Duerr AG. Highly geared to the emerging markets. Good prospects ahead. Cost base improved. New peak earnings in sight

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1 GERMANY DUE GR Outperform Price 6 Oct month target month TSR % Upside/Downside % 13.6 Valuation - Other GICS sector Capital Goods Market cap m day avg turnover m 0.4 Number shares on issue m Investment fundamentals Year end 31 Dec 2009A 2010E 2011E 2012E Sales revenue m 1, , , ,461.4 EBITDA m EBITDA growth % EBIT m EBIT growth % Reported profit m Adjusted profit m Gross cashflow m CFPS CFPS growth % nmf nmf EPS rep EPS rep growth % nmf nmf 1, PER rep x nmf Total DPS Total div yield % ROA % Equity to assets x Source: FactSet, Macquarie Research, September 2010 (all figures in EUR unless noted) Christian Cohrs Christian.Cohrs@macquarie.com Jean-Michel Belanger Jean-Michel.Belanger@macquarie.com Andrew Carter Andrew.Carter@macquarie.com Beat Fueglistaller Beat.Fueglistaller@macquarie.com Leah Jiang Leah.Jiang@macquarie.com 11 October 2010 A German Emerging Market Investment Initiation of coverage: Outperform; 14% upside potential We set our price target at 25, reflecting the average of pricing indications by several valuation measures, corresponding with a 2012e P/E multiple of 10.5x and EV/EBITDA of 5.4x. A strong player with leading market positions Duerr offers products and services that cover various stages of vehicle production, holding leading positions with approximately 40% world market share for nearly all of its offered business activities. Roughly 80% of the company s topline is generated by the automotive industry. Turn-key paint shops, as well as equipment and systems for automated paint applications, form the core of the business. Highly geared to the emerging markets These accounted for 60% of reported H1/10 group order intake. China represents the company s biggest single market with 20% revenue contribution, which is likely to move towards 30% in the upcoming years. Growth is strong: order intake from emerging markets tripled YTD, boosting group-wide new orders up 45%; sales from China grew by 80%. Good prospects ahead We expect that demand for vehicles in the emerging markets will keep growing by 8 9% in the upcoming years, triggering high investments into new car production facilities. Given its dominating position and strong local presence in these markets, we see Duerr well in place to benefit. Cost base improved Taking 2008 volume levels, we estimate the total cost-saving amount at 25m per annum, consisting of 20 from lower operating expenses (which is also reflected in a strong improvement of gross margins) and another 5m savings coming from this year s refinancing measures. New peak earnings in sight Fuelled by the recent order intake trend, we foresee a revenue increase of 36% between 2009 and In the same period, EBITDA should more than triple, reflecting the leaner cost base and positive operating leverage effects. On the bottom line, we predict a small net profit this year after posting a loss in 2009, followed by strong earnings momentum for the years thereafter. For 2012, we expect Duerr to reach a new earnings peak, with EPS of Our forecast is 18% above current consensus. Upcoming Q3/10 result could mark a turning point The upcoming results release on Nov. 3rd represents a potential near-term trigger. After five consecutive loss-making quarters, we expect Duerr s underlying (excluding any potential one-offs related to refinancing measures) net earnings to re-enter positive territory, marking a turning point and enhancing confidence in our projected growth story. Please refer to the important disclosures and analyst certification on page 2 and the inside back cover of this document, or on our website

2 Inside SWOT Analysis 3 Valuation: Not cheap, but still attractive 4 A business portfolio of market leaders 8 Tailwind from booming markets abroad 10 Strongly improving financials 16 Shareholder structure suggests a higher free float in the mid-term 22 Appendices 24 Company profile Focus on Automotive. Duerr offers products and services that cover various stages of vehicle production. Turn-key paint shops, as well as equipment and systems for automated paint applications, form the core of the business. Roughly 80% of the company s topline is generated by the automotive industry. Duerr serves western OEMs, but has also good ties to the Asian players (ex Japan) e.g. in Korea, India and China. High degree of Internationalisation and a remarkable footprint in emerging markets. Duerr operates 31 production facilities in 21 countries, aiming to maximise the local content in its products. A quarter of the workforce is located in emerging markets, in which nearly 50% of the group s topline is already generated. Due to its excellent positioning (eg, dominating market shares in China for car production-related mass paint shops), Duerr should benefit from the strong vehicle growth expected for these regions. Plant engineering and machinery. Approximately 55% of group revenues are project driven and best characterized as plant engineering. The remaining 45% of revenues represent the machinery business, namely, the construction, sale and service of equipment. The two business activities are in some cases complementary, ie, Duerr is acting as a system provider, especially in the field of paint shops and assembly plants. Business division I: Paint & Assembly Systems (70% of group sales). The spectrum of activities includes planning and realization of mass production paint shops as well as assembly lines, which are mainly for automobile manufacturers and suppliers, but to a smaller extent are also for aircraft construction. The range of products and services rounds off with exhaust-air purification systems for different industries. Business division II: Measuring & Process Systems (30% of group sales). The segment offers equipment and systems for balancing, testing, filling and cleaning. Automotive again represents the most important endmarket, but the aerospace, electrical and power generation industries are also significant end-markets. Large installed base secures high-margin service revenues. Approximately 24% of group sales are generated by the company s service activities. As is the case for other engineering names, we estimate Duerr is generating double-digit margins in this business, positively affected by the sale of spare-parts. The service business is usually less exposed to cyclical ups and downs. Fig 1 DUE GR vs Stoxx600 / Industrials Source: FactSet, Macquarie Research, October 2010 (all figures in EUR unless noted) 11 October

