Sauer-Danfoss, Inc. (SHS) – Research Report

Strong Buy – Target $58.00

 Background: Sauer-Danfoss is a mobile hydraulics manufacturer operating in North America, Europe and Asia Pac.

- GARP Value Opportunity (Growth at a ridiculously [cheap] price)

- Piotroski Score = 9

- High Magic Formula rank using earnings yield and ROIC

- Low PEG

Catalysts

Potential Tender – Back in 2009 Danfoss A/S launched a tender offer to acquire the roughly 30% of outstanding shares they did not already own. The tender price reached $14 per share before expiring without meeting the minimum tender condition. Looks like the minority shareholders were right in not accepting the tender as prices have more than doubled since 2010. We believe Danfoss may again try to purchase the remaining outstanding shares but this time at a much more lucrative price.

Ownership Structure

Some might see the ownership structure as a negative aspect of SHS as minority shareholders will always play second fiddle to Danfoss. That being said there are a few positive aspects that we believe offers us an edge. SHS has somewhat of a thin float and low daily volume which makes sense when you think about that fact that 70% of the company’s shares are held by Danfoss. This however makes many large institutional money managers unable to establish big positions in SHS. SHS is also largely ignored by the sell side as the brokerage firms are unable to generate large commissions from selling this stock to their clients per the reasons mentioned above. Value investors should always search for companies that are not closely followed by the large buy and sell side firms as there are less eyeballs watching the tape. When few investors follow a company, there is often a greater chance for the stock to trade further from its intrinsic value. The ownership structure and float might partly explain why the stock trades at such a discount from its peers and we have factored this into our model but we still believe that SHS’s undervaluation is more caused by lack of attention than by its ownership.

Expansion in China

China seems to be the future growth catalyst for many companies including SHS. Even if there is a slowdown in China we still believe China will provide growth for SHS for years to come. Recently SHS announced plans to invest over $100 million in China and expects sales in Asia Pac to reach $900 Million by 2015.

Valuation

Current Price: 40.84    
Target Price: 58.00                      
Potential Returns:  42%                      
Alpha: 20%

SHS is trading at a historically low price to earnings ratio of 5.8 compared with a pre recession average of 27 (excluding a high outlier).  Present revenue CAGR (Compound Annual Growth Rate) is 32% vs. pre recession of 10% CAGR.  EPS is 6 times pre recession levels with a growth rate of 54% (YOY).   Operating margins continue to improve significantly despite a competitive business environment.  Our valuation is based on a conservative P/E valuation and confirmed with our DCF model. (below) 

P/E Valuation

DCF Inputs

Expected Case
WACC	18.00%
Base Sales Growth Rate	20.00%
Terminal Growth Rate	3.00%
Effective Tax Rate	0.00%
Depreciation % of Sales	4.00%
Operating Margin	20.00%
Cap Ex % of Sales	2.00%
Change in WC as a % of sales	10.00%
Market Price	$59.27

DCF Model

Disclaimer: Neither Will nor Tim currently owns SHS and will not be initiating a position within the next 48 hours.