Lifco Stock: The Swedish Juggernaut Keeps Accumulating (OTCMKTS:LFABF)

Since I’ve written about the compelling Swedish serial acquirer Lifco (OTCPK:LFABF) about one year ago, the company continued to improve its business quality and value constantly. The latest report about the fiscal year 2023 was no exception, demonstrating the resilience of the business model and further growth driven by acquisitions. During the course of the year, investors were finally rewarded with an exceptional share price appreciation after Lifco traded -15% during October last year.

Therefore, I think it’s a good moment to review my assumptions and update the fundamental perspective, so we can reevaluate the current prospects of one of my largest holdings.

So let’s dive into it!

Business Performance

Lifco is a Swedish company that is constantly accumulating quality companies with stable cash flows in several regions and industries. Predominantly, acquisition targets are small industrial companies that are able to contribute solid cash flows due to a high level of specialization in a specific niche. While the organic growth rates related to these type of businesses are rather small, Lifco’s primary growth engine has always been external growth through acquisitions. Adding this ability to the existing underlying businesses, we derive a promising business model that historically demonstrated a high level of resilience due to the constantly increasing level of diversification of each individual business risk. However, the Group’s ability to deploy cash cannot prevent its cyclical-exposed businesses to suffer in economic downturns in the first place. Hence, I already mentioned in my last article that the short-term expectations on growth rates could be missed with Sweden being one of the most impacted countries among Europe.

Coming over to the latest quarter, the company reported a solid overall growth of 7.3%, while the sales of existing businesses declined by 5% YoY. This organic decline is attributable in particular to the Demolition & Tools segment and partly to the Systems Solutions. As the companies among Demolition & Tools are mainly niche manufacturers of equipment for the infrastructure, demolition and construction industries, they’re having the highest cyclical exposure of the Group, while contributing about 30% of the total sales. Including Q4, the segment has now reported negative organic growth for the last three quarters, especially as a consequence of the weaker market situation and lower volumes. And while the overall results for Q4 stated -2.2% and -0.9% for the sales and EBITA growth of Demolition & Tools, respectively, Lifco further noted that these results were even positively impacted by deliveries of special orders with high profitability. Hence, we should expect that the company’s most cyclical segment hasn’t found its bottom yet, and will likely perform sobering in 2024 as well. However, even under these market conditions, the businesses successfully defended their prices and reported an overall increased EBITA margin of 24.4% (22.9%) in Q4. Besides the positive impact of acquisitions and favorable projects, the results demonstrate the fundamental quality of these niche businesses.

Similar conclusions can be drawn for the largest segment of the Group, Systems Solutions, that also reported negative organic growth in the last quarter. The broad offering of systems solutions faced mixed market conditions and a partly weaker demand situation, particularly for infrastructure products , which profitability declined during the year. Overall, however, the segment benefits from its diversified operations and healthy growth rates in the other divisions, resulting in 11.3% and 18.6% growth in net sales and EBITA, respectively. The third segment of Lifco, namely the Dental businesses, showed no particular vulnerability to the current market development and achieved net sales growth of 11.1% in Q4 due to positive organic growth and acquisitions. Similarly noticeable, Lifco reported an enhanced EBITA margin of 20.4% (18.9%) for this segment that is now attributable for about 25% of the Group’s top-line.

As a combined result for Q4, the Group’s net sales and EBITA grew by 7.3% and 12.9% respectively, leading to a new high in profitability with an EBITA margin of 23.2%. Regarding the full-year results, the mixed quarterly organic performances nearly offset each other as Lifco stated organic growth of 0% compared to 2022. However, the primary growth engine of the company kept on running and contributed 9% sales growth in 2023.

Performance Among Swedish Serial Acquirers

Interestingly, there is a quiet prospering niche of serial acquirers from Sweden that are relying on similar values and operating models. However, the long-term performance of each individual company can differ significantly with some of them outperforming constantly. In order to review the quality and competitive advantages of Lifco among the group of serial acquirers, we can focus on the main growth drivers: organic business growth and growth from acquisitions.

