Industrial distribution has never been an easy place to compete. Not only are there numerous competitors offering more or less the same products, but price transparency has increased substantially over the last decade and the expansion of e-commerce has made it increasingly difficult to achieve margin leverage. At the same time, though, top competitors in the space have found new ways to differentiate themselves by harnessing technology to improve service offerings to customers and gain share.
It’s been a while since I’ve updated my thoughts on Switzerland-based Bossard Group AG (OTC:BHAGF) (BOSN.SW), but the shares have done okay since that last update (up a little more than 30% excluding dividends) – slightly outperforming the broader industrial space, but lagging comps like Fastenal (FAST) and W.W. Grainger (GWW), with the stock taking a hit from the war in Ukraine and the more challenging economic conditions in Europe.
At this point, my feelings on the shares are mixed. I like the company’s focus on what it calls “sunrise” industries like electric vehicles, robotics, and healthcare, as well as its strong focus on automated and digital solutions. Still, though, the near-term outlook for Europe is not strong and the valuation isn’t a clear-cut bargain. I think there’s still money to be made from here with these shares, but it may take longer than some investors want to wait and investors may want to place this name on a watch list until there’s a little more clarity on a recovery in major European markets.
I also want to note that Bossard Group shares are not particularly liquid. Even on its home exchange, there isn’t a lot of daily trading volume, so entering or exiting a large position may take some patience.
Growth Markets Versus Slowing Economies
Recent financial results highlight some of the near-term macro challenges that Bossard is facing. I’ve talked in other recent articles about the fact that pretty much all of the world’s major economies are showing some signs of weakness, including sub-50 PMI readings in the U.S., China, and Europe, as well as ongoing challenges with property markets and persistent inflation. Summed up, it’s a challenging backdrop for a business like Bossard whose revenue is meaningfully tied to current business activity.
Revenue slowed from more than 7% growth in the first quarter of 2023 to a small contraction in the second quarter (-1.5% in constant currency), with a nearly 11% quarter-over-quarter sequential decline. Although sales in the Americas (largely the U.S.) remain comparatively strong (up 4% in the second quarter), here too there has been a noticeable slowdown with a low double-digit sequential decline. Weakness has also become more pronounced in the EU, with a 13% qoq decline and a modest 3% year-over-year decline in the second quarter.
Although gross margin improved slightly (from 31.5% to 32.0%) in the second quarter from the year-ago level as COVID-19 and supply disruptions have gone away, operating income was still down 10%, with a 110bp decline in operating margin due to ongoing pressures like wage inflation.
Pivoting Toward Growth Markets And Automation Opportunities
In my opinion, the foundation of a bullish case for Bossard rests on a few fairly straightforward drivers and opportunities.
There are some relatively “standard” potential drivers here like market share gains, increased fixed asset leverage, and improved operational efficiency and I don’t mean to give the impression that they’re unimportant, but I think they’re pretty easy to understand without a lot of explanation. Distribution of Class B and Class C products (particularly fasteners, where Bossard largely focuses) is still a highly fragmented market in most of the places where Bossard competes, and I believe the rising costs of remaining competitive (improved service offerings and so on) will squeeze smaller players out over time. At the same time, like almost any distribution business, there’s meaningful incremental margin potential for Bossard if it can run more volume through its existing business and do so more cost-effectively.
More unique or specific to Bossard is its leverage to some attractive growth markets and automation opportunities within Class C product management.
On the growth side, Bossard has significant leverage in basic manufacturing (machinery and electrical products), and that’s a risk in the near term. What the company has been doing in recent years, though, is actively seeking out opportunities in faster-growing markets like EVs (including personal transport like scooters), medical equipment, and automation equipment (robotics, et al). In many cases, the company has engaged with these companies to develop custom fastening solutions from the ground up, giving the company a stickier position within the bill of materials.
The bigger opportunity is likely on the automation side, where Bossard continues to work with customers to drive adoption of its Smart Devices offerings, including its SmartBins and Smart Ordering.
The SmartBins concept is pretty simple but still value-additive. Commonly-used components like bolts, screws, nuts, and so on are kept in bins that have weight sensors and wireless communications capabilities. When the sensors detect that a bin is getting low, an order is automatically placed. Smart Ordering goes a little further, using company-developed algorithms to analyze product consumption, order quantities, and timing to stay ahead of actual usage trends. This approach reduces out-of-stocks, operating disruptions, and express/emergency orders, making life easier for both the customer and Bossard.
This may all sound basic, but there are still many businesses that don’t use more advanced parts management or digital ordering systems. The end result is that sometimes there are expensive production disruptions due to shortages of essential (but low-cost/low-value) components and/or companies have to make expensive rush orders to avoid those disruptions. At the same time, offering these more advanced on-site technologies requires scale and capital that small distributors can’t manage, and so companies like Bossard and Fastenal have been gaining some share on the basis of these more comprehensive offerings – in some cases, taking over a customer’s on-site Class C inventory management allows the company to grab more share of wallet, and it also makes for a stickier long-term relationship (pulling out/replacing these systems takes time and space, and it’s not something a customer will undertake lightly).
The catch in modeling Bossard today is figuring out how long and how bad this downturn in Europe will be, as well as whether the U.S. will see a recession (or a more pronounced slowdown) and whether China can get its house in order. While the U.S. economy has held up better than I expected, there are still some worrying signs and I’m very curious to see what industrial companies will say with respect to results and guidance with this upcoming third quarter reporting cycle. Europe, on the other hand, has weakened more than I expected, and it remains to be seen if the second half of next year will see any sort of meaningful recovery.
I expect that Bossard will end up showing modest (around 3%) reported revenue contraction for 2023 and modest growth next year, but that relies on a second half recovery in Europe and China. Beyond 2024, though, I think the company’s leverage to growing end-markets like EVs and automation, as well as the opportunity to introduce its automated offerings to more of its traditional fastener customer base, can drive solid mid-single-digit revenue growth for several years and a long-term revenue growth rate around 4% to 5%.
Margin leverage is tricky to model. Although the company has roughly doubled revenue over the last decade, EBITDA and free cash flow margins haven’t improved all that much. I do still think that EBITDA margins can improve to the mid-to-high teens level (15%-16%) over the next few years, and likewise, I do think that high single-digit FCF margins are possible over time, supporting a double-digit FCF growth outlook.
The ”but” is that even if Bossard can achieve all of that, valuation isn’t a slam dunk. Bossard looks modestly undervalued on a cash flow basis with a prospective long-term total annualized return in the high single-digits (around 9%), but the shares already trade close to 11x my FY’25 EBITDA multiple (discounted back one year), and meaningful rerating will require some acceleration in revenue growth or margin leverage (or both).
The Bottom Line
Bossard sets up for me like a pretty typical “like the business, but have mixed feelings on the stock” situation. It’s possible that we’ve already reached a point of maximum pessimism for the economic outlooks in its major markets and that the company will see a healthy rebound starting in around 9-12 months. It’s also possible, though, that this correction could drag on a while longer. Were the shares to trade back to around CHF 190, I’d definitely be more inclined to be positive now, and I am still positive on the long-term prospects, but I’m hesitant to recommend aggressively adding shares right now given the macro uncertainties.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.