3 SWOT Analysis More Positives than Negatives Fig 2 SWOT analysis Strengths Strong business portfolio with world market leading positions. Well-perceived brand for innovative products, not only in the field of mass painting shops and paint and sealing applications, but also for its remaining business portfolio. Excellent footprint in the emerging markets. High degree of local content in products and services sold. Broad customer base. Strong business ties with nearly all western OEMs but also with new regional players arising in the emerging markets. Low degree of vertical integration, but mostly assembly of parts allows for good operational flexibility. Opportunities Participating in the expected above-average growth in the emerging markets. Improving margins from better geographic balance of production /content in/from high- versus low-cost countries Substantially lower financing costs driven by improved debt level and successful refinancing at better terms. Horizontal expansion: 1) leverage existing customer base and offer additional automotive-related products and services; 2) leverage existing knowhow to develop products and services for nonautomotive related end-markets (e.g. expanding the business field Environmental & Energy ). Source: Macquarie Research; October 2010 Weaknesses Lack of diversification: 1) high dependency on the automotive industry (~ 80% of group revenues); 2) the top five customers make up for ~ 40% of group revenues (and the top ten for ~60%). High financing costs; company rated B with negative outlook by S&P, reflecting risks of the plant engineering business and off-balance obligations. Low free float and small liquidity of Duerr stock Threats Goodwill represents 93% of equity. Accordingly, unexpected write-downs could harm balance sheet s solidity. Increasing price pressure, especially in times of economic slowdown Duerr losing its competitive edge by: 1) alternative / more efficient application procedures for paint and sealing; 2) insufficient protection of intellectual property 11 October

4 We have based our valuation mainly on 2012 estimates. Given the expected momentum and fresh impetus, we regard a focus on 2010 and 2011 as too short-sighted Valuation: Not cheap, but still attractive Price target set at 25 Despite the recent stock-price run, we see some 14% upside potential left. We have based our valuation mainly on our 2012 estimates. Any other approach is too short-sighted and inadequate, in our view, in light of the strong earnings momentum and fresh impetus we expect to see in the upcoming years. The valuation picture derived from several different measures is heterogeneous. The range of indication ranges from the current price level of 22, up to We have taken the average of the various pricing indications, arriving at our target price of 25. Based on 2012 estimates, our target valuation corresponds with a P/E multiple of 10.5x and EV/EBITDA of 5.4x. Fig 3 Overview Pricing indications of various valuation measures Valuation Method Pricing Indication ( ) Comparison with Macquarie Capital Goods Universe >22.0 Comparison with extended Peer Group ~ 22.0 Applying historic P/E >24.0 Price Book Ratio vs. Cost and Return Equity 24.9 EV/CE vs. ROCE/WACC 28.5 Perpetuity Growth Model 27.7 Price target set at 25.0 Source: Macquarie Research, October 2010 Comparison of actual multiples does not deliver a consistent picture Attractive or fairly priced?!? While a comparison of 2012e multiples with our Macquarie Pan European Mechanicals universe indicates upside, Duerr stock looks rather adequately priced when benchmarking versus an extended peer group of small- and mid-caps. Both the market cap-weighted mean as well as the median of our Pan European Mechanicals universe are above current valuation multiples of Duerr. However, when double-checking this result versus an extended peer group of small- and mid-caps (with a focus on automotive, plant engineering or automation/robots), we derived a different result. In comparison to these names, Duerr stock seems to be rather fairly priced. Aside from this contradiction, we see another issue that stops us from drawing a useful conclusion: The multiples in both comparison groups differ, with quite a large variance. Fig 4 Valuation Pan-European mechanicals Company Rec 1 Price Upside/ Period Local Price Mkt Cap EV 2 /Sales EV/EBITDA 3 EV/EBITA 4 PER 5 Dividend Yield (%) Target D'side End Date FX EUR 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E 2010E 2011E 2012E Pan European Mechanicals Bucher Industries N (2%) Dec-10 CHF , Burckhardt Compression * O % Mar-10 CHF Cookson O % Dec-10 GBP , Demag Cranes U 22.0 (26%) Sep-10 EUR GEA Group N % Dec-10 EUR , Georg Fischer O % Dec-10 CHF , Morgan Crucible N % Dec-10 GBP Rheinmetall O % Dec-10 EUR , Rieter Holding U % Dec-10 CHF Sulzer O % Dec-10 CHF , Tognum N 15.0 (6%) Dec-10 EUR , Vossloh U 70.0 (14%) Dec-10 EUR , Mkt cap weighted mean 18, ^ 11.6^ 9.8^ Median O % Dec-10 EUR Source: Macquarie Research, October 2010; prices as of 6 October October

