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Morningstar | SKF's Automation of Its Manufacturing Process Should Provide Moderately More Margin Protection

SKF provides its customers with measurable operational cost savings versus competitor bearings, which it can accomplish by designing its ball bearings on an application-specific basis. As one of the two largest industrial bearings suppliers, along with Schaeffler, it draws on its more than 100 years of experience in industrial application design to lower energy costs and extend the length of time in between maintenance breaks. Customers are willing to pay a premium for this engineering and often sign supply contracts, as work stoppages are very costly for customers running processes for hours at a time, or even on a continuous basis. Demand for ball bearings swings with the business cycle, and SKF's research and development focus targets sectors in growth industries like renewables, on top of its general industrial base of business. By tilting its research and development portfolio towards wind turbines and other equipment with above-GDP growth, the company can take some, but not all, of the sting out of the cyclical swings. SKF is undertaking a restructuring program, installing more automation in its manufacturing process and updating its ERP systems; this is a multiyear project running through to 2022. This should increase productivity and improve inventory management during cycle swings. The company has also been reducing working-capital commitments by outsourcing receivables, with a third party being better at collections than the company itself, reducing the number of suppliers and using more vendor financing. Combined, these initiatives should bring around SEK 500 million annually in working-capital reduction. Productivity improvements from increased automation, as well as operating leverage, increases our operating EBIT margin forecasts to 12.2% in 2022 from 11.3% in 2017. In sum, we forecast the benefits from working-capital improvements plus margin expansion as driving 3%-7% growth in earnings and free cash flow in the medium term, while we expect revenue to grow at around 3%.