cycle Source: Frailey et al, 2000 / Citigroup Investment Research Climate change With respect to greenhouse gas reduction, the benefits of LPG and CNG are more balanced and complex as follows. Throughout the fuel cycle, LPG and CNG are c.15% more CO2-efficient than petrol/gasoline. However, diesel is c.20% more efficient than gasoline. So, at first glance, diesel would appear likely to become the fuel of choice in a carbonconstrained world. However, this conclusion ignores: The structural shortages of diesel in Europe, which is likely to increase diesel cracks over coming years; The hydro cracking process needed to improve the diesel yield from a barrel of oil is an energy (and therefore carbon) intensive process; The forthcoming tightening of local emissions regulations (to Euro 5) that will increase the cost of diesel cars; The fact that a diesel engine cannot be retrofitted into a gasoline car in the same way as LPG/CNG technology can be retrofitted. Hence, further diesel penetration in Europe may be limited and LPG and CNG may have an ongoing role in the reduction of CO2 emissions from the European automotive fleet. Environmental benefits - general Overall, we see local air quality considerations continuing to support the penetration of both CNG and LPG. Likewise, albeit to a lesser extent, we see both technologies playing a role as part of the portfolio of technologies that will be needed to mitigate the greenhouse gas emissions of the road transport sector. Cost drivers Part of the growing demand for LPG and CNG kits is derived from cost issues: studies indicate gas fuel costs to be as much as 50% cheaper than petrol and diesel fuels. Indeed, with the spike in the oil price in past years, and with prices having remained at very high levels, consumers have increasingly been looking for fuel alternatives to petrol and diesel for running their vehicles. 22

23 Payback of kit 6-24 months Alternative fuels such as bio-diesel, bio-ethanol and ethanol have become increasingly popular alongside LPG and CNG. All these alternative fuels cost less than petrol, and require minor investments to adapt the vehicles engine to run on the alternative fuel as opposed to just on petrol. In the case of gas fuel, the cost of a complete aftermarket system inclusive of the installation cost, is typically amortised between 6 and 24 months depending on the type of product and the local installation cost. Figure 25. Natural Gas, Ethanol, Petrol prices: a Study Case in Brazil (cost per unit in Brazilian Real) Source: Company Presentation On the other hand, factory and dealer-fitted systems are typically priced with a similar price premium as that of diesel vehicles compared to petrol-fuel vehicles. The advantage LPG and CNG have over these other alternative fuels is that their price is lower still and, particularly compared to bio-ethanol and bio-diesel, they are not subject to fluctuations tied to the seasonality of their production (bioethanol is derived from sugar cane in Brazil, which is a seasonal crop). Figure 26. Cost of running vehicles with different fuels DIESEL PETROL LPG CNG Cost for 1Lt/1Kg Consumption to run 10 Km with 1 Lt/1Kg Lt 0.75 Lt 1 Lt 1.2 Kg 0.6 Total cost to run 10 Km Savings compared to petrol to run 10Km 35.70% % 71.70% Km run with Source: Company Presentation and Quattroruote periodical magazine, Dec

24 Fiscal incentives lower payback of kit further Aside from being cheaper, CNG is also believed to be more energy-efficient than both petrol and diesel, and also considerably more than LPG, thus significantly reducing the running cost of a CNG-powered vehicle. The economic convenience of natural gas and LPG is even higher if we consider that installation costs are lowered considerably by the fiscal incentives introduced by governments. In Italy for example, fiscal incentives are of 1,500 on a new vehicle purchased with either CNG or LPG dual fuel systems, and of for a system retro-fitted on a used vehicle, depending on the type of vehicle (incentives for 2007 ended in H1). Resource usage and security of supply Some countries are driven by energy security and diversity factors. For example: Gas-rich countries such as Iran are keen to use their own abundant resources; Resource-poor countries, by contrast, might look to technologies that can help them diversify their energy supply chains and prevent them having to build a dependence on any single country. Legislative, fiscal and regulatory drivers For the environmental and security of supply reasons mentioned above, governments are likely to continue to support technology through a variety of mechanisms, most notably: Emissions regulations; Tax incentives and rebates; Public purchasing decisions. Figure 27. Key Regulatory and Legislative Mechanisms Driving Gas Vehicle Demand Source: Landi Renzo In the EU and increasingly elsewhere, emission regulations are becoming stricter. Euro 5 standards will be introduced by