5 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 P/E multiple Expected EPS growth P/E multiple Expected EPS growth Macquarie Research Fig 5 Comparison with the extended peer group (consensus based) 10/7/2010 Currency Share Market Cap EV/Sales* EV/EBITDA* EBITDA EV/EBIT* EBIT PER** EPS price (Euro m) CAGR 10-12e CAGR 10-12e CAGR 10-12e ElringKlinger AG EUR , % % % Faurecia S.A. EUR , % % % Komax Holding AG CHF % % % Leoni AG EUR % % % Valeo S.A. EUR , % % % Georg Fischer AG CHF , % % % Rieter Holding AG CHF % % % KUKA AG EUR % % Average % % % Mkt cap weighted mean 9, % % % Median % % % DUERR AG EUR % % % * Sales, EBITDA, EBIT, Earnings and Dividends calendarized; **Mkt-weighted P/E mean calculated using earnings yields (1/PER); for stock-related data for the companies mentioned in the table above, please check the appendix. Prices as of 6 October 2010 Source: FactSet; Macquarie Research, October 2010 Historical multiples indicate a P/E of >10x Given the company s substantial reduction of financing costs, future EV/EBITDA should be higher than in the past Pricing indication: more than 24. Relative to other companies in our universe, we also see for the Duerr stock a strong correlation in the trading history between the multiple and corresponding earnings growth expectations. The four charts below illustrate the historical trend for the P/E and EV/EBITDA multiples on an NTM (Next-Twelve-Months) and STM (Second-Twelve-Months) basis. The growth axis reflects the earnings expectations for STM, divided by earnings estimates NTM, minus one. The company s historical average STM P/E stands at 10.1x. If we apply this multiple to our 2012e EPS forecast, we come up with a price indication of 24. However, since earnings growth for Duerr in the upcoming years are expected to be higher than ever, this should allow for an even higher multiple, in our view. At first glance, our conclusion derived on an historical P/E basis does not match with the historical EV/EBITDA trend. At a price level of 24, the stock would trade at a 2012e multiple of 5.2x, which compares with an historical average of 4.8x. However, it should be taken into account that Duerr has made substantial progress this year to lower its financing costs. Hence, the conversion rate of EBITDA into net profit will improve, to an expected level of 46% in 2012 from 37% in Against this background, future EV/EBITDA multiples should be higher than in the past. Fig 6 Trend in P/E NTM (average of 15.1x) Fig 7 Trend in P/E STM (average of 10.1x) 27 90% 24 90% % 70% 60% 50% 40% 30% 20% 10% 0% % 70% 60% 50% 40% 30% 20% 10% 0% 3-10% 3-10% Expected EPS grow th P/E NTM Expected EPS grow th P/E STM Source: FactSet, Macquarie Research, October 2010 Source: FactSet, Macquarie Research, October October

6 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 EV/EBITDA multiple Expected EBITDA growth EV/EBITDA multiple Expected EBITDA growth Macquarie Research Fig 8 Trend in EV/EBITDA NTM (average of 5.8x) Fig 9 Trend in EV/EBITDA STM (average of 4.8x) 9 Historic EV/EBITDA vs. EBITDA grow th 40% 7 40% % 6 30% 6 20% 5 20% 5 10% 4 10% 4 3 0% 3 0% 2-10% 2-10% Expected EBITDA grow th EV/EBITDA NTM Expected EBITDA grow th EV/EBITDA STM Source: FactSet, Macquarie Research, October 2010 Source: FactSet, Macquarie Research, October 2010 NAV multiples propose a valuation range of 24.9 to 28.5 Given positive EVA, the company should be priced with a premium The company is currently trading on no more than its 2012e book levels. Price-book and EV/CE multiples come to only 1x, despite generating a premium on its capital costs. Applying a beta of 1.2, a market premium of 5% and a risk-free interest rate of 4%, we derive 10% for the costs of equity. Return on equity should substantially rise over the coming quarters, in the course of the expected business pick-up. For 2012e, we predict an ROE of 11.6%, ie, generating a 16% premium on the costs of equity. Translating this into a price-book multiplier, we come up with a price indication for Duerr of Using the same methodology on a ROCE/WACC vs. EV/CE basis and applying costs of debt of 7.5% propose a fair valuation at Cashflow model suggests strong upside Our model is styled conservatively Our perpetuity growth model indicates a fair value of Regarding the calculation of the cost of capital, please refer to our comments on the paragraph above. We have based our model on an FCF (to entity) forecast that is based on a rather conservative assumption: Our sales input reflects the average of the years 2011 and EBIT margin of 4.4% is well below the expected 2012 level of 5% and management s midterm target of 6%. As for our other companies and in order to remain consistent, we have assumed capex spending of 10% above the D&A level. In the case of Duerr, this comes to a rather unlikely figure of 22m (capex is usually in the 15 18m corridor). As for most other companies in our sample, we have applied a perpetuity growth rate on the derived FCF-to-entity of 2%. 11 October

7 Fig 10 Fair Value of 27.7 derived in our perpetuity model ( m) ( m) Costs of Equity (%) 10.0% Costs of Debt (%) 7.5% Costs of Debt after Tax (%) 5.5% WAAC (%) 9.2% Growth (%) 2.0% Perp. Model Sales 1,412 Perp. Model EBITDA margin 5.7% Perp. Model D&A in % of Sales 1.3% Tax rate (%) 27.0% NOPAT 45 Add D&A 19 Minus Capex (D&A +10%) -22 FCF to entity 42 EV = [FCF / [WACC - Growth]] 584 Minus Pensions & Net Debt -102 Minus Minorities (BV) -7 Add Financial Investments 5 FV Equity 479 FV per share ( ) 27.7 Source: Macquarie Research, October October

