With Warren Buffett in town last week hunting for bargains in Europe, I thought it timely to cast our net across the Channel too. One interesting play is the unfashionable £20bn global bearings market. Bearings – used to provide frictionless joints in everything from cars and planes to industrial drills – have tended to be low cost, dull, commodity items.
Now, due to rising demand from high-performance applications – wind turbines, mining and offshore oil/gas exploration – they’ve become more sophisticated. That’s meant new light-weight materials bringing massive improvements in strength, reliability, heat dissipation and energy-saving properties.
SKF AB, rated a BUY by Evli Bank (Stockholm Stock Exchange)
Along with these changes, bearings now tend to come with comprehensive service packages. This is where SKF, the world’s largest manufacturer of industrial bearings, comes in. With 19% of the market, SKF competes against the likes of Schaeffler in Europe, Timken in North America and NSK in Asia – but has differentiated itself with its impeccable service and innovative technology.
For example, although it still offers a full range of bearings, it is increasingly moving away from the lower-value end to niche sectors. Its latest products reduce energy consumption by around 30%, and a third of its turnover is already derived from its services division, which provides customers with repairs and support. Last year, SKF’s revenues were up 10% at SKr58.6bn (or £5bn). This delivered underlying earnings per share (EPS) and dividends of SKr10 and SKr5.00 (a 4.5% yield) per share.
CEO Tim Johnstone now predicts the group can achieve 6%-8% a year volume growth, along with generating impressive operating margins of 12%. So far, so good. In the first quarter of 2008 organic top-line growth was an encouraging 8.5%, with earnings before interest and tax (EBIT) margins of 13.1%. And demand isn’t slackening. Only last week Hansen Transmissions, the London-listed Belgian gearbox maker, reported that it is having trouble buying advanced bearings due to competing orders from the mining and steel industries.
For the full year 2008 analysts are predicting revenues and EPS of SKr61.7bn and SKr 10.8 respectively, rising to SKr63.3bn and SKr11.2 in 2009. This puts the stock on miserly forward multiple of around ten times earnings. Net debt of SKr5bn also looks comfortable, since interest payments are over 12 times covered.
The only possible flies in the ointment are the cyclical nature of the industry, rising raw material costs (ie, steel) and exchange-rate risks (the weak dollar). Nonetheless, selling prices are being hiked in response to the cost pressures, while the “outlook is for continued good growth”.
Recommendation: BUY SKF B shares (which tend to be more liquid than the A shares) at SKr110 (£9.40). Market capitalisation £4.3bn
• Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments