Atlas Copco A - Survival of the fittest: Upgrading to Buy
Solid cash flow and balance sheet, attractive risk/reward
After the recent share price underperformance, Atlas Copco is trading at what we consider an
unwarranted sector discount. At a price of SKr200 Atlas shares seem to be discounting SKr13 EPS on
mid-cycle multiples (in line with 2016 consensus), disregarding Atlas's strong balance sheet which we
estimate could add up to 30% EPS growth through leverage (increasing to 2x Net Debt to EBITDA).
Consensus earnings expectations have been curbed and now look undemanding. Despite lacklustre end
markets, we see Atlas outperforming the sector on the back of improving returns, superior cash flow and
a strong balance sheet which, combined with lower market values, could also potentially rekindle its
M&A appetite. We upgrade the stock to Buy.
Better end markets + better cash flows = outperformance
We believe Atlas Copco deserves a premium valuation rather than its current discount to the sector. It is
the sector player least impacted by (still) deteriorating mineral investment patterns (click here for our
latest mining capex report) and, mining apart, Atlas Copco's growth has been in line with peers. Recent
organic growth, and positive trends for margins and cash flows, should mark the beginning of operating
outperformance, especially once the firm restarts its M&A cycle and/or continues to distribute
shareholder returns ahead of peers.
Limited downside to consensus; upside if M&A is factored in
We think it is quite unusual to see Atlas Copco underperforming its peer group, as consensus is
forecasting for the next three years: the consensus call is for 7% EBIT CAGR in 2015-17 (we estimate
6%), which is more modest than the "hockey-stick" (>10%) recoveries being forecast for the likes of
Sandvik, FLSmidth and Outotec. Moreover, Atlas Copco's balance sheet is in a better condition than
those of its peers. We think this balance sheet strength could be used to acquire growth, mitigating part
of the earnings downside risk (our upside scenario factors 15% M&A-derived growth).
Valuation: Lifting our price target to SKr230; valuation discount unjustified
We raise our price target to SKr230 (the average of our FCF and static valuation methodologies), driven
by better cash flows (lower working capital) and balance sheet (lower net debt) resulting in higher ROEs
and ROICs. At our target, Atlas would trade on 12x 2017E EBIT. Atlas Copco still trades at a premium to
its long-term average multiples (12%), but only trades in line with its peer group despite its superior
quality, in our view.