KHD Humboldt Wedag (KHD) is an international industrial engineering and equipment supplier for the cement processing industry. Thanks to reduced demand for its products due to the recession, the company is pretty close to just breaking even. However, the company has negligible debt and a cash position of about $350 million, yet it trades for just $273 million! Sounds like a steal, right?
Perhaps not. The strangeness of this company's name is matched only by the strangeness of its balance sheet: if one were to remove that net cash balance, the company would have negative equity of about $100 million! Meanwhile, the company is trying to sell its fixed assets in order to raise even more cash. What gives? Can shareholders expect a massive payment?
It would not appear so. KHD appears to operate in such a highly cyclical environment that not only is it not sufficient to not have any debt (as we've discussed is important for cyclical companies), but it needs an extremely large cash buffer to boot!
To understand this phenomenon, we have to understand the cash conversion cycle for this company. When a company contracts KHD to design/build a plant, it makes a large chunk of the payment upfront. KHD doesn't get to count this as revenue yet, since it hasn't performed any services. But using these funds, KHD will pay its suppliers, workers and other expenses associated with performing its end of the contract.
When a cyclical downturn hits, however, not only does it hit hard (order intake in the second quarter was a full 90% lower than that of the year-ago period), but it means there's no cash coming in! Even though KHD will be booking revenue in future quarters as it fulfills its backlog, it won't be receiving cash, but will still be spending cash on its costs.
The highly cyclical nature of this business combined with the fact that cash is paid upfront means there can be long periods of low cash intakes for this company. But during these long periods, the company still has to perform on its end of the contracts. As a result, the company has to maintain a large cash hoard just to stay in business, even though shareholders might think the cash can be paid out! It would appear that sometimes cash is not king: do not automatically believe that companies with strong cash positions offer a margin of safety.