KH Group Q2'24 preview: The value melts as Indoor sputters

Translation: Original comment published in Finnish on 08/12/2024 at 8:00 am EEST

On Friday, KH Group revised its guidance for the current year for a second time, referring to Indoor’s poor performance and sending a message about really weakQ2 figures. We cut our estimates especially for indoor Group, but also slightly for KH-Koneet. Our sum-of-the-parts calculation still indicates clear value related to KH Group’s balance sheet, but in a very challenging business environment, significant leverage combined with poor performance exposes the entity to value destruction. Due to the weakened risk/reward ratio of the stock, we lower our target price to EUR 0.60 ( 0.72) and revise our recommendation to Reduce (was Accumulate).

The profit warning clearly referred to Indoor, but KH-Koneet's sputtering has probably also continued

KH Group's updated outlook expects 340-360 MEUR pro forma revenue and 4-7 MEUR pro forma EBIT (was 370-390 MEUR revenue, 9-13 MEUR EBIT). With two drastically reduced guidance items, this year will be a clear disappointment. With current data, it is challenging to assess to what extent the Group suffers from temporary cyclical weakness and to what extent the relative competitiveness of the subsidiaries has deteriorated. In its profit warning, KH Group specifically referred to Indoor’s weakness and stated that the furniture market is not expected to recover in H2. In the furniture market, Ikea has been very aggressive, which amidst a shrinking market, pushes other players into a tight position. Ideally, the Group’s challenges are limited to Indoor Group, but after the Group’s substantial profit warning and exceptionally weak Q1 performance, the development of KH-Koneet also worries us.

Estimates cut for Indoor Group and KH-Koneet

The profit warning was not a significant surprise, as our estimates were at the bottom of the previous guidance range and we flagged the risk related to the guidance in connection with our previous update. However, the scale of the profit warning surprised us and brought the balance sheet concerns back to the surface. We cut our estimates especially for indoor Group, but also for KH-Koneet. Our updated estimates for 2024 predict pro forma revenue of 354 MEUR for current operations and an operating result of 6.2 MEUR (previous pf revenue  : 378 MEUR, operating result 9.7 MEUR). In connection with the profit warning, the company said that it does not expect the furniture market to improve during the year, but H2 is seasonally stronger for Indoor and the completion of the new ERP system should create conditions for the company to improve. In connection with the Q2 report, our attention is particularly focused on Indoor and KH-Koneet.

There is value, but it is quickly destroyed at the current performance level

Our sum-of-the-parts calculation indicates a value of EUR 0.78 per share for KH Group. In our opinion, there is no doubt that significant value can be extracted from KH Group's balance sheet andthe stock's  bull thesis is easy to communicate: Balance sheet risks will not materialize, relative profitability of KH-Koneet and Indoor Group will recover  to historical levels as the cycle turns, which pushes earnings-based valuation to a low level and enables a structural change. However, due to the balance sheet risk caused by significant leverage, the fair value of the stock is very sensitive to changes in the performance of subsidiaries, and a turn for the better is urgently needed to avoid balance sheet risks.  The Group’s challenges are undeniably focused on Indoor Group, and we believe that KH-Koneetwould separately be priced with a higher multiple, as the current ownership structure poses a risk of the challenges in Indoor being prolonged and weak capital allocation, where Indoor’s debt would also infect the parent through excessive capitalization.