8 Share of group sales Macquarie Research A business portfolio of market leaders Fig 11 Overview Business activities and divisional split-up 100% 90% 80% Measuring & Process Systems Division ~ 30% Cleaning and Filtration Balancing & Assembly Machinery ~ 45% 70% 60% 50% Application Technology Aircraft & Technology Environmental & Energy 40% 30% 20% Paint & Assembly Systems Division ~ 70% Paint & Final Assembly Plant Engineering ~ 55% 10% 0% Source: Macquarie Research, October 2010 Paint & Assembly Systems The dominating division Afraid of plant engineering business? You do not have to be! ~40% world market share ~50% world market share Mainly plant engineering but better than you might initially think. The division accounts for approximately 70% of group sales. The relevant end-market is the automotive industry and their suppliers. The bulk of activities are characterized as plant engineering. We know about the general prejudices, but we really do think the business is better than one might think at first glance: As we will highlight in the financial section in more detail, 1) the business capital intensity is lower than in the machinery activities of the company, as it is mainly the assembly of pre-manufactured products (though partially coming from Duerr machinery activities); 2) there is a high share of prepayments made by the customers (otherwise group working capital would not be on the current extremely low level); and 3) even in the pre- Lehman crisis, there were virtually no cancellations of orders. The division consists of four units: Paint & Final Assembly The bread-and-butter business: We regard these plant engineering activities as the company s bread-and-butter business, generating nearly 50% of group-wide revenues. The business focus is on turn-key (mass) painting shops and assembly lines for the automotive industry. The company usually takes over responsibility for the complete project from planning to realisation. Duerr s world market share is ~ 40%; its main competitors are the German company Eisenmann (20%) and Taikisha (13%), which hold strong positions in Japan. Application Technology A key supplier internally and externally: We estimate the revenue contribution to be approximately 15% of group sales. The business unit is producing state-of-the art equipment / robots for the automated paint and sealing applications (hence, it has not a plant engineering but a machinery nature). The activities are strongly linked with the Paint & Final Assembly activities described above, ie, the Application Technology supplies the equipment for the turn-key painting shops. Duerr s world market share is ~ 50%; its main competitors are ABB and Fanuc (with roughly 20% market share each). German company Kuka, which is also focused on robots, is not active in this particular business field. Instead, Kuka is a supplier for Duerr, as its robots form the platform for Duerr s sealing equipment. 11 October

9 ~30% world market share; potential subject of M&A Making some additional money with existing knowhow Environmental & Energy Focused on the Chemical and Pharmaceutical industry: The revenue contribution comes to around 90m. Originally, this unit s activities were focused on the automotive industry for the removal and treatment of exhaust air but, meanwhile, 80% of the revenues are mainly generated from the chemical and pharmaceutical industry although other industries could follow, in our view. Management has stated its intent to broaden and expand this business and, hence, we do not rule out minor M&A transactions that could either enhance Duerr s technologic know-how or that allow access to new clients and sectors. Duerr s world market share so far is ~ 30%; its main competitor is John Zink/KEU (20% market share). Aircraft & Technologies Leveraging existing know-how: The smallest business unit achieves annual revenues of around 35m, providing paint and assembly solutions for the aviation industry. Due to a lower annual volume output of aircrafts (compared to vehicles), the automation intensity in the production is substantially lower than that in the automotive industry, but is constantly increasing. This offers growing business prospects for Duerr, which can leverage its know-how from the remaining units. The market is substantially more fragmented than for the preceding activities, with no player having a share of more than 10%. Measuring & Process Systems (Partially) nice add-on Higher operating margin, but also more capital intense Possible downsizing mid-term 25-40% world market share ~30% world market share, possibly for sale mid-term We regard this as non-core Machinery business with low level of vertical integration. The division accounts for approximately 30% of group sales, consisting solely of machinery activities. Hence, while being more capital-intensive than plant engineering, the division s operating margin is usually higher. Nevertheless, taking historical sales and operating earnings figures into the equation, we calculate a high share of variable costs (~70%) and a low fixed-cost basis, pointing towards low vertical integration and, accordingly, good flexibility on the cost side in case some unforeseen happens. The divisional picture is two-fold. The division consists of three units, of which just two are running very well, and we do not rule out a mid-term downsizing of this segment if opportunities arise. The amount of the potential divestment proceeds is difficult to evaluate at present but, assuming a total sales volume (of those activities that could be divested) of around 160m, an operating margin of 4 5% and a transaction multiple of 5 6x, we calculate a range of 30 50m. Balancing & Assembly Products Good value contribution. There are two main pillars: 1) balancing and diagnostic products and systems for various industries (automotive, aerospace, energy); and 2) end-of-line testing and filling systems for the automobile production. In total, the business unit generates revenues of around 190m and is strongly value-accretive, according to management. Duerr s world market share is ~40% for balancing (main competitor Kokusai with 15%), ~30% for testing (main competitor BEP with 20%) and ~25% for filling (main competitor Cinetic with 22%). Cleaning & Filtration Systems Restructuring and divesting thereafter? The business unit has an annual sales contribution of roughly 150m. It offers products for industrial cleaning and filtration processes. Automotive represents an important endmarket, but the electronic and aerospace industries are also significant end-markets. Duerr is the leading provider in this business field, with 30% market share (competitors Harry Major with 15%; Technofirma with 12%). Operating earnings /losses of this unit are not disclosed, but management stated that these were not satisfactory and that the restructuring initiated last year is on track. Mid-term, if the price is right and businesses with a better fit to the remaining Duerr activities are available, we do not rule out a divestment of this unit. However, such a move has not been indicated so far by management. Schenck Technologie-und Industriepark Also possibly for sale: This property service provider recorded 14m sales last year, half of which was from rental income. According to management, it is generating a good return on capital. Nevertheless, we regard this business as truly non-core and we expect a divestment once a suitable buyer comes up. 11 October