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In the last quarter of 2023, most of the peers considered reported negative organic sales growth, with Volati and Teqnion experiencing the sharpest declines. In addition to some individual challenges, the companies mostly cited the weaker construction market as a key issue, which had the greatest impact on the relatively smaller groups, while the results of larger peers such as Indutrade (OTCPK:IDDWF) or Addtech (OTCPK:ADDHY) remained solid. Thus, Lifco’s operating slowdown is visible among the Swedish serial acquirer, but the company seems to be slightly more impacted currently than other larger names. However, a key advantage of this business model is that short-term organic growth is not crucial for the prospects of a healthy-financed and diversified serial acquirer and a broader economic downturn could even present additional opportunities for acquisitions. Therefore, I will now take a deeper dive into the M&A activity of Lifco during the last year.

M&A Activity

In 2023, Lifco noted a new record high of 18 business consolidations, which approximately will add annualized sales and EBITA of about 2.3 billion SEK and 659 million SEK, respectively. Interestingly, only one of these companies is located in Sweden, while 14 of them were acquired in Europe outside of the Nordics. In my last article, I was already mentioning that Lifco has successfully expanded its focus within Europe, therefore reducing the risk of depleting M&A opportunities while enhancing the potential runway for external growth. At that time, Swedish companies were already on #3 and are now even moved to the #4 most prominent country for acquisitions.

Of course, the long-term success relies on the quality of the acquired companies, but I find it very noticeable how well Lifco has managed to expand its M&A horizon without diluting on margins or underlying quality. The difference compared to smaller serial acquirers that still rely heavily on Sweden might not be visible on the income statement right away, but reduces my perception of the Group’s business risk significantly.

However, these differences are not meaningful if the underlying quality of the acquired business or the price paid for it becomes worse. Serial acquirers should be approaching their M&A activity patiently while being strict about their values and hurdle rates. During the latest earnings call, CEO Per Waldemarson described Lifco’s approach as follows:

We want to grow Lifco from acquisitions, not too quickly, obviously, not too slow either, but growing it in a reasonable amount […]. I think it’s very wise to grow step by step and not to grow too much in one year because then you will have a different type of risk control and way of handling new business.

From my perspective, this is a key factor for my assumption that Lifco will be able to continuously accumulate for a long period of time. From my perspective, “reasonable” growth can be defined as growing externally without sacrificing on quality, values or the financial health of the group as a whole. In 2023, Lifco deployed a total of 3.7 billion SEK on acquisitions representing 82% of its operating cash flow before changes in working capital, and thus being consistent to the target of reasonable growth. Additionally, the Group’s ratio of net debt (interest-bearing net debt) to EBITDA remained unchanged at about 1.7x (1.1x), thus leaving much financial room left for further acquisitions. Regarding the quality of the acquired companies, we can conclude that Lifco is impressively demonstrating continuous margin expansion as the average EBITA margin in 2023 was 28%. However, as these are still industrial-related companies, we should be cautious and not expecting this trend to continue unlimited. This was also indicated by Lifco’s CEO:

We strive for always improving our margin in our existing companies, and our appetite for very high-quality companies has basically increased. However, I would like to also here – put a statement out that we are not necessarily in acquisitions – going to always have a higher margin on the acquisitions. Now we’re on a level where we think there’s companies that could be good enough for Lifco with slightly lower margins. So the outcome here can be quite – could be a little bit different in the next coming years.

So while the margins of acquired companies reached new highs, it’s impressive to notice that Lifco didn’t even back down on the takeover multiple. If we include contingent considerations, Lifco paid a total EV/EBITA multiple of 6.6x on average during 2023, which is slightly below the average paid over the last 10 years.

The positive impact of these increasingly profitable acquisitions combined with an overall organic margin expansion is further responsible for an enhanced ROCE of 22.6% in 2023. However, the increase here is less significant due to a simultaneously decreasing capital turnover that partly offset the profitability improvements. Nevertheless, it remains remarkable how quietly and steadily Lifco accumulates additional cash flow through acquisitions and still seems able to deploy it with solid returns.

Cash Flows

In order to analyze a company’s ability to generate cash from operations, I focus primarily on its free cash flow. Despite the usual calculation (OCF – CapEx = FCF), I adjust the operating cash flow for changes in net working capital. Using this approach, I try to get closer to the actual and sustainable cash generation of the business through the perspective of its owners.

