Initial Report: Instalco AB (OM:INSTAL), 49% 5-yr Potential Upside (EIP, LEE Cheng Jia)

Cheng Jia thinks that Instalco stands as an attractive investment opportunity, leveraging a strong foundation, disciplined management, and a strategic vision for growth.

Executive Summary

Instalco, a leading Nordic-based technical installation and service provider, presents a compelling investment opportunity characterized by robust fundamentals and strategic positioning in the dynamic construction and infrastructure sector. Their strengths in having high quality acquisitions, providing a long runway for growth in buying the businesses and high quality of management sees them as a feasible investment.

Instalco is also a serial acquirer in the Nordic installation industry. It seems that the market has underestimated Instalco has strong durability of growth through their acquisitions, and the underlying quality of Instalco’s business, masked by legacy issues and post-covid normalization. The market fails to realize the fair multiples in which Instalco acquires them for.

Assuming they are able to continue growing with their quality acquisitions and maintain their strong market share, using DCF, a 3Y target price of __ and a 5Y target price of 68.7 SEK (65.7% upside) froom the current price of 41.46 SEK.

Company Overview

Business Segments

Instalco Intressenter AB (Instalco Intressenter) is a provider of installation and services for renovation, maintenance, and new construction projects. The company offers services such as plumbing and sprinkler services, electrical installation services, ventilation installation services, installation of cooling and heating equipment, industrial electrical and pipe installation service, and technical consultancy services, among others. Instalco Intressenter also offers installation and regular repairs of district heating, plumbing replacement, new construction, and preventive maintenance, design, installation, and maintenance of the electrical installation. It operates in Norway, Finland and Sweden. Instalco Intressenter is headquartered in Stockholm, Sweden.

Instalco’s business concept is to offer complete technical solutions for electrical, heating and plumbing, ventilation, and cooling systems, along with solutions for industry and technical consulting in the Nordic market. Their operations consist of 125 companies in 3 countries, covering 6 areas of technology; and employing over 5,600 employees.

The company reported revenues of (Swedish Krona) SEK12,063 million for the fiscal year ended December 2022 (FY2022), an increase of 35.7% over FY2021. In FY2022, the company's operating margin was 6.5%, compared to an operating margin of 8.1% in FY2021. In FY2022, the company recorded a net margin of 4.3%, compared to a net margin of 6.3% in FY2021. The company reported revenues of SEK3,310 million for the third quarter ended September 2023, a decrease of 13.6% over the previous quarter.

Diversified Geography and Sector

The main business represented in Sweden accounts for 76% of net sales and 84% of EBITDA. The rest of the Nordic Region accounts for the remaining 24% of sales and 16% of EBITDA.

Number of Entities

Sales by Customer Group

Business is well diversified geographically and within their own sectors as well, lowers potential concentration risk of their business.

Competition and Key Players

The technical installation and services market is highly fragmented, consisting primarily of small companies with less than 10 employees and focused on a single area of Technology. The total addressable market in the Nordics is at 210 billion SEK. Within the industry, 69% of the market is by other installation companies while the remaining 31% are by 4 major players: Instalco (4%), Bravida (11%), Assemblin (5%) and Caverion (11%).

Market leading in a highly fragmented industry.

Strongly profitable with high margins over time. Instalco has roughly half the revenue of its largest local competitor Bravida but its margins are higher because of different organizational structure and M&A pace.

Porter’s Five Forces

New Entrants

There is a high threat of new entrants as the installation industry has low barriers of entry.

Buyer Power

In the industry, installation firms offer similar services and do not have pricing power. Instalco meanwhile, offers end-to-end solutions, increasing their pricing power due to the range of services provided. They operate across various technical areas, including electrical, heating and plumbing, ventilation, industrial, cooling, and technical consulting.

Supplier Power

Small individual installation firms are unable to negotiate favourable terms with their suppliers. Instalco subsidiaries gain cost advantages by centrally negotiating supplier agreements.

