May 16, 2021

Is Muehlan hiding a promising renewable energy treasure?

Even inveterate fans of German small caps are not necessarily familiar with the Muehlhan Group (XTRA: M4N). First of all, the market cap of ca. 50m EUR is not only tiny but also limited in liquidity, as more than 50% of the shares are still held by related parties of the founder Wulf-Dieter Greverath and the current management. In addition, as a cyclical industrial services provider, the company is not a safe bet for e.g. dividend investors. Moreover, a significant part of the business is related to the oil & gas business (especially offshore), which is why the share was excluded from the outset by many - be it for ESG criteria or fear of the volatility of the oil price. However, that is something that is changing right now and hence I decided to dive a little deeper into the business... 


Why bother?

As mentioned before, Muehlhan is currently shifting some priorities. In fact, the company came out on January 27, 2021 with a press release stating that they are planning to sell the oil and gas activities and that they have already mandated an investment bank. While the timing to sell such assets might not be perfect right now, it could definitely be worse in the last 12 months. Here's the full press release:

Hamburg, January 27, 2021—As part of a strategic review of its business segments, the Muehlhan Group (Muehlhan AG; Open Market; ISIN DE000A0KD0F7) is planning to sell its oil and gas activities. In the future, the company will focus exclusively on business segments in which the Group holds a market-leading position. This includes the offshore wind power segment, which is experiencing dynamic growth, the vessel market and the infrastructure business. Muehlhan will use the resources freed up by the sale to further expand its market position in these areas. [...]

After reading the press release for a second time, I tumbled about the last sentence. What, if that is more than just a general phrase? Let's have a closer look at the business operations of Muehlhan.


Muehlhan - The Business 

In general, the Hamburg-based industrial service provider does everything related to corrosion protection, fire protection, hot and cold insulation, access technology, steel construction, and scaffolding. The business is divided into four operating segments:
  1. Oil & Gas – 23% Rev.-Share (2020), 0.5% EBIT-Margin: Muehlhan is active both in offshore and downstream Oil & Gas, providing construction activities for oil drilling platforms and refineries, LNG plants, and tank farms => This is the business up for sale
  2. Ship – 25% Rev.-Share, 5.5% EBIT-Margin: Within the maritime division, Muehlhan provides surface corrosion protection for both new shipbuilding and repairs and is also active in scaffolding.
  3. Industry & Infrastructure – 27% Rev.-Share, (6.0%) EBIT-Margin: In the industrial segment, Muehlhan is mainly active in thermal, cryogenic, and acoustic insulation as well as in steel construction, passive fire protection, and also in related training, engineering and inspection services.
  4. Renewables – 24% Rev.-Share, 9.6% EBIT-Margin: The renewables segment consists mainly of Muehlhan Wind Service, a leading full-scope contractor and supplier of wind turbine technicians as well as Installation- and Service solutions. The activities of the company are in the field of mechanical works, painting and surface treatment, blade works, and electrical and high voltage works.

Historically, the firm has its roots in the shipping business. In recent years, the shipping industry went through a wild ride and tried to cut down costs wherever possible. Yet, Muehlhans services are quite essential to maintain a ship in good shape (and often also mandatory due to various regulations). Still, this seems not to the place to invest further capital to.

For industrial customers, Muehlan mainly provides surface protection for bridges or plants in the chemical sector, but also scaffolding, insulation, passive fire protection, enclosure services as well as steel construction. As a result of the corona pandemic, many projects in this segment were postponed and Muehlhan was left with many costs, as the catastrophic EBIT-margin in the last fiscal year shows. While this business was historically also very much related to the maritime sector, Muehlhan managed to broaden its reach. Yet, I do not think that this is the area where a lot of capital can be deployed wisely.

This leads us to the last segments: Renewables. Muehlhan has shown some impressive growth within this division over the last years, both due to strong organic initiatives but most importantly the smart move to start Muehlhan Wind Services A/S. Muehlhan Wind has been the main driver over the last years and we will look closer into that soon.