25 Tax incentives and rebates which partially recover the cost of conversion to gaspowered and dual fuelled vehicles (petrol and gas), thereby lower the initial investment required by the car-owner, and thus the payback period. On the other hand in London such vehicles receive an exemption from the congestion charge. In some countries, governments have required all public transport and taxis to be converted to gas propulsion on a mandatory basis. This is the case of India in Delhi and Pakistan, but also of several local authorities in Italy. In New Delhi, where the Supreme Court required a conversion to CNG of all public transportation on 2001, with a transition period allowed only for <8 year old vehicles, the number of vehicles running on CNG was boosted from 10,000 in 2000 to 85,000 in 2004 (reaching a CAGR of 71%) and CNG refueling stations moved from 30 to 135 in four years. The successful case of New Delhi has been followed by Pakistan, requiring a mandatory conversion by A case study carried out in Turin (Italy) has concluded that the conversion of 10% of passenger and commercial vehicles in to gas propulsion would decrease the emission of particulates by 45%, those of benzene by 18%, those of NOx by 20% and those of CO2 by 3%. Growth is faster for CNG than for LPG Growth of the CNG kit market has been faster than that of LPG in the period, 15.5% versus 6.5% CAGR, mainly because methane is more readily available in the faster growing economies, but also because these economies often attempt to diversify their energy requirements away from the expensive petroleum based fuels. CNG kit sales are forecast to continue growing faster than those for LPG, although generally acceleration is expected in both: CNG sales are forecast to grow by 22.2% whilst those of LPG are estimated to grow by 14.3% ( CAGR). Figure 28. Breakdown of LPG Kits Sales by Country (World) in %, E Figure 29. Breakdown of CNG Kits Sales by Country (World) in %, E Source: Citigroup Investment Research based on Frost & Sullivan Source: Citigroup Investment Research based on Frost & Sullivan The main countries expected to drive this growth are India and Iran for the CNG kits and the Indian and German markets for LPG kits. 25

26 Figure 30. Gaseous Fuel Systems GAS (CNG& LPG) Biodiesel / Gas to Liquid/ Bioethanol Coal to Liquid (1 st & 2 nd Generation) Hydrogen / Full Cell Hybrid Technology Environmentally Friendly X / Availability of Technology X Affordability X X X Short-Term Outlook X X X Long-Term Potential X Infrastructure X X X Public Perception X Source: Landi Renzo 26

27 Growth is faster in the OE segment although the AM is larger LPG and CNG kit sales are channeled through the aftermarket as well as through OE manufacturers. In the aftermarket, specialized vehicle repair shops fit the conversion kits (either CNG or LPG) onto used vehicles; in the OE segment it is the car manufacturer which mounts the kits during the assembly phase of the vehicle. Car dealerships which have the kits mounted on the vehicles before these are sold are also considered OE sales. As reported by Frost and Sullivan, the aftermarket is currently dominating the scene with 85% of global market share. The aftermarket is benefiting from both a low percentage of vehicles with gas as a factory-fitted option, and governments gas regulations on existing vehicles which are retrofitted. Notwithstanding, OEM sales are experiencing strong growth driven by the increasing availability of new vehicle models in all markets, mainly the emerging ones. Forecasts by Frost & Sullivan show OEMs unit sales moving from 15% in 2006 to 27% 2012E, thus gaining ground on the aftermarket E CAGR for the aftermarket is reported to reach 15.2%, while is calculated to be 30.3% for OEMs. Even if the aftermarket will still be dominating the global scene, OEM sales of LPG kits are expected to increase from 12% in 2006 to 25% in 2012E, while OEM sales of CNG is forecast to move from 15% to 33%. Figure 31. LPG - World Aftermarket and OEM (Conversion Kit Sales), E Figure 32. CNG - World Aftermarket and OEM (Conversion Kit Sales), E Source: Citigroup Investment Research based on Frost & Sullivan Source: Citigroup Investment Research based on Frost & Sullivan 27

28 Landi Renzo s Products As mentioned earlier, Landi designs, produces and distributes ready to go LPG and CNG alternative fuel systems for cars, including fuel injections, pressure reducers and electronic devices through a multi-brand strategy in different markets worldwide. Figure 33. Landi Renzo Production Process Source: Company Presentation LPG and CNG systems include pressure reducers and vaporizers (LPG, only), valves (electrical valves included), electronic control units, injectors, switches and air & fuel mixers. Landi Renzo s products are installed on top of the existing fuel system, thus allowing the vehicle to use both petrol and LPG or CNG fuel. Tanks are not produced by the company. In the LPG system, the gas flows from the tank and, running along the highpressure piping, passes through an on-off solenoid valve, that is closed when the car is running petrol or when turned off, and reaches the reducer-vaporiser. In the reducer-vaporiser, the LPG, heated by the engine water to ensure perfect gasification, changes from gas to liquid and thus at atmospheric pressure enters a special device that injects the gas into the engine according to demand. 28

