Company Reports

While market conditions in early 2024 proved mixed for Atlas Copco, the wide-moat capital goods supplier delivered a solid first-quarter result, featuring buoyant top-line and EBIT growth that tracked ahead of our prior full-year forecasts. Organic order intake fell 4% year on year, declining from an exceptional level achieved in the prior comparative period. While demand for air compressor equipment held in, demand for vacuum pump equipment and power tools were particularly weak, driving organic order intake declines for the vacuum technique and power technique segments of 4% and 17%, respectively.

Atlas Copco is a sharply focused supplier of capital equipment, with a selective presence in attractive market niches for engineered equipment where the firm can optimally leverage its reputation for innovation and quality products. In doing so, Atlas Copco seeks out industrial and scientific equipment categories that are considered mission-critical by their users and where it possesses or can assume a market leadership position from a technology and brand visibility standpoint. At the same time, the firm shuns significantly commoditized capital equipment categories and market segments. Its air compressor and vacuum pump and equipment businesses—its two largest, account for approximately three quarters of group EBIT—are prime examples of the firm’s discerning approach where it sports industry-leading market shares in medium- to high-end market segments.

Wide-moat Atlas Copco’s fourth-quarter 2023 result underwhelmed, with weak new order intake falling short of our and the market’s expectations. Fourth-quarter order intake fell by a material 13% sequentially, leading full-year 2023 organic order intake for the group to finish flat year on year, trailing our full-year forecast for modest growth. Full-year organic revenue growth of 14% was also somewhat soft relative to our forecast of about 17%, with Atlas Copco’s delivery of orders in late 2023 tracking behind our expectations. Investors soured to Atlas Copco’s guidance that current weak demand conditions are likely to persist into early 2024, sending shares some 4% lower.

Atlas Copco is a sharply focused supplier of capital equipment, with a selective presence in attractive market niches for engineered equipment where the firm can optimally leverage its reputation for innovation and quality products. In doing so, Atlas Copco seeks out industrial and scientific equipment categories that are considered mission-critical by their users and where it possesses or can assume a market leadership position from a technology and brand visibility standpoint. At the same time, the firm shuns significantly commoditized capital equipment categories and market segments. Its air compressor and vacuum pump and equipment businesses—its two largest, account for approximately three quarters of group EBIT—are prime examples of the firm’s discerning approach where it sports industry-leading market shares in medium- to high-end market segments.

We are increasing our fair value estimate for Atlas Copco by 17% to SEK 140 following the upgrade of our economic moat rating to wide from narrow. Our wide moat rating reflects the strong reputational/brand intangibles and high customer switching costs that provide Atlas Copco with pricing power and shelter its earnings from competitive incursion. Elsewhere, we retain our Medium Morningstar Uncertainty Rating and Exemplary Morningstar Capital Allocation Rating.

Sales reached record levels in the third quarter of 2023, rising 17% year on year to SEK 44.5 billion from 38.1 billion as Atlas Copco continues to work through its 2022 backlog. New orders grew 5% in the quarter but fell 1% organically. The near-term sales outlook remains worrying as management anticipates customer activity to weaken in the near term, largely due to slowing demand in semiconductor end markets. Our 2023 financial estimates remain largely unchanged, as do our long-term expectations for the narrow-moat stock. Atlas Copco still screens as overvalued, trading at a 19% premium to our unchanged SEK 120 fair value estimate.

Sales continued to ascend strongly in the second quarter of 2023, rising 31% year on year to SEK 43.4 billion as Atlas Copco works through its considerable backlog of orders from 2022 and early 2023. However, the near-term sales outlook is waning, with chilly demand conditions in semiconductor end markets causing new orders to decline 5% organically in the second quarter, reversing course abruptly from the prior quarter where orders grew 5% organically. Our 2023 financial estimates remain largely unchanged as do our long-term expectations for the narrow-moat stock. Investors sent Atlas Copco shares 5% lower on confirmation that the order book for its important vacuum pump division is weakening cyclically. Nonetheless, Atlas Copco still screens as overvalued, trading at a 22% premium to our unchanged SEK 120 fair value estimate.

