An overlooked German micro cap Gem I bought
Stemmer Imaging Business model
Since Stemmer Imaging is getting acquired, I decided to drop the Paywall from all Stemmer Imaging articles. While the company won’t be tradable anymore, it still gives you an idea of the type of work I do for paid subscribers.
Welcome to my first article on a hidden European Champion. As I developed and learned as an investor, I started to get drawn to small companies outside of the public opinion. There are many high-quality businesses waiting to be discovered. With an enterprise value of Let’s get started right away. This post will be split into parts, with the first focusing on the business and the second focusing on the numbers. Disclaimer: I own shares in Stemmer Imaging.
Stemmer Elektronik was founded in 1973 near Munich by Wilhelm Stemmer and then later merged into Stemmer Imaging in 1987. Since then the company has grown to be the leading value-added distributor of machine vision/artificial vision in Europe. In 2017, the founder sold the business to the business development firm PRIMEPULSE SE, a holding company looking to grow sustainable technological growth businesses, which then listed it in 2018. Owning initially 50.1% of the company, PRIMEPULSE has since then acquired more shares and owns 69% of the shares, with management owning another 8%. Stemmer has good alignment with shareholders due to its large anchor investor with a long term investment horizon, insider ownership of the management team and a compensation structure focused on EBITA growth and share price performance. While management hasn’t been at the company for decades (most joined after the IPO), they sound conservative and focused. After selling the business, Wilhelm Stemmer founded the Wilhelm Stemmer Foundation to improve education in the STEM fields in Germany as a result of observing the lack of qualified new workers in the field.
Business Model
Stemmer is a value-added distributor, service provider (operational and engineering) and developer of subsystems and own products/IP in the machine vision (MV) and artificial vision (AV) space. While MV/AV was in the past largely an industrial business case, this is changing with more non-industrial use cases appearing after the opportunity was identified on the 2019 Capital Markets Day.
The majority of these non-industrial use cases are in the AV space. In the two shared pictures, you can see the wide array of use cases for these technologies, and I expect we will find many new use cases in the coming years. AI is the big buzzword of the last year and looks to be a growing trend instead of just hype. AI needs data, lots of data and Machine Vision can capture and process visual data, enabling AI applications in all sorts of fields. MV is a fundamental part of AI infrastructure and should see substantial investment for that reason.
The Machine vision market is expected to grow in the high single digits by most analyst firms, while artificial vision is expected to grow at a (much) faster clip.
Besides AI, there are a number of other trends driving business:
Scarcity of skilled labor
Digitalization
Electrification/Decarbonisation
Circularity/Reuse of materials
De-globalization
As a distributor and service provider it is important to have a dense network of locations. This network effect helps to create new business and cost advantages (buying power and logistic savings). Below you can see Stemmers’s 15 locations, with the majority across Europe, but also two in Latin America. In FY 22 Germany accounted for 51 million, Europe (ex Germany) 99 million and LATAM 4 million Euro. We can see that Stemmer has well-diversified revenue and is not just focused on its home market. I am, however, skeptical of the LATAM business. It was acquired together with the Spanish location in the INFAIMON acquisition in 2019. It could be too early for Stemmer to focus resources on expansion on another continent. However the company is producing good cash flows, so there is enough cash to reinvest here. The company also is looking to get into the USA, if they find a suitable acquisition. I like the focus on internationalization, but I’m not sure if outside of Europe is the right move at this stage. The development of the expansion ex Europe has to be observed by investors.
The company has a culture of an entrepreneurial approach to operations and continuous improvements with a KPI-based process management. Over the last year, they consolidated sales and sales support into one model between locations and launched a central digital offering for customer interactions. These, together with other growth, digitalization, and efficiency initiatives, led to steady margin expansion over the last years, as we’ll see in the follow-up article diving into financials and valuation.
Through its diversified product and service offering, Stemmer can benefit from cross-selling/up-selling, and the products often have a lock-in effect once a Stemmer component is inside the engineered product. Often, this is a result of regulations, and getting another part speced in is too much effort to justify, leading to sticky customer relationships and revenue.
Stemmer has increased its focus on two areas in the last years:
Artificial Vision has taken revenue share from the Machine Vision and Solutions has taken share from the Distribution business. AV, with large parts in non-industrial sectors, is the higher margin segment and a great diversification for Stemmer while also contributing to rising margins. Similarly, Stemmer has continually increased the percentage of its solutions business (where Stemmer develops components or subsystems at a higher margin than distribution) to currently 32%. The goal is for a 60:40 split between Distribution and Solutions.
Risks to the business model
Stemmer is in a stable business, but there are definitely risks. The MV/AV industry is cyclical, especially MV depends greatly on industrials and their willingness to invest. While some of the revenue is reoccurring through service contracts, much is project-based. Right now, the industry is going through a tough period, and companies are drawing down inventories (which we can observe with Stemmer, too, in the next article diving into the numbers). Obsolescence of inventory is also a risk, while many items can be used for several use cases, the technology is advancing, so you can’t hold onto inventory forever until it will lose value.
A growing end market often means an increasing number of competitors. While Stemmer is a leading European distributor, competition will increase in the coming years. I am confident that Stemmer will be able to fend off competitors and at least keep its market share while increasing it with M&A in other geographies.
Business model conclusion
Stemmer Imaging is operating in an industry crucial as the infrastructure for many technological developments. It is a leading distributor and value-added solutions provider, which has been able to outgrow the industry in the past. Due to its network, it has scale advantages, but the industry is still early and growing. The company is well managed with a focus on KPI-based operations and low risk-taking, with a large anchor shareholder and 8% of shares owned by management. Distribution businesses are attractive because they are the intersection between many sellers and buyers and can add expertise and customer service to differentiate and upsell customers.
Up next
I’ll split this article into two pieces, with the next one on fundamentals and valuation coming at the end of the week. I’m currently a bit ill, so excuse the delay. I hope you enjoyed this post, and please take a second to vote on the post below.