26 January 2009
Swedish Mechanicals
Priced for imperfection, but
lacking fundamental triggers
Johan Wettergren
Research Analyst
(46) 8 4635 518
johan.wettergren@db.com
Peter Reilly
Research Analyst
(44) 20 754 59835
peter.reilly@db.com
Martin Wilkie
Research Analyst
(44) 20 754 51956
martin.wilkie@db.com
Stay cautious, low valuation not enough to trigger a sustainable recovery
A raft of negative macro and company news together with elevated demand
uncertainty has put the brakes on last year’s late sector rally. Although valuations
are inexpensive on broadly all metrics, with a bear-case earnings scenario already
reflected in share prices, the continued free-fall in leading indicators and further
downside risk to earnings forecasts point to a sustained cautious stance.
Deutsche Bank AG/London
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from local
exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. Deutsche
Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm
may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single
factor in making their investment decision. Independent, third-party research (IR) on certain companies covered by DBSI's research
is available to customers of DBSI in the United States at no cost. Customers can access IR at
http://gm.db.com/IndependentResearch or by calling 1-877-208-6300. DISCLOSURES AND ANALYST CERTIFICATIONS ARE
LOCATED IN APPENDIX 1.
Forecast change
Top picks
Alfa Laval (ALFA.ST),SEK58.75 Buy
Atlas Copco (ATCOa.ST),SEK54.50 Buy
Companies featured
Alfa Laval (ALFA.ST),SEK58.75 Buy
2007A 2008E 2009E
DB EPS (SEK) 7.80 9.96 7.93
P/E (x) 12.9 5.9 7.4
EV/EBITA (x) 9.4 4.4 5.1
Assa Abloy (ASSAb.ST),SEK83.00 Hold
2007A 2008E 2009E
DB EPS (SEK) 8.76 8.81 8.59
P/E (x) 16.7 9.4 9.7
EV/EBITA (x) 12.1 10.1 7.6
Atlas Copco (ATCOa.ST),SEK54.50 Buy
2007A 2008E 2009E
DB EPS (SEK) 6.47 7.63 6.55
P/E (x) 16.4 7.1 8.3
EV/EBITA (x) 12.1 5.9 6.2
Hexagon (HEXAb.ST),SEK26.60 Buy
2007A 2008E 2009E
DB EPS (SEK) 7.18 6.99 6.20
P/E (x) 17.1 3.8 4.3
EV/EBITA (x) 19.2 6.8 6.4
Sandvik (SAND.ST),SEK44.30 Hold
2007A 2008E 2009E
DB EPS (SEK) 8.21 7.51 5.52
P/E (x) 15.2 5.9 8.0
EV/EBITA (x) 12.3 6.4 7.3
SKF (SKFb.ST),SEK66.25 Hold
2007A 2008E 2009E
DB EPS (SEK) 10.67 10.30 8.61
P/E (x) 12.4 6.4 7.7
EV/EBITA (x) 9.0 5.3 6.4
Trelleborg (TRELb.ST),SEK42.00 Hold
2007A 2008E 2009E
DB EPS (SEK) 15.26 14.59 10.85
P/E (x) 11.5 2.9 3.9
EV/EBITA (x) 15.6 11.3 9.3
Global Markets Research Company
Q4 reporting – weak demand will be partially masked by favourable currency
SKF kicks of the reporting season for the Swedish mechanicals on 29 January.
Capex deferrals and production cuts, partially offset by the sudden fall in the
Swedish krona, are making forecast uncertainty abnormally high. We expect
average organic sales growth of -5% YoY (a sharp reversal from growth of 6% in
Q3) but a currency boost of about 8-9%. We forecast EBIT margins to fall 310bps
YoY, despite an estimated 150-200bp currency benefit. For detailed Q4 company
forecasts, please refer to the ‘Company section’ beginning on p.21. Note also that
this report changes forecasts and target prices for several companies; for a
summary, please refer to the tables on page 3.
