Institutional investors may have the tools and resources that make international investing indistinguishable from domestic investing, but the retail investor is not so lucky. Consequently, high-quality industrial names like Atlas Copco (OTCPK:ATLKY) can often go unnoticed by many investors. While Atlas Copco doesn't have the left-for-dead valuation of some industrials, investors who want a blue chip company with solid growth prospects can still pick up these shares for less than fair value.
Q2 Results - Another Beat, But Worries Building
Atlas Copco has built a pretty good reputation for itself as it pertains to guidance and financial performance. Nevertheless, while financial results continue to come in solidly with respect to expectations, order trends and basic end-market conditions do have investors and analysts concerned.
Revenue rose almost 18% as reported for the second quarter, with organic revenue up about 9%. Reported growth was led by the mining and industrial business (up 27% and 34%, respectively), while compressors grew 13% and construction brought up the rear at 3%. Reported profit growth was also strong, with EBIT and EBITDA up about 20%.
The downside to the story was the company's order book. Reported orders rose 5%, but the order book shrank 2% on an organic basis, with the compressor business down about 7% and mining up just 1%.
Mining Driving The Negative Sentiment
Along with Sandvik, Atlas Copco is a leader in its part of the mining industry where it sells a variety of drills, tools, rigs, and loading equipment. There's limited overlap here with Joy Global (JOY), Caterpillar (CAT), Komatsu (OTCQB:KMTUY), and Chinese mining equipment companies, and original equipment orders are only about one-third of the total, but investors are rightly nervous about where the market is heading.
Neither Caterpillar nor Joy Global thrilled the Street with recent guidance for mining equipment demand. Likewise, major miners like Rio Tinto (RIO), BHP Billiton (BHP), Vale (VALE), and Anglo American have all announced either lower capital spending plans or a "review" of current plans.
That said, the long-term picture for mining development is still strong, and Atlas Copco has made the decision to position itself strongly on the ground in markets/regions like China, Latin America, and Africa. Nevertheless, this segment could get dicey for the next year or two.
Quality Compressor Business Seems Underappreciated
Not only is Atlas Copco the largest company in the compressor business, it's about two and a half times the size of Ingersoll Rand (IR) and well ahead of others like Gardner Denver (GDI) and Sullair. This is a large business with a broad addressable market and here again Atlas Copco is looking to buy/build its way into long-term growth markets like China and Brazil. Atlas is also looking to build strength from strength; the company leads the market in product development and although it often leads on price, it still boasts total lower life-of-ownership costs than many of its apparently cheaper rivals.
Blue Chip And Broad-Based
There's a lot to like about Atlas Copco's business. For starters, nearly half of the company's sales fit into the "MRO" subtype (that's "maintenance, repair, and overhaul") that tends to be more consistent across the economic cycle. Like in the case of say Lincoln Electric (LECO) or Illinois Tool Works (ITW) and welding equipment, customers buy Atlas Copco's equipment and then continue to buy supplies and parts. What's more, while companies cut back on new equipment spending during tougher times (like now), those that stay in business continue to use parts and supplies.
It's also worth noting that, although the company has a fair bit of debt, it generates solid returns on capital. While free cash flow conversion has trailed off a bit lately, the underlying "structural" free cash flow has stayed intact. Last and by no means least, the company is well-diversified across the globe - it's under-exposed to the still-growing North American market (about 20% of sales), but about half of the company's revenue comes from Latin America, Africa, and Asia.
The Bottom Line
Weakening large compressor order growth from industrial customers is reason for worry, as is the uncertain state of emerging economies like China and Brazil. What's more, the company doesn't seem to have quite the same infrastructure growth kicker that has improved the outlooks for companies like ABB (ABB) and Honeywell (HON) recently.
All that said, Atlas Copco is a quality industrial company that doesn't get, and stay, cheap very often or for very long. Assuming that the company can continue to grow revenue at a mid-single-digit rate and return its free cash flow conversion rate to its historical average, these shares look just about cheap enough to buy at today's level.