Since Q2 results in late August, the Germany-based automotive sealing provider’s€275m 6.250% SSNshave progressively traded off, coming down from ~95 hitting lows of 81.0 (YTW of 11.9%) before recovering slightly to current trading of ~83.6 (YTW of 11%).

Top line leaking

As of FY20, Profil operated 11 production sites, 11 sales offices and ten R&D centres across ten countries, with ~8,000 employees. The company holds ~20% of the European automotive sealing market, and is the third largest player behind leader Cooper Standard (30% share) and SaarGummi (25% share). However, Profil is less globally competitive, dropping to the ~fifth largest player worldwide (Cooper is number one, Toyoda Gosei second, SaarGummi third). High customer concentration also leaves the company with limited sway to negotiate pass throughs - customer and geo splits per H121 below:

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During the Q2 Earnings presentation, management stated their expectation that sales for Q3 would be at a “similar level” to those in Q2. However, looking into the Q3 production figures of four of its largest customers, constituting ~50% of its total client base, we can see the following trends for Q3 vs Q2:

• VW (19% of H121 sales): 27.7% reduction in production
• Audi (13% of H121 sales): 41.6% reduction in production
• Renault (8% of H121 sales): 39.4% reduction in sales
• Ford (10% of H121 sales): 48.7% increase in production

Although Ford has demonstrated stronger resilience in the face of semiconductor shortages (with a more aggressive approach to shoring up its supply chain than competitors), European vehicle manufacturers (Profil’s principal segment) are still heavily affected.  LMC Automotive’s August forecast for semiconductor related production constraints may prove again to be an underestimate (already twice revised downwards), currently showing a ~1 million unit Q3 dropoff:

At the end of Q2, management conceded that the pickup in the European automotive market has been slow (EMEA 73% sales, H121), with recovery in China quicker as a result of its faster Covid bounceback. Management in the August conference call were hopeful that Electronic Data Interchange (EDI) volumes, which process documentation such as Purchase Orders between businesses, would remain healthy in H2. However, upon questioning, management also detailed that EDIs are non-binding and can be (and have been) revoked with little notice, meaning that the lower than expected OEM production volumes hits Profil’s orderbook with no lag. Therefore, order cancellations tend to present in earnings same-quarter. Bearing this in mind and given the relatively underwhelming production volumes amongst Profil’s European customers in Q3 , we find it difficult to see how the forecast of “similar level” sales for Q3 vs Q2 will hold true. 

More notable however, will be the deepening of raw material costs.

Cost drivers weigh on EBITDA

Profil’s key raw material inputs, notably Brent Crude, Carbon Black and EPDM (a type of rubber) have each continued to experience relatively sustained inflation since Q2, with a total negative hit on Q2 EBITDA of €2.7m (€3.7m for the year). Despite managements thoughts of a “stabilising” period through Q3, Crude saw ~6.5% run-up between June 30 and September 30, with a ~6% run-up in Carbon Black and an even more significant hike of ~9% in EPDM over the same period (note that we reference a synthetic rubber index, including Ethylene Propylene, as a proxy for pure EPDM price). 

The situation reached crisis point early in Q2 where Profil received force majeure letters from suppliers across these three inputs. Hedging activities around these key inputs also seem minimal, with no long term contracts in place and payments made at spot prices. “Take it or leave it” scenarios are in effect with major partners, explaining the unobstructed hit to EBITDA. Pass throughs to OEMs are on a case-by-case basis, and given the buying power of its major clients, Profil has little room to manoeuvre. Management stated more clarity on the effectiveness of pass throughs would be available in Q3. 

Expect an even more glaring slide to the one below in the Q3 presentation:

Aside from raw material inputs, FX is also worthy of mention. 11.8% of FY20 revenues were denominated in Lira, which held steady in Q3, but suffered significant weakness in recent weeks dropping from 8.5 versus the dollar to 12.0 today (23 November). Per the April OM, aside from natural hedging (negotiating both customer and supplier contracts in local currency), Profil says it engages in strong FX hedging, with fluctuations historically having a “negligible impact” on Adjusted EBITDA. However, there may be some weakness here, given that in Q2 management stated they were seeing “some FX effects” which were not cash relevant at the time. The steep move in the Lira over October and November may hit Q4 numbers. 

On-top of raw material inputs, the company is struggling to capitalise on strong demand in the Americas due to significant ramp up issues at its Mexico plant, resulting in poor efficiency, high scrap rates, sub par product delivery and a recovery programme initiated this summer which required the personal oversight of top executives. This translated into a €3.3m quarterly hit on Q2 EBITDA, with the EBITDA margin falling ~4% (quoted at ~16.4%) purely as a result of Mexico with additional margin pressure expected due to the above input cost factors.

The company has been quiet on Mexico developments through Q3 - but as one of the few geographies experiencing healthy demand (see below), successful implementation of their recovery programme will be a focus point in the upcoming numbers. 

RCF still not sealed?

Management stated their intention to reduce the ~€30m of factoring facilities to ~€5m in H2, with the late Q2 spike in working capital needs anticipated to decline in Q3. Given the drop off in factoring, and highly constrained free operating cash flow (estimated by S&P to drop to negative €20m for the year) the liquidity buffer provided by an RCF may prove necessary if Q4 does not deliver on expectations. In August’s call, management highlighted that there were RCF “discussions running” with relationship banks, to be finalised in H2. Looking to the company’s cash position, as a result of April’s bond financing, €219.1m in bank loans at various international operating subsidiaries were paid down, leading to a 90.8% reduction in restricted cash in Q2 (a previously voiced concern with restricted cash of €98.8m in Q1 committed to local loans). As of Q2, €75m of the €83.6m in cash was available at the issuer level. However, upcoming repayment of the non-recourse factoring arrangements referenced above are expected to weigh on cash balances for Q3/Q4. 

Ownership structure

Briefly, the commitment of sponsor Actera (~$3 billion AUM) may be a cause for concern. Having attempted a failed IPO in 2018 (it has held Standard Profil since 2013), whether they can be relied upon to stump up equity in a downside scenario remains to be seen. Per S&P, Profil’s direct parent (Sealing Technologies Sarl), has also issued ~$95m in preference shares.

A silver lining: in the long term, seals are insulated

One touch of upside in which buysiders may take some refuge is the long term outlook for the segment. Sealing products are insulated from the electrification of the Light Vehicle manufacturing sector, with Profil well positioned, supplying its products for vehicles such as Tesla’s model Y, Ford’s Mach E, and orders from the latest EV moonshot Rivian.

The opening of Tesla’s Brandenburg factory will be another boost to the topline, which should be reflected in Q4/Q1 numbers. Profil’s competitive cost structure has attracted younger, lean OEMs, reflected in new business awards for H121 of €41.6m. Generally, the company supplies products to a relatively young vehicle lineup, with the exception of its Morocco plant’s “mature” product portfolio. EM demand has also compensated somewhat, with Mexico (300% YoY sales growth), China and Bulgaria demonstrating promising trends. 

The question remains as to whether the company’s order book can withstand semi conductor induced cancellations and outweigh severe cost pressures to avoid a reprofiling.