29 Figure 34. The LPG system Figure 35. The CNG system Source: Company Reports Source: Company Reports In the CNG system the gas flows from the tank and, running along the high pressure piping, reaches the reducer, where its pressure is decreased and it passes through the reduction stages. The water from the engine cooling system provides the heat needed to prevent the reducer from freezing. The gas leaves the reducer at atmospheric pressure and flows to a special device that injects the gas into the engine according to demand. Landi systems for LPG include the following products: Omegas multipoint sequential injection system represents a new generation of bifuel (gasoline LPG) gaseous LPG or conversion system. IGSystem: it enables the conversion of a continuous gaseous LPG injection in petrol injection engines that are provided with a lambda sensor (oxygen sensor) and three-way catalytic converter. The IGSystem has been designed and developed to integrate with the most recent petrol injection systems. LPG System with SE 81 Step motor regulator and Lambda Control System / 2 for cars with catalytic injection: The SE 81 step-motor reducer is located in the engine compartment. Lambda Control System/2 is a self-adjusting electronic system. LCS/2 electronically manages the gas flow adjustment, allowing the Lambda factor to reach the required value at all engine rpm thanks to two electromechanical actuators. 29

30 LPG System with SE 81 SIC or SE 81 regulator and Lambda Control System V05 for cars with catalytic injection: The air/fuel mixture is constantly kept in a stoichiometric ratio by the LCS-V05 computer that is activated by the signal of the lambda sensor. A linear electromechanical actuator, controlled by the LCS-V05 computer, continuously changes the flow of gas to the engine so as to ensure optimum carburetion in terms of driving, consumption and emissions. The LCS-V05 computer, besides its other functions, allows an engine to start on petrol automatically passing over to gas and, by means of the LCS-V05 switch/gauge, allows the user to select the desired fuel at any time, displaying the level of LPG in the tank. Landi systems for CNG include the following products (apart from the already described Omegas and IGSystem): Natural Gas System with TN1 Step Motor regulator and Lambda Control System/2 for cars with catalytic injection: The TN1/B step-motor reducer is installed in the engine compartment where the pressure of the incoming natural gas is reduced from 220 Bar to the engine supply pressure. The Lambda Control System/2 computer electronically manages the gas flow adjustment, allowing the Lambda factor to reach the required value at all engine rpm thanks to two electromechanical actuators. Natural Gas System with TN1 SIC or TN1 regulator and Lambda Control System V05 for cars with catalytic injection: The air/fuel mixture is constantly maintained at a stoichiometric ratio by the LCS-V05 computer that is activated by the signal from the lambda sensor and continually adapts the rate of flow of gas to engine by means of the linear electromechanical actuator so as to ensure optimum carburation in terms of driving, consumption and emission. The LCS-V05 computer, besides its other functions, always allows starting on petrol automatically and then passes over to gas and, by means of the LCS- V05 switch/gauge, allows the user to select the desired fuel at any time, displaying the level of natural gas in the tank. Figure 36. Landi Renzo LPG System Figure 37. Landi Renzo CNG System Source: Company Presentation Source: Company Presentation 30

