Energy Save reported Q3 23/24 net sales of SEK50.3m (SEK87.4m) versus our estimate of SEK55.7m. A decrease of 42% y/y, but an increase of 51% q/q. The deviation stems primarily from weaker-than-expected sales in the commercial segment. However, we were encouraged to see that sales grew 51% sequentially, which we believe is almost solely driven by the Aira partnership starting to generate deliveries from Energy Save.

Sales from the residential segment accounted for 84% of sales, while the commercial segment represented 13%. Sales from Nordic countries reached SEK8.4m (SEK49m), primarily driven by the weaker Danish market, which only contributed to SEK0.9m in Q3 23/24 versus SEK45m in Q3 2022/23.

This development was rather expected, as the European market (although somewhat dependent on region) has had a very challenging two recent quarters. Also, as Energy Save primarily goes to the market through its network of distributors, it seems that there has been inventory build-up (at the distributors), which can cause clear short-term drops in the order intake as short-term demand weakens and the inventory levels among distributors have been more than enough to supply existing market demand. This seems to have been the case in Denmark in this quarter.

The gross margin reached 27.0% (31.5%) versus our estimate of 31.0%. This was a decrease relative to the Q2 '23/24 margin of 30.9%, which seems to be driven by a greater extent of direct deliveries to customers than before (which has a lower margin). We believe this is also a function of Aira-related sales taking place to a great extent in the quarter.

The quarter saw higher OPEX levels than the previous quarter, especially related to some other external costs related to the Aira partnership and product development. We also understand that Energy Save has recruited new staff to handle higher sales volumes in the future while positioning the company for when the markets normalise and regain momentum. In combination with the lower-than-expected gross profit, EBIT came in softer than expected at SEK-7.4m (SEK14.3m) versus our estimate of SEK0m.

Operating cash flow after changes in working capital came in at SEK-10.5m while underlying free cash flow was SEK-22.8m due to high CAPEX which is related to the investment in the new factory in Turkey. Energy Save ended the quarter with a net cash position of SEK46m versus SEK87m in Q2 '23/24.

Inventory levels increased sequentially and reached SEK115m (SEK77m in Q3 2022/2023), corresponding to 72% (27%) of LTM sales. Even though this ties up capital, we believe the obsolescence risk is low and that it allows Energy Save to act quickly once the market rebounds. We also consider it a necessity at the beginning of the Aira partnership.

Energy Save’s product offering allows companies like Aira to go to the market via its own brand, based on Energy Save’s technology platform. Earlier in 2023, Energy Save announced it is partnering with Aira, backed by Harald Mix-led Vargas.

There have been two press releases from Energy Save with information regarding the partnership with Aira.

The first was press released in conjunction with the publication of the Q1 report (published in June 2023) and referred to Energy Save becoming a technology partner to Aira, which initially included technology development and deliveries of equipment to Aira worth up to SEK20m. This initial development agreement was expected to be completed during 2023/2024. We believe that the SEK20m in revenues reflected cost coverage for the services provided by Energy Save – i.e. around 0% gross margin.

This first agreement then led to an updated partnership: a license agreement, which was press released in conjunction with the Q2 report published in September 2023

A summary of what has been communicated regarding the Energy Save-Aira partnership

We also know that Aira has previously acquired a factory in Poland to produce heat pumps starting in 2024. Therefore, we consider it likely that Energy Save’s sales to Aira will be tilted towards products and components in the early stage, moving towards license revenues in the later stage.

We estimate that product/component revenues should have a gross margin of around 20-25%, whereas license revenues should be 100%. Therefore, the sales mix is very important for the margin, and it is difficult from an outside perspective to assess the blended margin. However, as the partnership progresses in time, we believe it will be tilted towards license (as Aira should want to produce in-house given its Polish factory), and the blended margin should increase.

We believe Aira’s business concept allows the company to penetrate untapped parts of the heat pump market, approaching “uneducated households” through its vertical go-to-market strategy, where it has a growing network of installers while offering a subscription-based price model towards the customers (combined with generous service and guarantee commitments) – which should lower the barriers for approaching and acquiring potential new customers.

We believe that Energy Save will provide direct deliveries for Aira, which means that Aira will not hold any significant inventory levels. As such, Energy Save’s Aira-related sales should correlate rather well with Airas order intake. Therefore, we believe that Energy Saves sales from Aira should be linear going forward – even if the market is turbulent – as we expect Aira to be aggressive in gaining market shares (thus outgrowing the market).

It is, however, difficult to pinpoint these volumes from an outside perspective. However, we consider Aira a very credible partner, which we also argue verifies Energy Save’s business model and product offering. We do not rule out additional partnerships with other brands like Aira that might take place in the future. This could have a further positive effect on our estimates and valuation.