10 Tailwind from booming markets abroad Emerging markets record high rise in vehicle sales The growth story continues ~8 9% light-vehicle sales growth pa in the emerging markets We forecast a disproportionate rise in vehicle sales for the emerging markets. According to our global light-vehicle sales forecast (please be aware that it can differ from forecasts on production numbers), strong growth in the emerging markets will continue in the upcoming years. Albeit at a slower pace than in 2010, light vehicles will still clearly outperform versus the developed markets. In 2013, we estimate a share of 56.4% of all light vehicles sold in the emerging markets, up 3pp versus the projected level for We expect Russia and Eastern Europe to post the strongest momentum, but in absolute numbers China will contribute most to this performance. Due to the size and importance of the Chinese car market, we will dig deeper into it. Fig 12 Macquarie global light-vehicle sales estimates '000 units 2008 % YoY 2009 % YoY 2010e % YoY 2011e % YoY 2012e % YoY 2013e % YoY US 13, % 10, % 11, % 13, % 14, % 14, % Japan 4, % 4, % 4, % 4, % 4, % 4, % Germany 3, % 3, % 2, % 3, % 3, % 3, % France 2, % 2, % 2, % 2, % 2, % 2, % Italy 2, % 2, % 2, % 1, % 2, % 2, % UK 2, % 2, % 2, % 1, % 1, % 2, % Spain 1, % % 1, % % 1, % 1, % Other W. Europe 3, % 2, % 2, % 3, % 3, % 3, % Western Europe 15, % 14, % 13, % 13, % 13, % 14, % Other developed 2, % 2, % 2, % 2, % 2, % 2, % All developed markets 36, % 31, % 32, % 33, % 34, % 36, % Russia 2, % 1, % 1, % 1, % 2, % 2, % Other Eastern Europe 2, % 1, % 1, % 1, % 2, % 2, % Europe 20, % 17, % 16, % 16, % 17, % 19, % China 8, % 12, % 15, % 17, % 18, % 20, % S Korea 1, % 1, % 1, % 1, % 1, % 1, % India 1, % 2, % 2, % 2, % 2, % 3, % Other Asia 2, % 2, % 2, % 3, % 3, % 3, % Total Asia (ex Japan) 13, % 18, % 22, % 24, % 26, % 28, % Brazil 2, % 3, % 3, % 3, % 3, % 3, % Other ex-asia 8, % 7, % 8, % 8, % 9, % 9, % Other emerging markets 10, % 10, % 11, % 11, % 12, % 13, % All emerging markets 30, % 32, % 36, % 40, % 43, % 47, % Global light vehicle sales 66, % 64, % 68, % 73, % 78, % 83, % Source: Autodata, ACEA, JD Power, JAMA, KAMA, SAIM, CAAM, Macquarie Research, October 2010 In this chapter, we have taken several extracts from Leah Jiang s chart book: China Autos snapshot of an emerging giant thanks mate! Digging deeper into the China story 11% CAGR ( ) for private vehicle sales China is by now the largest single vehicle market in the world and clearly the place to be when doing business in automotive. With total vehicle sales having grown with an impressive CAGR of 22% since 1998, China has become the biggest single car market these days, with expected full-year 2010 light-vehicle sales of more than 15.5m units (representing more than 22% of the worldwide market), substantially ahead of the US (11.5m) and Western Europe (13.5m). Given the market s growth prospects, in combination with the size it has already reached, China is the place to be for those who do business in automotive, in our view. 11 October