Competition

Despite the high levels of competition, there are 25000 companies in the industry. However how Instalco stands out is their end to end offering solutions as well as their ability to attract different types of customers ranging from homes to corporations.

Substitutes

Installation services are a crucial aspect of construction that cannot be substituted away. This provides Instalco with long term demand.

Headwinds

1)      Higher Energy prices and greater focus on Sustainability – leads to an increased demand for sustainable and energy efficient solutions. These solutions are provided by Instalco and their subsidiaries.

2)      Aging Property – 25% of Swedish Property was built in the 1960s and 1970s; there is now a rising demand for renovations and technical upgrades. This would account for up to 3.3 billion SEK in additional Revenue for Instalco.

3)      Public Investments in Infrastructure -Sweden, Norway and Finland are planning major investments in Hospitals, Schools, and public transport systems. All these requires manpower and the technical expertise which instalco would be able to provide.

Tailwinds

1)      Higher interest rates – The current high interest rates results in slowing pace of new construction projects, resulting in slowing business needs for Instalco. It also leads to higher cost of debt when Instalco acquires their subsidiaries.

2)      Rising Inflation – Higher Material Costs will negatively impact the industry’s profitability.

Serial Acquirer Model

Serial acquirers focus on acquisition-driven growth, acquiring niche market leaders that have durable growth and profit potential at a relatively rapid pace whilst adopting a decentralised approach to management.

Instalco uses Platform serial acquirer model. Platform serial acquirers grow via acquisition in an optimal manner that requires minimal integration but also ensures that best practices are shared across the subsidiary network to increase efficiencies – for example, through INTAL’s local units.

The Nordic installation and services industry’s heavily fragmented nature lends itself as an ideal opportunity for platform serial acquirers to capitalise on.

Acquired companies leverage client networks and expand product offerings while retaining independence and sustaining individual profitability.

MicKinsey studies show that programmatic acquirers outperform the market by >2% a year from 19954-2019. Nordic serial acquirers are shown to historically outperform the market.

Thesis 1: High Quality Acquisitions

Each firm acquired by Instalco in a genuinely good business with strong fundamentals. Instalco Operates with a highly selective acquisition filter: Instalco spends 2-5 years investigating potential acquisitions, highly leveraging its network and relations to source the companies which fit its highly selective criteria. They regularly acquire firms for around 0.5x sales or 4-6x EBITDA.

Some of their criteria includes:

1.       Profitability above 5% and a strong track record for revenue growth and meeting financial targets.

2.       Mature leadership with a proven ability to create value.

3.       Company that specialises in a specific area having unique expertise and has a high number of recurring customers.

4.       Able to collaborate with other Instalco units, are team players and demonstrate cultural fit.

They also have strong order pipeline demonstrating the potential of the firm for continued growth.

Individual firms are chosen specifically for their unique moats. Firms acquired are leading installers in their geography, with a loyal customer base. Pricing power is evident with the use of cost-plus projects and their high and stable EBITDA margins, despite high inflation.

Examples include:

Thesis 2: Instalco has a long runway for Growth in buying these businesses.

Instalco has seen high growth from past acquisitions. Instalco has been steadily acquiring high-quality companies since their inception. They average an EBITDA margin of 8.1% in Sweden since 2017. They have also averaged a 35% CAGR since 2017, strong FCF growth and high reinvestment rate.

Their acquisition growth has remained high over the years too. With an average of 26.2% annual growth from acquisitions since 2017. The acquisitions historically funded 78% by CFFO, with difference funded in early years by share issuance, and more recently by debt.

On average, from 2015 to 2022, they have acquired 19 companies a year at 65m SEK Revenue each, totalling 6.5m USD.

There is a lot more potential for further expansion: Instalco currently owns 125 out of a total of 25000 installation companies in the Nordics and accounts for 69% of the total market by revenue.

An estimate by the company shows at least 1000 more firms in the region that fits the Instalco Profile.(Leading to 55 years’ worth of acquisitions if rate of acquisitions stays constant at 18 per year.

