An intensified focus for Atlas Copco

A year on, we think that events in the intervening period have added ballast to our conjecture, while a proposed split of the company’s key mining interests from the rest of the group could substantially enhance investor returns and improve efficiencies across the group’s businesses. Add in balance sheet strength and improved prospects for the group’s ‘vacuum technique’ business and we feel justified in reiterating our buy recommendation for this constituent of Sweden’s blue-chip OMXS30 index.  

A key event for Atlas in 2018 is a planned split into two listed companies, comprising an industrial business and a separate mining and civil engineering business whose equity would be distributed to the same shareholders. Epiroc will be the name of the entity that the group will spin out (via a distribution arrangement) provided shareholders approve the split at the 2018 annual meeting in April. 

If the proposal is approved, Atlas Copco’s shareholders will receive shares in Epiroc in proportion to their existing shareholding. The plan is to list Epiroc on the Nasdaq Stockholm stock exchange in the second quarter of 2018.

Analysts at JPMorgan Cazenove characterise Epiroc as “an attractive standalone asset” that provides an opportunity to “play the mining upcycle”, with near-term demand “at high levels, albeit not accelerating at the same rate as in 2017, while revenue should see stronger growth”. 

The entity could prove an attractive acquisition target and the shares could benefit from related speculation as well as any approach. The new entity will feed into the mining and civil engineering sectors by taking over the hydraulic attachments portion of the existing business, while the residual Atlas Copco should be in a better position to focus the group’s expertise in areas such as automation and digitalisation, encompassing air compressors, high-tech vacuums and industrial power tools. 

A feature well worth mentioning is the relatively high proportion of profit that is derived from aftermarket and service channels, which helps to insulate earnings. 

It’s also worth highlighting that the group’s Vacuum Technique business, which is forecast to account for 17 per cent of sales this year and 20 per cent of profit, continues to perform well following a strong 12-month period. The business unit sells into the semiconductor and scientific markets, in addition to various industrial sectors such as food packaging. Another year of growth is envisaged through 2018 on the back of increased industrial activity, a rollout of ‘next generation’ vacuum-intensive techniques, improved activity in China and positive newsflow from the semiconductor market.

The flexibility afforded by Atlas Copco’s balance sheet also stands as a compelling feature of the investment case, particularly as the group has an established track record of generating shareholder value through acquisitions. 

JPMorgan Cazenove expects a small net debt position at the end of this year, giving way to net cash at the end of 2018. Operating free cash flow is forecast as SEK 4.65bn for the final quarter of this year, through to SEK 9.3bn for 2018 and SEK 20.5bn in the following year. Remember: cash is king. Over the same period, the conversion rate on cash profits is forecast to remain at or above 100 per cent, while the adjusted cash profit margin is forecast to increase from 20.5 per cent in 2016 to 22.9 per cent by 2018.