Atlas Copco is a market leader with a focused product portfolio of mainly compressors and vacuum pumps. These two product areas contribute around three fourths of revenue and four fifths of profit for the company. Its two smaller divisions, industrial technique and power technique, make up the remaining revenue. The company's equipment is highly engineered, often with customization and application-specific variations. To that point, equipment sales are done by engineers. End markets for the company's compressors are diverse, from automotive assembly to food processing. However, for vacuum pumps, semiconductor chip demand is the key driver. The electronics industry contributes two thirds of vacuum pump division revenue and, as a result, nearly one fifth of revenue for Atlas Copco at the group level.

Atlas Copco is a market leader with a focused product portfolio of mainly compressors and vacuum pumps. These two product areas contribute around three fourths of revenue and four fifths of profit for the company. Its two smaller divisions, industrial technique and power technique, make up the remaining revenue. The company's equipment is highly engineered, often with customization and application-specific variations. To that point, equipment sales are done by engineers. End markets for the company's compressors are diverse, from automotive assembly to food processing. However, for vacuum pumps, semiconductor chip demand is the key driver. The electronics industry contributes two thirds of vacuum pump division revenue and, as a result, nearly one fifth of revenue for Atlas Copco at the group level.

Atlas Copco's fourth-quarter 2022 group orders and margins were disproportionately hit by weakness in its vacuum division, whose primary end market is the semiconductor manufacturing sector. We see the divisional weakness as temporary as we expect many sectors of the economy to continue supporting long-term semiconductor demand by expanding use cases. Full-year group earnings were slightly ahead of our forecasts with reported EPS of SEK 4.81, just ahead our SEK 4.73 estimate. We maintain our narrow moat rating and EUR 120 fair value estimate.

Atlas Copco is a market leader with a focused product portfolio of mainly compressors and vacuum pumps. These two product areas contribute around three fourths of revenue and four fifths of profit for the company. Its two smaller divisions, industrial technique and power technique, make up the remaining revenue. The company's equipment is highly engineered, often with customization and application-specific variations. To that point, equipment sales are done by engineers. End markets for the company's compressors are diverse, from automotive assembly to food processing. However, for vacuum pumps, semiconductor chip demand is the key driver. The electronics industry contributes two thirds of vacuum pump division revenue and, as a result, nearly one fifth of revenue for Atlas Copco at the group level.

Atlas Copco’s demand slowed in the third quarter, with book/bill slipping below 1 for the first time in seven quarters in two of its divisions: vacuum and power technique. That said, the absolute order level was impressive. Putting demand into context of prepandemic levels, the SEK 41 billion in group orders for the third quarter of 2022 was 50% above the SEK 27 billion in the same period for 2019. Third-quarter 2022 orders in vacuum and power technique were up 50%-60% over 2019. The elevated group order levels continued to favor revenue growth. On an organic basis, orders and revenue grew 6% and 18%, respectively, while we expect midcycle revenue growth closer to 5%. Operating profit margin remained solid at 22%, reflective of Atlas Copco's successful price increases and operating leverage. We maintain our narrow moat rating. While we expect to adjust our near-term forecasts to account for strong revenue growth this year and perhaps lower revenue growth next year than our current forecasts, we do not expect the changes to materially affect our SEK 109 fair value estimate.

After a breathless pace of demand growth in the last several quarters, in the second quarter Atlas Copco's vacuum division end markets finally seemed to pause for air. Orders from semiconductor and flat panel display customers are still close to twice the level before the pandemic started but seemed to have peaked. Orders were down sequentially in the second quarter for the first time in several quarters. However, group results still reflected an extraordinary (and unsustainable) demand environment with 13% organic order growth and 8% organic revenue growth. That said, management expects third-quarter demand to be sequentially lower than the second quarter. Overall results were solid, and we are maintaining our narrow moat rating and SEK 109 fair value estimate.

