- machines and tools for earth moving and construction (48.1%; No. 1 worldwide): drilling semi-trailers, rock perforation tools, excavators, lifting machines, etc.;
- cutting tools and machine-tools (28.9%): intended for machining metals;
- special products (15.6%): tubes, hoops, wires, bars, refractory materials and facilities for transforming chemicals and food products made of stainless steel, special alloys, and heat-resistant materials;
- other (7.4%): carbon drills, milling machines, etc.
Net sales are distributed geographically as follows: Europe (33.8%), Asia and Australia (29.5%), North America (18.1%), Africa (10%) and Latin America (8.6%).
Caterpillar (CAT) is the world's leading producer of mining construction and operation equipment, diesel and natural gas motors, and industrial gas turbines. Net sales break down by activity as follows:
- sale of machines and motors (95.7%): terracing and construction machines (power shovels, high-lifts, bulldozers, etc.), agricultural and forestry tractors, motors and turbines (for heavy trucks, boats, industrial machines, and power stations), conveyer systems, hydraulic circuits and components, etc.;
- financial services (4.3%).
Net sales are distributed geographically as follows: North America (36.5%), Asia/Pacific (25.9%), Europe/Africa/Middle East (24%) and Latin America (13.6%).
Besides their truly global footprint with similar distribution of sales, the two companies are quite obviously very different. So isn't this a comparison between apples and pears? I don't think so, as both companies' end markets are mostly the same: mining, construction, mechanical industries. It's just the approach to these end markets and thus the business economics that change.
Here are some basic figures (for 2012) for both companies:
CAT ($ billions)
SANDVIK (SEK billions)
EPS ($ / SEK)
Dividend ($ / SEK)
We see quite similar ratios. Caterpillar enjoys a higher return on equity, but this is only due to higher leverage. If you look at returns on total assets, you recognize that actually Sandvik achieves higher returns on capital. Sandvik's dividend beats Caterpillar's, too: The Swedish company can pay out more of its earnings because of lower capital expenditures. In fact, over the past 5 years, capital expenditures have averaged only 5.4% of Sandvik's sales while averaging 7.1% of Caterpillar's sales.
Now let's take a closer look at Sandvik's segments:
We immediately recognize the gem hidden in Sandvik's accounts: the Machining Solutions segment enjoys operating margins north of 20% and brings in almost half of the entire company's operating profit, while accounting for less than 30% of its sales.
This is how Sandvik describes the segment in its 2012 Annual Report:
Sandvik Machining Solutions primarily focuses on tools and tooling systems for metal cutting. The products are sold under a number of international brands, such as Sandvik Coromant, Seco Tools, Walter, Safety, Dormer and Carboloy.
Market leader for advanced, productivity-enhancing products and solutions for metal cutting. The focus is on increasing customer productivity by providing products, services and applications know-how.
Customers include companies in the general engineering, aerospace and automotive industries, the energy sector, as well as the electronics and medical technology industries.
This is actually a business value investors should be familiar with. Seven years ago Warren Buffett's Berkshire Hathaway bought an 80% stake in a company named ISCAR, based in Israel, that produces exactly the same kind of tools. Since then Buffett seems to have literally have fallen in love with the business and recently bought the remaining 20% of ISCAR that Berkshire Hathaway did not already own for $2.05 billion. As he paid $4 billion for 80% seven years ago, this means that the value of the business has doubled over the past 7 years. ISCAR is the largest single investment that Berkshire has made outside the United States so far. (Source)
The production of cutting tools is a highly automated process, only a few people are required to run a huge production site. On the consumer side, tools need to be replaced on average after 25 minutes. So this seems to be a case of a razor/razor blade franchise.
While I believe that both Caterpillar and Sandvik are good value at current price levels, in my opinion Sandvik is the better choice for conservative investors. It is less leveraged, needs less capital expenditures, pays a higher dividend and enjoys better business economics. While the business remains subject to economic cycles, the cutting tool franchise has proved to be a solid base that even during the Great Recession remained profitable.
During its recent Capital Markets Day Sandvik's management has outlined its strategy for the next few years. By focusing on higher returns on allocated capital, lower earnings volatility and increased supply chain efficiency the company has good chances to deliver on its long-term 8% CAGR / 25% ROCE target.
Consensus estimates for 2015 see EPS growing to SEK 8.84, which translates into a current share price of less than 10 times expected earnings for 2015. As recently as 2011 Sandvik has traded at a PER of more than 20, but even at a fair value PER of about 15 the shares should definitely have a good chance to get back to their 2011 high of SEK 135. Including dividends, if it takes three years for the shares to reach SEK 135, the total return would be about 20%/year. Even if it takes five years, investors would make a more than decent 12%/year.
Sandvik's ADRs are traded with decent liquidity in the OTC market segment.
For further analysis: