Q2 2023/24 was a challenging quarter, as expected. The heat pump market has seen a considerable slowdown from last year's exceptional activity levels as a consequence of a weaker macro environment, less favorable price conditions between gas and electricity, and uncertainties related to different subsidy schemes across several European countries.  

Net sales in Q2 2023/24 came in at SEK33.4m (110) versus our estimate of SEK36m. A decrease of 70% y/y but increased 21% q/q. Residential accounted for SEK21m (62% of sales), while the commercial segment contributed SEK11m. The deviation versus our estimates primarily stems from weaker sales in the commercial segment.

Sales from Nordic countries reached SEK14m (47), harmed by the temporarily weaker Danish market in particular (contributed with cSEK39m in Q2 2022/23) versus cSEK6m in Q2 2023/24.

The gross margin reached 31% (31.6), an increase versus 21.7% in Q1 23/24 due to a more normal sales mix. Opex levels came in higher than our estimates (even adjusting for cSEK1m in one-off fees), where new hires in its digital offering have put some upward pressure on salaries. The lower sales volume and higher Opex were the reason that EBIT came in below our estimates during the second quarter. EBIT in Q2 2023/24 came in at SEK-5.5m (21) versus our estimate of SEK-4m.

Cash flow was decent, and operating cash flow was positive SEK10m after two weak quarters from an operating cash flow perspective. The underlying free cash flow was SEK8m. ES ended the quarter with a net cash position of SEK80m versus SEK85m in Q1 2023/24.

Inventory levels increased sequentially and reached SEK107m (49), corresponding to 54% (21) of LTM sales. Even though this ties up capital, we believe the obsolescence risk is low and that ES could act quickly once the market rebounds.

During the fall, ES received several certifications for its products in important geographies, such as the UK, Germany, and Austria. This has become even more relevant from a market perspective as some certifications are required to be included in assessing subsidies. ES could now scale up its operations in the UK and Germany and is currently evaluating a local partnership structure in Germany. Austria is a new market for ES, which may be a fast-growing European market as its supportive systems for electrified heat pumps, covering costs up to 15,000 euros, promote cost-free transitions to eco-friendly heating for consumers.

New production facility

ES, in collaboration with Amitime Thermal Technologies, Energy Save is investing in a new heat pump factory in Turkey. Construction in Istanbul is set to begin in H1 2024, with completion expected in H2 2025. The total investment will be SEK23m, cSEK5.8m will be paid in FY 2023/24e, and the remaining part will be paid gradually until H2 2025e. The investment aligns with the partnership strategy, securing future product availability and ensuring higher priority during high-demand periods. The new European factory aims for an initial capacity of 50,000-100,000 units per year. The new production facility will be located in the “Istanbul Trakya Free Trade Zone” and is strategically located at the crossroads of Europe and Asia. It may also come with tax benefits and other financial advantages.

Financials skewed towards H2 2023/24

Management communicated that it will not be able to meet its financial targets in FY 2023/24e, which implies 20% sales growth y/y and an EBIT margin of 15% over a business cycle. However, even if the market challenges are likely to remain for one or a few quarters, management stated it was more now that a rebound in the market may be closer than expected.

We expect sales and profitability to improve in H2 2023/24e based on introducing and re-introducing subsidies in several key strategic markets such as Germany, Denmark, the UK, and Austria from 2024e. Furthermore, the commercial partnership with Aira is starting in Q3 2032/24e, supporting sales even though we anticipate a gradual upscale. Aira is now up and running in Germany, Italy, and the UK, and we pencil in a contribution of cSEK15m in Q3 2023/24e and cSEk20m in Q4 2023/24e.

We expect a stronger acceleration in FY 2024/25-2025/26e from a broader rebound in the market, Aira scaling up its activities and entering new markets. Its new production facility in Turkey will also support volume from H2 2025e.

We lower our sales estimates for 2023/24-2025/26e based on the Q2 2023/24 report and lower visibility in the coming quarters based on the continued challenging market. As such, we now expect growth levels to be muted even in Q3 2023/24e before accelerating from Q4 2023/24e based on the licensing agreement with Aira and improved outlook in several key markets. Lower sales volume and raised Opex assumptions put even further pressure on our EBIT estimates.

In total, we reduce sales from SEK326m to SEK190m in FY 2023/24e, from SEK466m to SEK350m in FY 2024/25e, and from SEK561m to SEK431m in FY 2025/26e.

Regarding EBIT, we reduce it from SEK33m to SEK-8m in FY 2023/24e, from SEK69m to SEK35m in FY 2024/25e, and from SEK85m to SEK54m in FY 2025/26e.

Peer valuation

Given ES's current geographic presence, we argue the Nordic peer group is the most relevant one. Nibe and Beijer Ref are the most relevant peers given the same end-exposure. However, the size, track record, earnings volatility, and history differ from ES. We apply a broader key peer group consisting of Nibe, Beijer Ref, Systemair, Nederman, Lindab, Absolent, and Munters. All are operating within the sustainability field but with different end-exposures. Our broader Nordic selected peer group trades at c15x-14x EV/EBIT in 2024-25e, while Nibe and Beijer Ref trade at c21x-19x EV/EBIT in 2024-25e.

Despite a stronger growth outlook and similar margin profile, ES trades c60-80% below our broader selected Nordic peer group and c80% below its closest peers, Nibe and Beijer Ref.

On the back of the weaker-than-expected Q2 2023/24 report, sustained market challenges, and lower visibility, we reduce our valuation due to lower estimates in 2023/24e-2025/26e. We have also increased our WACC due to increasing our risk-free rate from 2.5% to 3%.

In the long run, we take a conservative margin approach as we believe the fierce competition in the market could pressure margins over time. Our new valuation range is SEK90-SEK160 (100-275) with a base case of SEK90(150), based on a DCF and earnings multiple approach. We provide our key assumptions below. Our base case of SEK90 corresponds to 14.5x EV/EBIT(24/25e), c5% discount versus our broader selected peer group, and a c30% discount versus Nibe and Beijer Ref.