11 A low rate of vehicle penetration so far reveals the significant customer potential that is still left Despite the recent volume hike, China s vehicle penetration is still on a low level, revealing the significant potential for future growth. Overall vehicle penetration remains very low in China (32 vehicles per 1,000 inhabitants in 2009) relative to developed countries (464 in Japan, 508 in Europe and 794 in the US) and even relative to some developing countries (eg, 108 in Brazil, 233 in Russia). The table below shows the differences between regional car markets in the world and the growth potential in China, as wealth and income levels rise. China has about four times the population of the Eurozone but only one-third of its GDP. As a result, GDP per capita is extremely low, reaching only about 8% of the level in Euroland and 40% of the level reported for Brazil. The charts below reveal a high correlation between vehicle penetration, vehicle sales per 1,000 inhabitants and GDP per capita. Fig 13 Economic data comparison 2009 Population (m) Surface Area (sqkm tsd) GDP ($bn) GDP per Capita Roadways tsd km PV ownership per 1,000 inhabitants China 1,325 9,598 4,327 3,266 1, India 1,140 3,287 1,159 1,017 3, Brazil 192 8,515 1,575 8,205 1, Russia ,098 1,679 11, USA 304 9,632 14,093 46,350 6, Japan ,911 38,456 1, Korea , Europe (Euroland) 326 2,583 13,582 41,654 3, China in % of Euroland 406% 372% 32% 8% 54% 6% China in % of Brazil 690% 113% 275% 40% 110% 30% Source: World Bank, JD Power, CAAM, Macquarie Research, October 2010 Fig 14 Vehicle penetration vs GDP per capita 2009 Fig 15 Vehicle sales vs GDP per capita PV/1,000 Inhabitants China India Brazil China 2015E Russia Korea R2 = 0.93 Japan Europe USA 0 10,000 20,000 30,000 40,000 50,000 $ GDP per Capita Source: World Bank, J.D. Power, Macquarie Research, October 2010 Source: World Bank, J.D. Power, Macquarie Research, October China 2015E PV Sales / 1,000 Inhabitants India China Brazil Russia Korea R2 = 0.87 Japan Europe USA 0 10,000 20,000 30,000 40,000 50,000 $ GDP per Capita Base-case scenario reveals 11% CAGR for e personal vehicle sales We see good likelihood of double-digit growth for several more years. In the table below, we have calculated various scenarios for the Chinese vehicle parc, depending on the car ownership percentage of households with a double income above US$6,000. We consider a household income of around US$6,000 as the threshold where people are able to afford to purchase a car for the first time. In the base case of our affordability model, we estimate that the personal-vehicle (PV) parc could increase 66% to 71m in the next five years from 42m in 2009, by assuming 7.5% income CAGR. This implies PV penetration of 53 units per 1,000 inhabitants, which is still well below the world average. Taking fleet expansion and replacement demand together, this leads us to an 11% CAGR for PV sales in the next five years. 11 October

12 Fig 16 Projection of PV ownership in China in the next five years, driven by rising income PV ownership in 2009 PV penetration per 1,000 inhabitants in 2009 Income CAGR assumption ( ) Population >US$6,000 income in 2014 (m) Assumption of % vehicle ownership of population with US$6,000 income in 2014 PV ownership in 2014 (m) Implied CAGR of PV sales ( ) Implied PV penetration per 1,000 inhabitants Base case % % 71 11% 53 Best case % % 94 17% 71 Worst % % 56 6% 42 Note: We use US$6,000 as disposal income threshold to measure whether a double-income family is able to afford a car. Source: CAAM, NBS, Macquarie Research, October 2010 boosting demand for new production capacity Annual sales of the project business (construction of paint shops) possibly up 40% from current levels Maximizing the revenue potential from the installed base Duerr s capacity projection looks reasonable to us Duerr calculates a total global demand (expansion and replacement) of 73 new production sites, with a capacity of ~ units each until All of these usually need a paint shop. Translating this figure into potential sales gives some colour on the prospects for the upcoming years in Duerr s project business, which usually represents 25 35% of group sales (the remainder are base orders with below 20m sales volume). The selling price for a mass painting shop is between 40m (low-end) and 80m (high-end), on top of which another 25% of selling price should be added for the application robots made by Duerr. Hence, applying a weighted (more low- than high-end demand) average of 65m per shop, we come up with a total revenue potential of more than 4.7bn. Assuming Duerr manages to keep its current market share of 40 50% constant, this translates into a prospective sales volume for Duerr of around 2.1bn within five years, ergo 500m pa. At present, the project business should not deliver more than 350m in sales. Hence, the delta is more than 40%. Positive follow-up and side effects. A higher car production capacity should also have positive effects on the demand for Duerr s products besides painting, namely, equipment and products for sealing, balancing, diagnostics and cleaning. Also, a larger installed base usually allows for more service revenues and after-sales business. The need for production capacity will be highest in the emerging markets. Duerr forecasts a demand for 47 new sites between 2010 and 2014, translating into a production capacity of 11.8m units. This forecast looks reasonable, when comparing this figure with our global light-vehicle sales scenario, which forecasts 47.2m units sold in Taking a simplistic approach and adding 4% for 2014 (yet no detailed and official forecast available), this figure would come to 49.1m, which translates into 12.3m more vehicles sold than in The table below lists some selective capacity expansion plans in China, which add up to extra capacity of around 5m units already. Fig 17 Selected capacity expansion plans in China Car maker Capacity expansion details BYD Local 200,000 expansion by 2010-end Chery Local Up to 700,000 expansion, from three all-new plants Fiat Foreign Market entry with new 300,000 plant by 2014 (JV with Guangzhou Auto) FAW Local All-new 200,000 plant by 2012 Ford Foreign Expansion of Chongqing plant to 600,000 units Geely Local Plans to build four all-new plants GM Foreign 210,000 expansion of light-truck capacity Great Wall Local Up to 600,000 units in new Tianjin factory Guangzhou Auto Local New own-brand plant to produce 100,000 initially, 200,000 later Honda Foreign 120,000 expansion in Guangqi-Honda JV and 240,000 expansion in Dongfeng-Honda JV Hyundai Foreign Expected imminent plan for third assembly plant, 300,000 capacity Nissan Foreign 240,000-unit of new plant, for planned completion early-2012 PSA Peugeot Citroen Foreign Third factory planned with capacity of 200, ,000 (JV with Dongfeng) PSA Peugeot Citroen Foreign Second JV with Chang'An Automotive with further 200,000 capacity Toyota Foreign Incremental additions adding 140,000 units by 2011 VW Foreign Announced two all-new plants plus an expansion of existing plans For stock-related data for the companies mentioned in table above, please check the appendix. Source: CAAM, Company data, Macquarie Research, October October