While it is difficult to assess what will happen after the initial four-year contract period with Aira, the likelihood is great that the vast majority of Aira’s installed base will be based on Energy Save’s technology platform. Given that Energy Save’s pumps are high quality while being attractively priced, we believe that it would not make sense to completely abandon the technology platform, and we do not rule out a continued strategic partnership between the companies (after the end of the contractual period).

2023 has been a challenging year for the heat pump OEMs active in the European market. NIBE highlighted in its Q4 2023 report, published a month ago in mid-February, that the end of 2023 saw a clear decline in order intake, driven by high-interest rates and elevated inventory levels among distributors, as OEMs delivery capacity has improved.

NIBE also saw further evidence of weak demand in the European market in the first week of 2024. As a result, the company initiated a cost savings program in conjunction with the release of its Q4 2023 report, where 500 FTE will leave the company, which is expected to save SEK600m pa. The cost-saving program was followed up in mid-March when NIBE announced that it would let 340 FTE go to Sweden.

In addition, Thermia announced in early March that it is letting 43 consultants leave, following another 29 in December 2023. The CEO also stated that, “Unfortunately, we don't see any improvement in the market”.

Furthermore, Bosch Thermoteknik, based in Tranås (Sweden), has decided to dismiss 100 FTE (following a similar action earlier in H2 2023) based on a sharp decline in the heat pump industry.

It is evident that there are significant near-term challenges in the European heat pump market, driven by high inflation and interest rates, coupled with delayed subsidy schemes and gas prices being on the same levels as before the sharp increase during 2021.

It is also evident that this has made an impact on Energy Save growth in recent quarters. However, with the Aira partnership in place, we believe that Energy Save will be able to outgrow the market in the coming quarters and years. We believe we are already seeing positive signs of this.

Data published by EHPA states that European heat pump sales declined for the first time in 10 years (-5% growth). The table also tells us that air/water, which Energy Save is active within, declined by around 12%.

Despite this, Energy Save has grown sequentially in the recent two quarters, despite the same quarters providing the lowest sales figures for heat pumps in 2023.

These EHPA figures do not include the UK, but we have learned that UK heat pump installations grew 20% in 2023 – probably largely thanks to its subsidy scheme. We have also found statistics from the UK government highlighting the number of heat pump subsidy applicants. We note that the activity in the recent four months has been high when compared to 2022.

The UK figures should be a very good indicator for Aira sales in the region given that the subsidy application should be a no-brainer for the customers – which is handled by the installer (which, in Aira’s case, plays an important role in the business model).

While the long-term market outlook remains very attractive for the heat pump market, short-term market fundamentals have deteriorated due to national subsidy schemes and the EU’s heat pump action plan being pushed in time.

This has likely, along with increasing interest rates, inflation, and lower gas prices, played a role in many European markets being hesitant – which has caused inventory build-up among distributors and directly affected Energy Save’s near-term sales figures.

We therefore consider the partnership with Aira, where direct deliveries will take place (which reduces the risk of inventory build-up), to be a good complement to Energy Save’s revenue streams.

We reduce our estimates on the back of Energy Save’s Q3 report and the current market conditions. We still expect Energy Save to generate attractive sales growth going forward, which Aira primarily drives.

Our growth estimates are largely dependent on Aira and the success it has in its markets. We argue that the company is operating in markets with relatively solid near-term market fundamentals, coupled with a value proposition targeting an untapped part of households that should allow for greater chances of gaining market shares in the overall heat pump market.

Tracking the adoption rate of Aira’s offering amongst European customers will be interesting. If successful, it should have a positive effect on Energy Save. We do already, however, expect sales to be scaled up gradually.

We slightly reduce our gross margin assumptions to better reflect a larger share of direct deliveries to Aira going forward (which was also why we saw a slightly lower margin in this quarter).

We also slightly increase our OPEX assumptions going forward, as we consider Energy Save to be forward-leaning in this environment to focus on developing its product offering and other measures to increase its long-term chances of further success with other potential partners.

All in all, our EBIT estimates are reduced for the period 2023-2026, but we have greater confidence in the Aira partnership turning out as a positive for Energy save – both strategically – and from a financial perspective.

On the back of the weaker-than-expected Q3 2023/24 report and sustained market challenges, we reduce our valuation due to lower estimates in 2023/24e-2025/26e.

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 SEK30(50)-SEK140(160) with a base case of SEK65(90), based on a DCF and earnings multiple approach. We provide our key assumptions below.

Our base case of SEK65 corresponds to 28x EV/EBIT(‘24/’25e), which is around 50% higher than our broader selected peer group and around 30% higher than NIBE and Beijer Ref. However, the multiple goes down to 10x EV/EBIT (‘25/’26e), around 30% lower than our broader selected peer group and around 45% lower than NIBE and Beijer Ref.

Please note that our estimates in this table use today's enterprise value of Energy Save in its forward-looking estimates rather than the enterprise value each year (which goes down as the cash balance increases).