EUR 850.00 For Business Accounts Only

Morningstar | Sandvik's 2018 In Line; Some End Markets Show Signs of Softness; Shares Richly Valued

Sandvik reported full-year results in line with our revenue and profit forecast. The share price looks rich to us at current levels. Sandvik has been enjoying what we think is peak cyclic order growth, which seems to be softening from automotive end markets in Europe and China, where the company also saw a weakening in demand from general engineering customers. We are maintaining our SEK 111 fair value estimate and no-moat rating. We believe the key difference between our forecasts and consensus is on margin, where we expect a slowdown in growth to lead to declining margins.

Since the last trough in 2015, Sandvik's organic order growth has gone from a decline of midsingle digits to a peak of 15% growth in 2017 and 11% growth in 2018. In that time, EBIT margins have expanded nearly 700 basis points. Order growth in the fourth quarter of 2017 was 6% but just 2% in the company's machining solutions business, including an 8% decline in China by our calculations. We think the cycle has turned and forecast just 2% revenue growth this year, in line with consensus. The consensus EBIT margin looks to us to be stable to slightly expanding. We think this is overly optimistic. Current management deserves credit for downsizing the cost structure, including shrinking the plant production and shedding lower-margin assets. This has most certainly helped to structurally expand the margins, but volume from the upcycle cannot be discounted as a major factor. Looking beyond the past three years, Sandvik's margins have undergone volatility from other upturns and dips in the cycle. We forecast margins to come down by around 140 basis points next year and a further 80 basis points in 2020. Our forecast midcycle margin is around 15% (which we expect for 2021). This forecast credits the company with structurally improving the margins, as it is above the roughly 13% historical average. We believe the consensus is too optimistic in holding margins stable.