13 Capex spending in m Macquarie Research The capex forecasts of our automobile analysts suggest growing investment activity also in the mature markets Besides the new capacities in the emerging markets, we should also see some replacement and refurbishment investments in the mature economies. In the chart below, we have added up the projected spending into property, plant and equipment of some European car makers we have under coverage (please check the appendix for stock-related information). While all players reduced their capex during 2009 (for the below sample, we calculate an average cut of 24%), investment spending started to recover this year. Adding up the expected 2012 capex levels for our manufacturers selection below, we derive a CAGR e of 11%. Please note that this figure does not include the capacity investments in China, since these are usually done by JV companies, which are in most cases solely consolidated at equity. Hence, we regard the outcome of this calculation rather as an indicator that investment activity of the automotive sector is not only dedicated to the emerging but also to the mature markets. Fig 18 Adding up expected capex spending of selected car manufacturers 24,000 20,000 CAGR e: +11% 16,000 12,000 8,000 4, e 2011e 2012e Volksw agen Daimler Fiat BMW Renault PSA Group For stock-related data for the companies mentioned in the chart above, please check the appendix. Source: Macquarie Research, October 2010 and fueling order and sales momentum for Duerr already YTD performance was good Order intake figures from emerging markets tripled in the first half of 2010, accounting now for 60% of the company s order intake YTD. In H1/09, the order intake share of emerging markets was around 30%; hence, this year s strong increase is not just a nice headline derived from a low-base effect but actually reflects a substantial sales volume in absolute terms. In contrast, the order flow from mature markets was down 20%. 11 October

14 Revenues from China in m Share in Group Revenues in % Order intake in H1 in m Macquarie Research Fig 19 Order intake split H1/2010: Emerging Markets take the lead Fig 20 Group order intake growth of +45% in H1/10 solely driven by Emerging Markets Emerging Markets: +199% YoY ~ 61% share of incoming orders Mature Markets 39% Emerging Markets 61% H1/2009 H1/2010 Mature Markets Emerging Markets Source: Company data, Macquarie Research, October 2010 Source: Company data, Macquarie Research, October 2010 China grabs the pole position in terms of absolute revenue contribution China has already caught up with Duerr s home market. China, whose sales contribution rose more than 80% YTD, and Germany both account for approximately 20% of group revenues at present. However, taking the current momentum as well as the geographic order split into account (which should feed through to sales within months), this tie is unlikely to last for long. We expect China s rapid growth of importance to continue, and the company should soon have the pole position, not only in terms of growth but also in terms of absolute revenue contribution. For 2011, Duerr management forecasts for China a revenue share of around 27%, which we regard as highly probable. Taking this in the context of our estimates, sales from China are growing by a CAGR of ~68% in the years e. Fig 21 Geographic sales split H1/10: China s piece of the pie Fig 22 is getting bigger and bigger China 20% Germany 20% e CAGR for Chinese sales ~ 68% 23% 27% 30% 25% % Asia ex China 11% % % 10% 100 Europe ex Germany 25% % North and South America 24% e 2011e China Share in Group Revenues 0% Source: Company data, Macquarie Research, October 2010 Source: Company data, Macquarie Research, October 2010 Dominating market positions in China, India, Mexico and Brazil Be global, act local! Taking into account the company s global market share in the range of 40 50% for mass painting shops and given that a) the market share of Duerr in Europe and North America is no more than 40% and b) there is nearly no business in Japan, we conclude that the company must have more than 50% share and, hence, dominating positions in its remaining markets, namely, China, India, Mexico and Brazil. We see two major reasons why the company successfully participated in the upswing so far and why we think it is likely to continue. Both refer to the company s local presence: 11 October

15 Local flavour helps to attract important local customers in fragmented markets A quarter of Duerr s workforce is located in emerging markets. At present, Duerr operates 31 production facilities in 21 countries. The company also operates several engineering offices. Expansion was focused not only in its home market Europe but also on the emerging markets, which incorporate one-quarter of the company s total workforce at present. This move was not only driven by lower labour costs but also reflects the growing demand of these markets and the company s intention to maximise the degree of local content. Strong ties with local players. Aside from the traditional Western OEM s, Duerr also enjoys good relations with the new players arising in the emerging markets (eg, SAIC, FAW and Changan [all China] or Tata [India]). Given that emerging markets are usually more fragmented, we regard good ties to local players as important, as they present a major share. The importance of local players is illustrated in the two charts below, giving some colour on the structure of the Chinese car market. Main takeaways: a) domestic, local brands account for 40% of total PV sales volume, followed by Japanese, American, European and Korean brands; b) when including minibus assemblers, the top 10 OEMs accounted for only 59% market share; thus, the Chinese auto market is still in the early stages of consolidation. Fig 23 Fragmented market Share of top 10 OEMs in China (PV including minibus, 2009) Fig 24 Mostly locals Share by origins of OEMs in China (PV including minibus, 2009) SAIC GM Wuling 10% SAIC VW 7% European 14% Korean 8% Others 41% SAIC GM 7% Chinese 40% FAW VW 6% Changan Autos 6% US 19% FAW Toyota 4% BYD 4% Chery 5% Dongfeng Nissan 5% For stock-related data for the companies mentioned in the chart above, please check the appendix. Source: CAAM, Macquarie Research, October 2010 BAIC Hyundai 5% Japanese 19% 0% Source: CAAM, Macquarie Research, October October