For Lifco, the calculation looks like this:

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In 2023, Lifco reported an EBITDA of 6,287 million SEK and was able to convert about 65% into FCF, which is slightly below the historically average free cash flow conversion. Per Waldemarson commented on the cash flows this year as follows:

On a full year basis, we have a big improvement of 45%, mainly related to weaker cash flow in 2022 due to the material supply situation and the inventory situation that is now gradually reversing in the right direction for us. […] And once again, I remind everyone we had some problems with cash flow during the raw material crisis, supply chain crisis in 2021, 2022 and now 2023, we are back to normality, again, which is very pleasing to see.

So despite current macroeconomic headwinds, Lifco is benefitting from an ongoing normalization throughout the supply chain that also should enable the company to increase the efficiency of working capital again. For now, this year’s results demonstrated why it can be appropriate to adjust the FCF for changes in working capital as these changes are often only temporarily and distort our assumptions of the actual cash generation of the business. By doing so, we derive at an increase of 8.4% of the FCF compared to 2022, while the conventional calculation would have stated an increase of 46%.

Using the current analyst expectations for Lifco’s EBITDA in the next two years and the 5-year average FCF conversion, we derive at an estimated CAGR of 9.5% until 2025. And in terms of the conclusions drawn earlier, we can assume that these expectations will only be possible if Lifco continues to fire up its M&A machine, as organic growth is likely to remain stagnant in the coming year. However, given the below-target leverage ratio and solid cash flow, I remain confident in the company’s ability to grow at a high single-digit or even low double-digit rate.

Valuation

After Lifco’s share price took a dive in the last October, we can notice a sharp comeback to 272 SEK, which represents a 30% increase over my last article one year ago. The operating performance during this period was solid, yet below the share price appreciation, which already indicates an equally increased FCF multiple. And indeed, using the unchanged number of shares outstanding we derive at a current market capitalization of 123.7 billion SEK and an enterprise value of 134.4 billion SEK.

Accordingly, Mr. Market is applying an EV/FCF multiple of almost 33x for the Swedish compounder after we faced a multiple of 28x last year, which was relatively close to the historical average.

Therefore, Lifco is currently trading at an above-average valuation, without having reached unreasonable heights. Of course, this sparks no excitement for investors looking for a cheap opportunity. However, given the uncertainty towards the organic business performance of the company, I would expect a similarly high variance of the share price as last year, which will could definitely open up chances for patient spectators.

This is made even clearer by the inverse DCF model. Using the current share price and FCF, we’re now having to apply a CAGR of 12% for the next 10 years to equal the implied market expectations. Also, I adjusted the TGR to 3.5% as the accounting for only the next 10 years probably won’t equal the current prospects for Lifco’s growth runway. Nevertheless, considering the analyst expectations of about 10% for the coming years, we quickly notice that the current valuation seems to be slightly ahead of the underlying business.

Conclusion

Lifco is one of my favorite holdings due to its resilient business model, the efficient capital allocation and its remarkable management of growing in a “reasonable” and sustainable way. Expanding the geographic reach for acquisitions will continually enhance the company’s competitive advantage and the overall market to fish for quality niche businesses that meet Lifco’s hurdle rate. At the same time, the accumulation of cash flows from more diverse geographies increases the Group’s resilience and reduces individual business risk.

That said, given the recent quarter and the overall macroeconomic headwinds, we should remain cautious about extrapolating growth rates too optimistically in the short term. Weaker demand and the absence of favorable projects are likely to result in another year of flat organic growth.

Yet Lifco has demonstrated its ability to successfully defend margins and acquire promising niche businesses, as reflected in a new record EBITA margin and the number of acquisitions in 2023. With a continued low net debt to EBITDA ratio of 1.7, Lifco has plenty of financial room to fuel its M&A engine to drive future growth rates.

All in all, these latest results have reinforced my conviction in this Swedish juggernaut, even though the recent price run doesn’t offer a significant investment opportunity. As a result, I’ll stick with my current holding and wait patiently for the next short-sided market decline.

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.