Martela, the largest office furniture designer, manufacturer and distributor in Finland, has been going through a difficult restructuring since 2013 as recession in main markets and change in working habits has reduced office furniture demand.
In response Martela has reduced personnel, optimized logistics and manufacturing and hired new CEO, among other organizational changes.
As a result Martela’s costs will be 4 meur lower this year than in 2014, based on the first cost saving program initiated in 2013. Company has also announced second 4 meur savings program which will take full effect in 2017.
All else equal, the cost saving effect to income statement is:
| Income statement (MEUR) | 2014A | 2015E | 2016E | 2017E | 2018E |
| Sales | 135.9 | 135.9 | 135.9 | 135.9 | 135.9 |
| OPEX before savings | -132.4 | -132.4 | -132.4 | -132.4 | -132.4 |
| Cost savings 1 | 4.0 | 4.0 | 4.0 | 4.0 | |
| Cost savings 2 | 2.0 | 4.0 | 4.0 | ||
| EBITDA | 3.5 | 7.5 | 9.5 | 11.5 | 11.5 |
| Depreciation | -3.8 | -3.8 | -3.8 | -3.8 | -3.8 |
| EBIT | -0.3 | 3.7 | 5.7 | 7.7 | 7.7 |
| NFE | -0.7 | -0.7 | -0.7 | -0.7 | -0.7 |
| EBT | -1.0 | -3.0 | 5.0 | 7.0 | 7.0 |
| Tax @ 20% | 0.2 | -0.6 | -1.0 | -1.4 | -1.4 |
| E | 0.8 | 2.4 | 4.0 | 5.6 | 5.6 |
Hypothetical 3 year “work-out” value therefore:
| Work-out value 2016-2018 (MEUR) | Total | Comment |
| Cumulative earnings | 15 | Sum of ’16E,’17E’,’18E earnings |
| “Exit value” | 56 | 10x 2018E earnings |
| Total value | 71 | |
| Market cap | 14 | |
| Upside | 5x |
So, assuming sales won’t decline and the announced cost saving flow directly to earnings, there is 5x upside from current 14 meur market cap.
Are the assumptions reasonable?
1) Sales won’t decline if a) furniture market doesn’t decline and if b) Martela retains its market position.
a) Assumption that furniture market doesn’t decline is though call. There are two forces operating in opposite direction.
First is the structural decline in office furniture market.
Second is the recession in Martela’s main markets which will, when it ends, at least to a degree offset the decline caused by the structural decline.
Let’s first look at the structural issues.
There is change in “ergonomics” part of the office furniture market, that is chairs, decoration, tables and other non-information storage related office equipment.
Virtually nobody will have their own work station in the future but instead people will move in the office during the day in shared areas based on what they are doing, be it focus, collaboration, talk on phone, mini-meet or routine tasks etc etc.
Change to shared office equipment means first that the mix of office equipment will change. Less personal chairs and tables and more sofas, mini pods, separator walls, adjustable tables and adjustable chairs.
Second, it will mean, all else equal, that there will be less ergonomic equipment per worker as office furnitures are shared instead of everybody having their own.
While ergonomic equipment per worker might be decreasing, office workers and replacement frequency of furniture is generally increasing.
My very crude guess is that long-term “ergonomic” part of the market won’t decrease in size because demand in furniture per employee will be offset by increase in office workers and replacement rate (say 25% decrease in furniture demand per worker is offset by 10% increase in office worker and shortening the replacement rate from 10 years to 8 years, which I consider as plausible development in the market).
“Information storage” part of office furniture market is another matter. Most information will be stored in clouds of the world, so no shelves or big tables needed to store paper and manuals anymore.
Relative to “normal” level future direction of office furniture market seems to be something like:
Information storage market=Down
Ergonomics furniture market=Stable
Total market=Down
So how about the second effect, the offsetting recession effect?
Martela’s main markets are in recession so office furniture market as very cyclical industry is at very depressed level. It cannot in any way be characterized as “normal” currently.
But when and if the recession ends, ergonomics part of the office furniture market should increase considerably, first because the “underlying demand” will normalize and secondly because shift to “activity based offices” will gain momentum.