Historical Financials

The historical ship business had been under pressure for years and the just-finished industry consolidation may take another round after the covid crisis. The management of Muehlhan thus moved early to other industries, first into the Oil & Gas business but later also more into the Industry & Infrastructure segment. However, it was not until 2017 as the firm started to put more focus on renewable energy - in particular, offshore wind - and started to report it as an individual segment.


                                          

Once the start was made, the revenue share of the renewables business increased rapidly. If we adjust for the Oil & Gas business (as most of it may be sold soon), the share of the revenue within the Muehlhan Group is even more remarkable. 


In terms of profitability, the oil business brought some major losses within the years of the global financial crisis. Yet, in the last couple of years, the segment provided nice cash flow to fund the ramp-up of the Renewables business. For the maritime segment, Muehlhan did a decent job and turned it around with a focus on more profitable projects. However, the industrial segment did not earn a solid margin within the last year, even though the economy did very well. Hence, it is no surprise, that in 2020 the EBIT turned negative again. 



The first observation is obvious: The business of Muehlhan is - as expected - not very stable and depends very much on the investment budgets of their customers. Yet, they managed to stabilize the margin both in Ship and Oil & Gas. Thus, we can already conclude some preliminary results. The surprising move out of Oil & Gas may not be due to bad performances in recent years. However, it still makes sense, given that Muehlhan did not reach a critical mass within the oil-producing regions in the North Sea. Also, both capital and management's attention are better allocated towards the renewables segment. Hence, I will focus on the prospects and opportunities of Muehlhan in that market.


Muehlhan Wind Services - Is the Growth Star getting profitable? 

When Muehlhan carved out the Renewables segment in 2014 out of the former Energy segment (both Renewables and Oil & Gas combined), it did not look like more than an accounting measure. Yet the company had just pointed out that they want to invest heavily into that segment and make a profitable business out of it. They did this both by establishing a new site in Cuxhaven but also by setting up a company dedicated to the servicing of offshore wind turbines in collaboration with industry specialists: Muehlhan Wind Services (MWS). Muehlhan acquired only 51% of the company based in Middelfart, Denmark, which was a rather unique move, as the company usually holds 100% of the share capital of its subsidiaries. Yet, it might be exactly due to the ownership structure, that granted the historical success of MWS and the excellent current positioning.

Fast forward to 2020, a lot of things have changed. With the annual report published in April, Muehlan disclosed that they are now holding already 56% of MWS. Although I do not know for sure, I suspect that Muehlhan bought the stake of Mathias Eltved Justesen, one of the experienced wind power entrepreneurs with whom Muehlhan had originally started MWS. This leaves five people who, according to public sources, hold minority shares of 5-9.99% in MWS. Since they are likely to withdraw from the operating business in the next few years, Muehlhan could naturally be the first buyer to take over their shares and thus further strengthen the focus on this segment - in addition to investing in the operating business.

This division of Muehlhan has been particularly convincing in operational terms in recent years. The Last Twelve Month revenue is increasing steadily at a high single-digit growth rate compared to the previous LTM figures:


Also, in 2020 the company showed that they have reached a base where they can finally start earning healthy margins: 9.6%. While this extraordinary good result might be inflated by some covid-19 effects, it is evident that this business can yield significantly higher margins than the existing operations in Ship or Industry & Infrastructure. Still, MWS is heavily investing in its workforce, as the FTE development of the MWS A/S subsidiary shows:



A look at the LinkedIn page of Muelhan Wind reveals that the division as a whole (i.e. not only the Danish MWS A/S) already employs over 300 people and that the total headcount has grown 26% over the last six months. Furthermore, the latest posts indicate that this number is to be expanded further at a high speed. This leads logically to the question as to what the new employees are needed and whether the development of the past can still be accelerated with them.