Atlas Copco is a market leader with a focused product portfolio of mainly compressors and vacuum pumps. These two product areas contribute around three fourths of revenue and four fifths of profit for the company. Its two smaller divisions, industrial technique and power technique, make up the remaining revenue. The company's equipment is highly engineered, often with customization and application-specific variations. To that point, equipment sales are done by engineers. End markets for the company's compressors are diverse, from automotive assembly to food processing. However, for vacuum pumps, semiconductor chip demand is the key driver. The electronics industry contributes two thirds of vacuum pump division revenue and, as a result, nearly one fifth of revenue for Atlas Copco at the group level.

Atlas Copco is a market leader with a focused product portfolio of mainly compressors and vacuum pumps. These two product areas contribute around three fourths of revenue and four fifths of profit for the company. Its two smaller divisions, industrial technique and power technique, make up the remaining revenue. The company's equipment is highly engineered, often with customization and application-specific variations. To that point, equipment sales are done by engineers. End markets for the company's compressors are diverse, from automotive assembly to food processing. However, for vacuum pumps, semiconductor chip demand is the key driver. The electronics industry contributes two thirds of vacuum pump division revenue and, as a result, nearly one fifth of revenue for Atlas Copco at the group level.

Atlas Copco's experienced another quarter of strong demand across all divisions; however, the exceptional growth is starting to weigh on profitability. Organically group orders and revenue were up 23% and 7%, and the adjusted operating margin stable, supported in part currency tailwinds. Stripping out the positive currency contribution, the compressor and power divisions still had positive margin contributions but vacuum and industrial technique were negative. We maintain our narrow moat rating and SEK 380 fair value estimate.

Exceptional semiconductor demand together with supply chain tightness continues to dominate Atlas Copco's earnings. That said, fourth-quarter and full-year revenue and operating profits were in line with our expectations. Looking out into the near term, demand continues to be strong especially for the company's vacuum technique, or VT, division, which caters to semiconductor companies. Customers have been ordering vacuum equipment in advance of starting up new fabs, leading to a higher-than-usual level of advanced payments, which favor the company's working capital for the year. As a result, the reported SEK 23 billion cash flow from operations was slightly higher than our forecasts. We expect advanced orders to continue while supply chains remain tight and continue to favor near-term working capital. We maintain our narrow moat rating and fair value estimate.

Supply chain constraints hampered Atlas Copco's ability to deliver orders with demand exceeding 2019 levels in nearly all divisions. Orders and revenue were 19% and 6% higher in the first nine months of 2021 than the comparable period in 2019 (prepandemic). The rebound in demand particularly from semiconductor end markets has continued to boost order growth beyond the company's supply chain capacity. Management estimated that overall revenue could have been SEK 1 billion to SEK 2 billion higher, or as much as 7% more than the SEK 27.8 billion reported in the quarter. Supplier capacity and component constraints are roughly 80% of the problem in getting orders executed. The remaining issue is the company's own capacity, running at full utilization rates. Pricing increases, mix, and volume helped to offset inflation pressures with the third-quarter EBIT margin remaining relatively solid at 21.6%, just 30 basis points below the 2019 level. Management cautioned that while demand remained robust, the fourth quarter is likely to be somewhat slower. We expect to make adjustments to our model but not enough to materially affect our fair value estimate. Our narrow moat rating remains intact.

Atlas Copco's second quarter continued a breathless pace of demand and order growth that we expect to hit a wall at some point, but not likely as soon as the third quarter. Organic orders and revenue were up 54% and 21%, respectively. Tightness in the company's supply probably muted revenue growth, with second-quarter orders supporting third-quarter growth. In addition, management has seen no slowdown in demand from semiconductor customers, China, or any other end market or region. We expect to tweak our full-year forecasts but don't expect this to have a material impact on our fair value estimate. The shares look expensive versus our valuation and are trading at a 36 times 2021 P/E consensus-based multiple, around 50% above the 10-year average.

We lower our uncertainty rating to low from medium and increase our fair value estimate for narrow-moat Atlas Copco. We apply a lower systematic risk adjustment to our cost of equity, which declines to 6.7% from 7.6%. Our fair value increase reflects our lower cost of equity adjustment, higher forecasts following recent results, and the time value of money. Combined, these adjustments increase our fair value estimate to SEK 380 per share from SEK 310 per share.