Thesis 3: Instalco’s Management is of high quality and doesn’t overpay for their businesses.

Management are incentivised to be shareholder friendly. Instalco has historically paid its acquired companies both in cash and Instalco shares to align incentives. Company policy is to distribute 30% of prior year’s Net Profit to shareholders. Low base salary means the company’s focus is to allocate its resources to maximise operations:” We need to prioritise efficiency, not compensation” – Robin Boheman, CEO.

Management Promises: Hits and Misses

Thesis 4: Firms want to be acquired by Instalco

Companies genuinely want to join Instalco, making the serial acquirer model work even better. Firms view Instalco as the Acquirer of choice as they operate as a highly decentralised model, allowing subsidiary leaders to maintain a high degree of autonomy and keep their culture, branding etc. At the same time, they also offer firms access to economies of scale available to the wider organisations.

These factors mean Instalco can acquire firms at a much lower multiple than competitors, as firms want to be acquired by Instalco and so are prepared to accept a discount compared to other acquirers.

There is also a culture of entrepreneurship maintained in leadership. Succession planning through subsidiary employees means senior leadership is composed of entrepreneurs who previously founded or headed Instalco subsidiaries. Through Instalco Academy, new leaders are identified, mentored, and trained. In 2021, more than 250 employees were identified with the aim of becoming the next senior management team. In the company, 45% of the Senior Management team have been internally promoted from subsidiaries.

Notable Examples

Companies benefit from having Instalco as a parent company due to 2 reasons:

1)      Economies of Scale:

a.       Firms benefit from bulk purchasing agreements.

b.       Materials purchased as a % of total revenue has fallen by 5% since 2016.

2)      Opportunities for collaboration:

a.       Best practice in operation shared within the group.

b.       Access to clients and collaborations inaccessible otherwise

c.       2 Instalco companies are collaborating on the development at Gardermoen Airport in Oslo, amounting to a combined order value of NOK 42 million.

Valuation

Some of the valuation key drivers includes:

-          Organic revenue growth: Believe that Instalco can continue low single – digit organic growth, driven by overall industry trends and fixing the previous organic growth issues in the rest of Nordics segment.

-          Inorganic revenue growth: Believe that Instalco will continue to find attractive acquisitions to add to their platform and offerings, with a long tail of companies that can be acquired.

-          Acquisition Multiples: – Instalco’s status as the preferred acquirer keeps acquisition multiples low, not exceeding 0.8x sales, and IRRs high.

-          EBITA margins:  Believe that EBITA margins will normalise at previously high levels due to company initiatives and returns from scale.

-          FCF conversion: Will remain low as Instalco invests in high ROIC opportunities, before normalising as Instalco stops acquisitions when they run out of sufficient opportunities.

 Risk and Mitigation

ESG Assessment

Regarded as low, thanks to their adept management practices that prioritize employee well-being and align with prevailing sustainability trends. Instalco places a strong emphasis on monitoring key indicators such as happiness, health, safety indexes, and employee satisfaction, recognizing the critical role these metrics play in the success of their industry. Despite facing a higher employee turnover, the company diligently tracks the internal health of the business, demonstrating effective management. It is imperative to manage these costs properly to mitigate potential adverse effects on the business.

Conclusion

Instalco stands as an attractive investment opportunity, leveraging a strong foundation, disciplined management, and a strategic vision for growth. The company's commitment to ESG considerations aligns with evolving market expectations, enhancing its long-term sustainability. Moving forward, the combination of Instalco's proven operational excellence and strategic foresight positions it as a compelling choice for investors seeking exposure to the dynamic Nordic technical installation and service sector.

Source:

CapIQ, Annual Report, Earnings Report, Marketline, GlobalData , Euromonitor, Statista

*Do note that all of this is for information only and should not be taken as investment advice. If you should choose to invest in any of the stocks, you do so at your own risk.