31 Relatively well protected by high barriers to entry Over time Landi has built on a series of strengths which have made its position particularly strong in the current competitive environment. Landi Renzo s strengths Strong client relationships These strengths consist of the close relationship with major clients and the higher technology of its products, which result in high safety standards and superior brand value of its products. In terms of its relationship with major clients, Landi has strong relations with all major car manufacturers in the OE segment and with installers in the aftermarket channel. As a supplier of specifically developed gas components for several models of major car manufacturers of the likes of VW, Skoda, Opel, Renault and PSA in Europe, Suzuki, Tata, Daihatsu, Chevrolet, Chery, Brilliance China Automotive and Weichai Perterson in Asia-Pacific, Landi has consolidated relationships with these automotive players, as increasingly they are introducing dual fuel (petrol/gas) vehicles in their product range. This strong presence in the OE channel, which involves developing components for car models in conjunction with car manufacturers before they are launched, also favours Landi in the aftermarket where it is often the first gas kit manufacturer to have developed kits for newly-launched vehicles. This close collaboration with car makers helps Landi in its relationship with installers, which often see its products as more reliable for this reason. Landi s breadth of product range also constitutes a major competitive advantage, as it gives Landi bargaining power vis-à-vis the installer client base over new comer competitors with a more limited product range. Finally, the fact that there are a myriad of different clients in the aftermarket makes it an uphill struggle for competitors wishing to increase their penetration. This is further strengthened by the support Landi supplies its AM clients both in the installation process and also in after-sales, with the introduction of a system of remote assistance, which enables Landi R&D engineers to remotely aid installers in the installation process, reducing installation time and improving accuracy of the newly-installed kits and also after-sales maintenance required on new systems. Focus on technology Landi has 20% of its workforce employed in R&D. This function is responsible for product innovation, product development and more recently (as of the start of 2007) also for product validation. Initially focused in mechanical engineering, since the acquisition of MED Spa in 2001 the R&D function has significantly enhanced its know-how in electronics. MED has extensive experience in electronics through its application in the car alarm business, a business to which it has exposure but that represents a marginal part of the group s business (3% of sales in 2006). 31

32 R&D is mainly based in Italy, within the headquarters of Landi, but also at local branches in those markets in which the group has a manufacturing or a distribution presence, like in Brazil, China, Holland and Poland. The local branches for R&D are mainly responsible for adapting the group s products to comply with the specific requirements of the local/regional market and to harmonise products to the specifics of the local markets as well as give technical assistance to local distributors and installers. The Chinese and Brazilian branches also are responsible for the development of projects specific to the local market s needs. As an example of this, the Chinese branch is working on projects to convert diesel engines to mono-fuel CNG, also on conversion kit applications to hybrid engines as well as on hydrogen projects. The Brazilian branch is working on flexible fuel applications i.e. applications which allow petrol/ethanol engines to work on CNG. This strong focus on Research and Development spending 4% of sales per year on R&D gives its products a high degree of innovation and sophistication. This also makes products more difficult to copy (protected by 41 patents currently), and helps put the group at the cutting edge of technology in this market niche. This technological edge has also allowed Landi to master the whole gas fuel system, making it a system manufacturer as opposed to being a mere manufacturer of components, allowing it to add even more value to its client base, both in the OE and AM. High safety standards Being the only player in the gas kit industry to be certified with the top quality certification ISO/TS 16949, as well as ISO 9001, Landi has the prerequisites to remain a long-term supplier of OE manufacturers. These high quality standards also imply that Landi products abide to the highest safety standards available in the industry. 32

33 Group Strategy Figure 38. Lean business model In a nutshell Landi Renzo s strategy is based on four main pillars. The first is an aggressive focus on product innovation and on research and development, to continuously build on its first comer know-how in this business. The second is to maintain a light manufacturing base, outsourcing the manufacturing of all components and products which are not critical or of high value-added. The third is to maintain control of quality control and purchasing, keeping these in-house despite the strong drive to outsource production. The fourth and final pillar is the coverage of distribution channels, which consists of a strong relationship with OEM s (absorbing 30% of group sales) and a global aftermarket distribution network (absorbing the remaining 70% of sales). Source: Company Presentation Technological leadership Landi s focus on Research and Development helps give its products a high degree of innovation, putting the group at the leading edge of technology in this market niche. Figure 39. Landi Renzo Research and Development Department Number of employees as of April 6, Since January 2007, two new divisions (Hand-book and Testing) have been created in the Technical Assistance and System Applications area. (1) Includes one employee of Landi Renzo operating in China. (2) Includes one employee of Landi Renzo operating in MED. (3) Consultant. Source: Company Presentation 33