Muelhan offers its services as a full-service provider to both manufacturers of wind turbines and operators of offshore wind farms. In the recent past, the focus has been on expanding the maintenance business in order to reduce the dependency on the more volatile offshore new construction business. The majority of the installation and service business is carried out through the subsidiary MWS A/S, which has its main activity in the overall service and maintenance of wind turbine generators. It is reasonable to assume that Muelhan might keep on investing heavily into this business segment. The expectations for new wind energy installations are high and the political environment with the European Green Deal and Biden's infrastructure plan could be another accelerator. The Global Wind Energy Council expects the new installed offshore capacity to grow from 6.6 GW in 2020 to 31.9 GW in 2030. They expect Europe to maintain steady growth while new installations outside Europe, predominantly from Asia and North America, are likely to surpass Europe in 2020 for the first time and continue exceeding volume in Europe through 2030. One of the most dynamic areas in the near term are China and Taiwan and Muehlan is currently expanding its Taipei footprint by hiring senior staff there.


Yet, the outlook for the European space - Muehlan's main business area - is still promising. Even though the industry has reached a mature stage, the power generated through offshore wind parks has become a cost-competitive source. The European Commission estimates that total offshore wind installations
between 240 and 450 GW will be needed by 2050, making offshore wind a crucial pillar in Europe’s power mix. Also, traditional energy companies like Enel, BP, Shell, or Total have announced large investments into wind and solar projects, while companies like Orsted have developed themselves into a Green-Energy pure-play company. Besides, the current investing environment with low yields and high equity valuations leads many institutional investors like pension funds to allocate capital towards specialized infrastructure funds. In summary, the market environment and outlook remain excellent and Muehlan has a very good chance of benefiting from this.


Valuation 

When analyzing situations like Muehlhan, one might be tempted to use a sum-of-the-part valuation and put adequate multiples on the different parts. Yet, I found it very difficult to come up with reasonable comparables for the different business segments. Therefore, I run a simplified DCF model with the following assumptions:
  • Ship segment turnover decrease by 4% p.a. while the margin can be maintained at around 9%
  • Oil & Gas is sold for nothing
  • Industry/Infrastructure margin is recovering not before 2023 and there is no catch-up effect for the recent turnover drop
  • In Renewables, the high growth rates can be maintained and 100m revenue are reached in 2023 while the margin ramps up to 8% in the steady-state
It is clearly evident that the case is almost solely built on the renewables segment while the other segments might yield to positive surprise. Yet my model (8% WACC, 2% g) computes an enterprise value of 116m which translates into 4.19€ per share. Of course, the valuation is sensitive to the assumptions made, but it certainly shows that the renewable energies business alone could soon be worth more than Muehlhan's current market capitalization. Once the sale of the O&G activities has been completed, this will become even more evident.


Summary & Outlook 

In conclusion, Muehlan represents a very interesting case in which success almost solely depends on their delivery of the ramp-up of the renewables segment. Given the track record shown in the past few years, I am confident that they will continue to succeed in that area. The natural catalyst for greater and changed attention for the company is, of course, the hopefully imminent final sale of the O&G activities. In addition to the failure of the O&G sale process, risks include problems with the minority shareholders in MWS and major, unexpected problems in the other areas. Nevertheless, I think that the last year has already shown something like a "worst-case" for the segments Ship and Infrastructure and it can only get better from here. Operationally, increasing competition in the service and maintenance business with wind turbines can also lead to falling prices or less favorable contracts. In addition, rising labor costs and the difficulty of finding enough qualified personnel are key risks. Yet I am confident that the current valuation of the company and the presented upside optionalities overcompensate for the risks. Given the attractive risk/reward ratio, I view Muehlan as an appealing investment opportunity for suitable investors who are not afraid of the special characteristics of micro-caps. Yet, if one intends to buy the share, one should also consider the low free float as well as the low liquidity and therefore order limited.

Disclaimer: I am long Muehlhan AG (XTRA:M4N).