Atai Capital - Bel Fuse: We Don't Think $140M EBITDA Is Out Of The Cards For 2025
Bel Fuse, an electronic components manufacturer, is expected to see significant EBITDA expansion over the next few years, from $83m in 2022 to $120m in 2024.
BELFA's EBITDA margins nearly doubled year-on-year from 8.5% to 16.3% in the most recent quarter.
Despite currently trading at a ~6.00x EBITDA multiple, it is predicted that Bel Fuse could be trading at 9.00x-10.00.
The following segment was excerpted from this fund letter.
Bel Fuse Inc.
Bel Fuse (NASDAQ:BELFB) is an electronic components manufacturer, and despite the rather large run-up in share price, we are still being provided with an attractive opportunity to buy a good business at a dirt-cheap price today. They design, manufacture and market a broad array of products that power, protect and connect electronic circuits. Like many industrials, they have 1,000s of SKUs (stock keeping units, which is just a fancy way of saying product), so I won't be diving into each product they make, but a few examples would be magnetic Ethernet connectors for servers, fuel quantity monitors for aircraft, and cable assemblies + fuses for electric vehicles.
Most of their products aren't exactly "ground-breaking" or super differentiated, but this is true of any electronic component manufacturer. Despite selling some commoditized products, these companies benefit from a low-cost but high cost of failure product offering. For example, while a fuse itself is usually a cheap and commoditized product in relation to the product it goes in, it remains an essential safety device that can save several other components. Customers want and need these products to work, and work well. Furthermore, while the switching costs for most of these commoditized products are usually low, it just doesn't make sense in most cases to risk failure and pick up pennies in front of a steamroller. However, because there typically aren't significant technological differences between fuses, connectors, etc., switching is easy. Hence, businesses offering these more commoditized components need to make sure inventory levels stay stable to maintain customers. If your fuses and other products are consistently in stock at distributors and affordable, it's unlikely customers have any good reason for switching. These more commoditized products are usually sold through distributors (~33% of Bel's business is through distribution) rather than to customers directly because these products tend not to be "custom built" for a specific end product. However, commoditized/distribution doesn't necessarily always mean low margin, and Littelfuse (LFUS, one of Bel Fuse's competitors) is a good example of this. Despite having 75% distribution exposure in their electronic components segment, they still maintain low-twenties operating margins.
Then on the flip side of things, these companies also have long-standing large contracts/relationships for more custom-engineered products (~67% of Bel's business). These relationships tend to be balanced, but the customer does have more "pull" in some cases. Pricedowns are commonly included in larger/longer-term contracts based on volumes, and price increases are usually only passed on to the customer when a contract ends/comes up for renewal. This means it might sometimes take a few years to pass on pricing to customers. In contrast, distributor pricing can typically be passed on within a couple of months to a year. As mentioned, this isn't a totally one-sided relationship, and manufacturers will usually negotiate some form of content growth in exchange for price downs as well. For example, if an EV manufacturer wants Bel Fuse to come down 5% on its cable assemblies, then Bel Fuse might say that is fine, but they'll want the EV manufacturer to offer them more content opportunities in exchange, such as Bel Fuse now supplying the fuses on that same EV - This is a benefit of these longstanding relationships and allows for both the customer and manufacturer to win.
Overall, these are pretty good businesses, with most sporting solid organic growth and strong end markets such as aerospace, networking, and electric vehicles (all of which Bel Fuse has a good amount of exposure to). They also benefit from the continued electrification of almost everything; look no further than Bluetooth/Wi-Fi-enabled temperature-controlled coffee mugs, and some even have LEDs! For these reasons, they usually trade around 10x-12x+ EBITDA (multiples have expanded some recently with LFUS and TEL at 15x and 13x, respectively), and some like Amphenol trade at a whopping 18x multiple, but to be fair, they are considered the gold standard.
The thesis here is straightforward, we believe Bel Fuse's EBITDA is going to expand materially over the coming years, from $83M in 2022 ($100M LTM) to $120M in 2024, and we also don't think $140M is out of the cards for 2025.
In the most recent quarter, EBITDA margins nearly doubled y/y from 8.5% to 16.3%, and it's worth noting that Q1 is also their weakest quarter due to seasonality (Chinese New Year), but despite this, margins still increased 150bp sequentially! This quarter had smashed our expectations, and we subsequently increased our position. But how did margins double you might ask, and is that even sustainable? Well, Bel Fuse makes good products that customers want, but there was practically zero attention paid to the bottom line under the current CEO's tenure - this led them to actually selling some products at a loss (yes, really). However, a new CFO was appointed in early 2021 (Farouq Tuweiq), and he is now turning that around. Under his tenure, EBITDA margins have more than doubled since 2020, and Gross margins are up over 500bps and comparable to peers.
Another interesting note is that Bel has yet to have a quarter where one of its segments isn't dragging down the others. In this quarter, it was Magnetics, which is facing inventory issues that will eventually clear up but have led to a 670bp decline in gross margins sequentially in the interim. This isn't related to a demand problem however, but rather a bottleneck that some of their customers are facing. For example, Cisco might have enough Bel Fuse RJ45 connectors for their servers but can't get enough power supplies from Bel Fuse to get the product out the door, so once supply for these missing parts catches up with demand, magnetics should normalize. The company has also recently undergone some restructuring that should add ~$5M in cost savings as we exit 2023, and as the company continues to benefit from more operating leverage and some final price increases, I believe they can get to 18% EBITDA margins or higher in 2024. I've spoken with Farouq many times and continue to be impressed with him, and he also continues to purchase shares in the open market. Bel Fuse's newly found attention to margin expansion can also be seen with the recent selling of their Jersey City headquarters in June of this year and their subsequent move to a less expensive property outside the city. While I doubt this moves the needle, it shows Bel Fuse's continued devotion to improving their bottom line.
Considering all the above, we see Bel Fuse doing around $120M in EBITDA for 2024 (give or take a couple of million in either direction). This means that at the current share price of ~$57, Bel Fuse trades at just a ~6.00x EBITDA multiple while peers trade at 12.00x+.This large disconnect in value should close over time as the market realizes Bel Fuse's margin expansion is here to stay and isn't even done yet. While we don't believe Bel Fuse deserves a 12.00x multiple today for a couple of reasons (They still have lower margins than peers, and there is a controlling shareholder as well - whom we are slowly getting more comfortable with over time), we see no reason they shouldn't be trading at 9.00x-10.00x which implies a share price of $83-$92 before accounting for incremental cash gen (capex runs around just $10M in a normal year, so the business is far from capital intensive). Bel Fuse has also traded at an average of 7x-8x EBITDA over the past decade (when it was a worst business, selling products at an actual loss and had materially lower margins). Even at an 8.00x multiple, you would still get to $73/sh today.
If we look out a few years to 2025/2026, I don't think it takes egregious assumptions to get to $120+ a share. LSD topline growth, 19%+ EBITDA margins, credit for incremental cash gen, and a 10.00x multiple get you there - those seem like reasonable assumptions to me today.