34 Figure 40. Landi Renzo Number of Patents and Year of Registration Source: Company Presentation... without sacrificing control over product quality... Industrial district strong in mechanical engineering know-how The R&D department employs 69 of the 396 employees (17% of employees at end April 07) the group has around the world across business functions. On a yearly basis the group spends 4% of sales in R&D (fully expensed at P&L), an amount which has doubled in absolute terms between 2004 and 2006, in line with sales. The R&D function is performed out of five centres in Italy, China, Brazil, Holland and Poland, with the Italian facility representing the coordination centre and the site where the main research effort is made. Light manufacturing base From the outset in the 1950 s, Landi s business has been based on a light production structure, outsourcing all the phases of production of those components and parts which were not considered strategic, choosing to keep inhouse only the manufacturing of those components which were considered to be the heart of the product. Today, thanks to this philosophy, 60% of operating costs are variable in nature, leaving the group with a very flexible cost structure. Aside from the production of key components, the company has also maintained testing and quality control functions internally, thus not sacrificing control over quality despite the high degree of outsourcing. Further on this note, all of Landi s suppliers are required to have quality certifications of the highest standards, and Landi itself is the only player in this segment to have ISO/TS as well as being compliant with ISO 9001 standards. This strategy based on heavy outsourcing of production has been possible thanks to the fact that Landi operates in an industrial district, around Reggio Emilia and Bologna in central Italy, which is extremely rich in mechanical engineering know-how. Indeed, there are a myriad of small shop-houses and factories producing components for the packaging, utensil manufacturing industries. As Landi expands its manufacturing base in other countries, this philosophy is not fully applicable, given the absence of similar industrial districts in the markets where the group has decided to focus its expansion efforts. In countries like Brazil, Iran and Pakistan, Landi s manufacturing base is thus necessarily a more integrated structure, where manufacturing is almost entirely kept in-house, requiring slightly more capital. Nevertheless, the more basic nature of products required by these markets means that the technological level is relatively simpler at the production level and thus far the capital required to set up production sites in these markets has been relatively low: the Pakistani site cost a total of 1m. This outsourcing strategy and the resulting low capex requirement has possibly freed up resources which the group is able to focus on more valuable areas, such as R&D and product innovation, quality control and in building stronger relationships with its customer base both in the OE and AM channels. Indeed, in 2007 and 2008 the group is planning to spend as much as 10m in the R&D function, increasing capacity in Italy and a structure in China to better serve the local OE manufacturers. 34

35 Quality control and purchasing One of the functions over which Landi has maintained strict control, is the quality control function. Managed with 18 employees (5% of group total), the function controls the quality of materials and outsourced components and defines with other departments the parameters of efficiency and effectiveness of processes. Coverage of distribution channels Landi has two main distribution channels, that of the OE where its clients are the automotive manufacturers and the AM where the main counterparts are the distributors and installers. Collaboration with OE clients in new product development AM - emphasis on after sales service The main effort in the OE channel is to develop new products in conjunction with car manufacturers to be employed in bi-fuel vehicles (gas and petrol), which have recently experienced an increase in demand. In the AM channel, Landi Renzo has built an extensive after-sales service centre, where group technicians may be contacted by installers to provide assistance both in the installation phase and in providing the required adjustments. This has been an important competitive edge for the company, particularly in providing assistance in remote areas. Thus aside from having a product range covering the widest number of vehicle models in circulation in any specific market, the key effort in the AM channel for Landi Renzo is to facilitate the installment of gas kits by installers through training to reduce installation time, improve product quality perceived by the end consumer and reduce costs to the installer. Figure 41. Landi Renzo Distribution Channel Source: Company Presentation Strong support to installers On this front, thanks to their strong electronic and technological content, Landi Renzo has just introduced an innovative system in the Brazilian market, due to be rolled out to other main markets. This system allows installers both in the European and more remote end-markets to receive live support in the installation phase from Landi Renzo technicians. 35

36 Figure 42. Remote assistance an important competitive advantage Source: Company Presentation The system provides significant advantages to Landi Renzo clients, improving the accuracy with which its products are set up, but also significantly reducing installation time for products, from about one hour to a mere 15 minutes. This system also presents significant advantages to the Landi Renzo group, providing it with some quality control of how the kits are set up even in remote areas, simultaneously reducing costs of training local installers. Also it helps it to build an important data base with an extensive list of installed vehicles with feedback from installers. It is also an important tool differentiating group products from those of the competition. Landi Renzo s brand-positioning and products The company sells its products to OEMs and in the aftermarket, each representing 30% and 70% of its sales. OEMs include major car manufacturers, such as Renault, Opel, Volkswagen, Suzuki and PSA, which do install factory-fitted systems. New targeted OEMs could include Fiat (FIA.MI ; 2H) and Ford (F.N - US$8.23; 2S). The aftermarket is channeled through independent installers, which are in charge of placing retro-fitting of kits in old vehicles (average time for placing is between 15 days and one month). Landi is operating worldwide through a multi-brand strategy carried by: Landi Renzo is the global brand for CNG and LPG products for OEMs and Aftermarket, in the premium-end of the market; Eurogas is the brand for Western Europe (Benelux-France-UK) for LPG products in both OEM and Aftermarket, in the high-end of the market; Landi is the mass-market brand for Italy and Eastern Europe for aftermarket LPG products. 36