We expect widespread dividend cuts
We think consensus expectations for dividends are too high. We now expect all
companies except Alfa Laval to cut dividends vs. last year. On average we expect
pay-outs to be 20% lower YoY, including a 22% hike from Alfa Laval. The biggest
cuts are expected from Trelleborg (54%), Hexagon (36%) and Sandvik (25%).
Inexpensive on broadly all metrics, but lacking fundamental triggers
Undoubtedly the sector looks inexpensive on the majority of metrics. A simple
EV/sales model implies the market is discounting a margin fall to <10%, which
seems unlikely. In addition, the dividend yield remains at high levels vs. history,
even with conservative pay-outs priced in. That said, with leading indicators
struggling to find a bottom and further downside risk in earnings forecasts, there
is a lack of fundamental triggers for a sustainable recovery.
Taking it even deeper - modeling a ‘bear case’ scenario
In this report we model a worst-case scenario for 2009, in which we assume our
new equipment volume forecasts see a further 15% cut from our base case
(which aligns with DB’s macro house view). In such a scenario, which implies
sector organic growth of roughly -20% vs. our ‘base case’ of around -10%, we
would need to push through an additional 35% cut to EPS. Still, multiples would
only expand to historical levels, suggesting a great deal of additional bad news is
already reflected in valuations.
Suggested sector strategy: we continue to prefer Atlas Copco over Sandvik
Given our sustained cautious stance, we recommend limited net exposure to the
sector, with preference towards companies with relatively low debt, flexible
production structures (i.e. less vertical integration) and relatively more recurring
revenues. Our preferred picks are therefore Atlas Copco and Alfa Laval, while our
least preferred picks are Trelleborg and Sandvik. For risks, please see p.36.

Table of Contents
Executive summary ........................................................................... 4
Lacking fundamental triggers; stay cautious.............................................................................4
Valuations inexpensive on broadly all metrics...........................................................................4
Taking it even deeper – modeling a ‘bear case’ scenario..........................................................4
Suggested sector strategy – prefer Atlas over Sandvik ............................................................4
Risks ........................................................................................................................................4
Q4 reporting season overview ......................................................... 5
Minimum visibility, but currency effects could turn into a rescue.............................................5
Outlook remains dire; still downside risks to forecasts................. 6
Economic indicators in a free fall ..............................................................................................6
Strong earnings downgrades....................................................................................................7
Where do we go from here?.....................................................................................................8
The revisions ratio remains strongly negative, while earnings uncertainty has reached an alltime-
high..................................................................................................................................9
FX worth a closer look – from headwind to tailwind................... 10
Currencies should provide a massive boost to profits from Q408..........................................10
But what if the tide were to turn? DB projects a sharp renewed strengthening of the SEK...10
Valuation inexpensive on broadly all metrics............................... 12
Cheap on earnings multiples, but great skepticism with regard to profit means there is little
valuation support ....................................................................................................................12
EV/sales model provides decent valuation support – a margin fall to <10% discounted -
appears overly conservative....................................................................................................12
The dividend yield provides good valuation support, although payout conservatism is likely.14
What is the risk to dividends? .................................................................................................14
What are the risks to earnings in a ‘bear case’ scenario? ............ 17
Modeling an even deeper downturn than the DB house view................................................17
Key assumptions....................................................................................................................17
The implications for earnings forecasts…...............................................................................19
…and the impact on valuation multiples .................................................................................20
Company section ............................................................................. 21
Alfa Laval (Buy, TP SEK85).............................................................. 22
Assa Abloy (Hold, TP SEK85).......................................................... 24
Atlas Copco (Buy, TP SEK75).......................................................... 26
Hexagon (Buy, TP SEK60) ............................................................... 28
Sandvik (Hold, TP SEK50) ............................................................... 30
SKF (Hold, TP SEK80) ...................................................................... 32
Trelleborg (Hold, TP SEK40) ........................................................... 34
Valuation and risks.......................................................................... 36