Morningstar | Currency Tailwinds Masking Atlas Copco's Modest Weakening in Demand; Shares Look Expensive
Narrow-moat Atlas Copco's second-quarter results on a reported basis were in line with expectations but boosted by a currency tailwind; while underlying demand and margins showed signs of retrenchment, albeit on a modest level. Revenue grew by 5% and 1%, on a reported and organic basis, respectively. The EBIT margin declined by 60 basis points year over year. While we have tweaked our forecasts for the results, the changes are not material to our SEK 241 fair value estimate. Shares look expensive at 20 times P/E (for the next 12 months) on consensus estimates, above the 18 times average since the end of the Great Recession. We expect near-term demand to remain soft, while not showing the same drop-off as 2015, post the commodities bust.Looking into the details, weakness from the semiconductor and automotive end markets led to revenue declines in the vacuum and industrial techniques divisions, respectively, of 7% and 3% on an organic basis. Negative operating leverage as well as mix led to modest margin compression in both divisions. The two divisions combined, generate about 40% of group revenue.
Nearly half of the company's revenue comes from its compressor business, which experienced modest revenue growth of 2% but was supported by large compressor orders, which tend to be both erratic and lower margin. The divisional EBIT margin declined modestly by 20 basis points year over year. The division's underlying demand is more dependent on small- and medium-sized compressors that are used across a wide array of sectors. Demand in this segment was softer seemingly because of customer concerns about the the effect of trend tensions and broader economic softness.
The standout in the quarter was power technique with 13% organic revenue growth. While impressive, demand was limited to North America and driven by the rental business. We would not expect sustained double-digit growth for the division.
Atlas Copco provides industrial productivity products and services. Co.'s operations are divided into four business areas: Compressor Technique (provides compressors, vacuum solutions, gas and process compressors and expanders, air and gas treatment equipment and air management systems), Industrial Technique (provides power tools, assembly systems, quality assurance products, software and service through a global network), Mining and Rock Excavation Technique (provides equipment for drilling and rock excavation), and Construction Technique (provides construction and demolition tools, portable compressors, pumps and generators, lighting towers, and compaction and paving equipment).
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