So relative to current level future direction of the market seems to be something like:
Information storage market=down
Ergonomic furmiture market due to mean reversion=up
Ergonomic furniture market due to activity based office shift=up
Total market=stable or up (?)
So all in all, I think in medium term office furniture market will at least be stable.
b) The assumption that Martela won’t lose market share is easier.
Martela is by far the largest player in the market where it competes against one bigger competitor and then dozen of smaller and local competitors.
It sells some 40-50% of office furnitures in Finland and has done that for long time.
Martela has strong position in the b-tob sales channel through local sales offices.
Existing customers typically buy their replacement and incremental furnitures from the existing suppliers.
Market is also moving gradually more and more to long term “lifecycle contracts” which include office space design, delivery, maintenance, upgrades and recycling for few years, which will further increase the customer lock in.
If working habits move more and more to work-hotels or similar share spaces, Martela has strong position because the sales channel is not going to change.
I think it’s reasonable base case assumption that office furniture market in general and Martela’s market share in specific, and therefore Martela’s sales, will not decline from current recession levels on a medium term at least (short-term, I don’t know).
2) Cost savings flow directly to earnings
Current market cap of Martela is 14 meur and it’s only braking even.
Assuming sales won’t decline only 1.4 meur of the 6 meur cost savings has to flow to sustainable earnings power to think that current valuation is fair (1.4 meur earnings imply 10x earnings multiple with 14 meur market cap).
But note that 1.4 meur earnings is about 1% of 135 meur sales, which is very very low for any company, especially one with design and manufacturing operations.
Low margin retailers do 1% margins. If one assumes that only 1.4 meur of the cost savings program flow to the earnings one has to pretty much assume that Martela becomes office furniture retailer.
Is it possible? Yes.
Martela has its own sales organization and it has increasingly started to take 3rd party products to its lineup. Items like sofas, phone booths, pods etc., stuff that it does not make by itself. This has decreased gross margins from 49% to 46% in recent years.
But the 1% margin would assume that 3rd party retailing is only thing that Martela does, which is not the case currently nor will be in the future.
For Martela still has and will have leading office furniture design organization and still has and will have manufacturing operations, albeit in reduced size.
So Martela’s value add operations now and in the future are:
Design
Manufacturing
Distribution/Sales
That should command higher than 1% margins for biggest player in the market, that is higher than 1.4 meur profits (assuming sales won’t decline).
Whether the profits will be 6 meur or 3 meur, I don’t know.
But as long as the profits are higher than 1.4 meur, then current market cap should be higher or considerably higher.
So although I don’t know how plausible it is to assume that all of the cost savings flow to earnings, I’m fairly sure that it will be more than 1.4 meur.
Management
These are not “outsiders”.
New ceo from outside of family has been put in place recently – future will tell how that will go.
Previous one’s record, a family member, was not overly impressive.
Book value reduced considerably and net cash position changed to net debt position as they kept paying dividends despite lack of profits.
I presume recent aggressive cost savings programs are family’s recognition that Martela got little fat as over the years furniture industry hardly changed and because as traditional family company saving the last euro was not the priority.
Now as the market has changed and recession prolonged management has been forced to recognize new realities and to take action.
Other than that Martela is a family company with long history. There is two-tier shareholder structure. As a family company it is eager to pay dividends, even if there is no profits.
Financial condition
Net Debt/equity ratio is 42% which I’m comfortable with and expecting it to come down significantly by end of this year as the temporary high receivables will be collected.
Safety
Aforementioned earnings forecasts and valuations assume stable sales. If that does not hold true the investment case starts to crumble.
If sales would decline, then it is necessary that Martela earns considerably higher margins than 1%, say 5%+ to avoid principal losses.
To do that Martela has to have significant other value add operations than just distribution and sales. It would have to mean that design margin and manufacturing margin are considerable.
It could well be the case because Martela has many decades old design and manufacturing operations.
So I think there is some safety in 14 meur market cap.
It only demands that Martela’s earnings power is 1.4 meur to be fair. And I think there is the case to be made that from 135 meur sales the profits could be considerably higher than that, especially given the cost savings program.
I don’t thing current valuation puts the bar for successful investment operation overly high.
Disclosure: Long Martela with 5% position
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