16 1,078 1,185 1,187 Group Order Intake and Revenues in m 1,361 1,362 1,460 1,477 1,464 1,437 1,480 1,461 1,603 1,554 1,782 EPS (continuing operations) in Macquarie Research 2012e: New earnings peak in sight Strongly improving financials A leaner cost base, operating leverage in the course of higher topline and better financing costs drive earnings We forecast a turnaround for 2010 and a strong earnings momentum thereafter. After posting loss in 2009, we expect the company to return into the profit zone these days as the recovery of order intake that we have seen since mid-2009 should now start to materialize into rising sales figures (our group sales forecast for H2/10 is 29% above the H1 level), feeding partially through to the company s bottom line. For full-year 2010, we predict a slight profit. However, earnings momentum should gain speed in 2011 before reaching a new peak level in Fig 25 Revenues follow order intake with approximately one year delay Fig 26 Out of the dark, into the light; from loss making to peak earnings 1,800 1, , ,500 1,400 1, , , , e 2011e 2012e order intake revenues e 2011e 2012e Source: Company data, Macquarie Research, October 2010 Source: Company data, Macquarie Research, October 2010 Our estimates and assumptions in more detail: This year s order intake is backing our predicted sales swing Top-line and order intake: We foresee a revenue swing of 380m (+36%) between 2009 and We regard sales as a function of order intake. The latter is likely to grow by around 20% and exceed the 1.4bn mark this year, providing a strong backing for our sales forecast of 1.46bn sales in With respect to the future order intake trend, we do not expect that the momentum of the current year will persist. However, against the background of growing capex plans of several automotive manufacturers, the prospects for Duerr should remain solid. Hence, we regard our projected growth rates of 3% and 5% for respective order intake in 2011 and 2012 as rather conservative. No major impact from FX and raw material prices. We have set the average USD/EUR exchange rate at 1.30 for 2010 and the years going forward. FX changes have mostly only translation effects, due to a high content of local products. Direct and indirect (via pegged currencies) USD exposure is smaller than the H1/10 revenue split of 44% (adding China, South and North America) suggests, since Duerr tries to contract in EUR terms whenever possible. Windfall gains or losses related to FX but also material prices play a minor role: Shortly after winning a contract, Duerr usually orders the necessary pre-manufactured goods. 11 October

17 in % of group sales Macquarie Research After a strong improvement in 2009, the gross margin will take a short dip but recover in 2012 Leaner cost base helps profitability. The company s history has not always been bright. Weak profitability and earnings creation at the start of the millennium resulted in a comprehensive review of strategy and processes (the so called Focus and Duerr 2010 programs). These are finalized by now. As a result, we regard the actual cost base to be more efficient (lower level of vertical integration, higher local content [often for a better price], homogeny of IT around the globe). The benefits can also be seen in the improved gross margin of 20.5% in 2009 (this compares with ~16% gross margin during and 17.8% in 2008), which we expect the company to achieve again in In the meantime, we expect profitability to suffer a bit, since we assume that Duerr was rather price-aggressive when pitching for orders during the early days of the current economic upswing. These orders should soon start to materialize into sales. Given the refilled order book (current backlog comes to 1.26bn, which compares with a low point of 0.82bn in Q1/09), aggressive pricing should be no issue at present. What is more, support for the profitability should also come from the high-margin service activities, whose revenue share should gradually move up from the present ~24% towards 30% in the course of the economic pick-up (more maintenance and service necessary when vehicle production numbers rise). Fig 27 Trend in costs: From gross to net margin 25% 20% 15% 17.8% 5.4% 20.5% 7.2% 19.6% 19.8% 6.6% 5.9% 20.8% 5.7% 10% 6.1% 8.7% 8.2% 8.0% 7.9% 5% 0% 1.6% 2.4% -0.1% 1.8% 1.6% 0.8% 1.8% 2.1% 1.3% -2.4% 2.2% 1.8% 0.2% 0.6% 0.2% 2.1% 1.2% 1.7% 0.1% 0.7% 2.1% 1.0% 2.9% 0.1% 1.1% -5% e 2011e 2012e Net margin Taxes in % of sales Financing in % of sales Other in % of sales R&D in % of sales Selling in % of sales G&A in % of sales Gross margin Source: Company data, Macquarie Research, October 2010 Successful launch of promissory note at more favourable terms Tax rate <30% as of 2011 Financing will be substantially reduced as of next year. While not all refinancing measures are yet completed (negotiations with the bank are ongoing), the most important step is done: Duerr has successfully raised new funds of 150m by launching a promissory note (maturity to 2015) with a coupon of 7.25%. The proceeds will be used for an early redemption of an outstanding bond ( 100m; 9.75% coupon) and also allow for a lower revolving loan ( 180m at present), which has been quite pricey so far, with Euribor +6.25%). Besides any extraordinary refinancing costs, we assume net financing expenses in 2011 to come down by 4.6m. Tax rate will come down. As of next year, the tax rate should return to the levels below 30%. In 2009 and in 2010 so far, tax expenses were excessively high, driven by an unfavourable country mix, as losses in Europe and the US could not offset the tax burden in emerging markets, where Duerr generated profits. We expect both business divisions to contribute to the favourable group development. However, due to its size, the incremental earnings improvement of the Paint & Assembly division is way more crucial for a successful turnaround. 11 October