The purpose of this report is to analyse the Swedish industrial manufacturers and to assess their investment potential. The report also aims at identifying specific companies in the industry that are candidates for investment. These candidates will be analysed in a separate more company specific analysis.

The industrial manufacturers are defined as the three industries Machinery, Electrical Equipment and Industrial Conglomerates based on the GICS (Global Industry Classification Standard). In addition only companies with a yearly revenue above MSEK 500 have been included. There are in total 21 companies listed on the Swedish stock exchange that fit into this category and that have been included in the analysis. As there are very few Electrical Equipment manufacturers (4) and Industrial Conglomerates (4), the industrial manufacturers were created by putting these two industries together with Machinery.  

During the period from 2013 to 2022 the median return on capital for all 20 companies has been 18%. The median operating margin (EBIT) has been 11.6%. These numbers thus pass my initial hurdle for investment consideration; long term historic return on capital (ROCE) and EBIT above 10%. In an initial step all Nordic industrial manufacturers were considered. The median ROCE of this group was 13% and operating margin 8%. This means that the companies (15) in the other Nordic countries only had a median ROCE of 2% for Electrical Equipment and 9% for Machinery. EBIT for these non-Swedish companies were 4% (Electrical Equipment) respectively 5% (Machinery). The non-Swedish companies were consequently eliminated from the analysis.   

The structure of the report is as follows: 

1. The first chapter of the report, after the introduction, is a summary of the main conclusions and recommendations for the industry. 
2. The next three chapters aim to give an overview and better high-level understanding of the industry. First there is an introduction of the 21 companies, that are being analysed, including revenue and a high-level description of their business. After that follows an overview of the industry and its history as well as an overview of the industry value chain.    
3. This is followed by an in-depth analysis of the financial performance of the industry. As the industrial manufacturers are facing many challenges in the near and midterm future a special chapter has been dedicated to assessing these challenges. 
4. The market dynamics of the industrial manufacturers and the factors that are likely to impact future industry growth have been analysed in a final chapter of the analysis.  
5. The conclusions from the analysis are summarised in the chapter Investment Considerations. In this chapter the rational for and against investing in the industry have been made. It’s important to point out that the investment horizon considered in this chapter is long term or at least 5 years.

The Swedish industrial manufacturers are attractive for investments. This analysis has identified 12 strong potential investment candidates out of 21 industrial manufacturing companies listed on the Swedish stock exchange. These 12 companies will have to be individually analysed in detail to assess the potential of each company. There are 7 further companies that are considered moderate investment candidates that also should be analysed on an individual basis.   

The companies that are considered as strong investment candidates have both a record of historical strong financial performance and are well positioned to benefit from one or several of the main secular global trends like use of alternative energy sources, improved energy efficiency, electrification of the society and transportation, automation, digitalisation and urbanisation. 

The return on capital is strong for the majority of the companies in the industry. The median return on capital during the last 10 years has been 18%. The median return on capital has been in an upward positive trend during the period analysed. Gross margins are relatively low but as the sales and administration expenses are also relatively low the operating margins are overall strong. Most companies show strong historic growth albeit not all of it has been organic but achieved through acquisitions. 

The Swedish industrial manufacturers face many changes and challenges in the near to midterm future such as inflation, increased interest rates, risk of recession, increased focus on sustainability and ESG reporting, digitalisation, Artificial Intelligence (AI), automation, shortage of skilled labor, protectionism, supply chain disruptions, protectionism and trade wars, risk of deglobalisation, real wars, …etc. 

Many of these changes and challenges also represent opportunities and in the bigger picture many of the challenges seems to be part of the life of doing business. Many of the Swedish industrial manufacturers have 100 – 150 years’ experience of going through these type of challenges and still managed to thrive. There is no reason why they would not manage to overcome them this time. In fact they are more likely to conquer these new changes and challenges and benefit from the opportunities they create. 

To conclude there are many Swedish industrial manufacturers that are well positioned to respond to the future trends of the industry and at the same time conquer the changes and challenges that the industry is facing. These companies have also demonstrated strong financial performance over time.  

It’s said that one should never try to time the market but there is still a possibility that we eventually will enter into a recession. The press has been scaring us about the imminent recession for almost 2 years now. Let’s hope it doesn’t turn into a ‘cry wolf’ story but if we were to enter into a recession share prices of these business cycle sensitive companies are likely to be punished. The prudent investor may therefore be better off keeping some of his powder dry until it one can see a clear trend shift in consumer demand.

Industrial Manufacturers include the industries Machinery, Industrial Conglomerates and Electrical Equipment based on the Global Industry Classification Standard (GICS).  The other industries within the industry group Capital Goods are big enough to merit a separate analysis per industry. These industries are Building Products, Construction & Engineering, Trading Companies & Distributors. Aerospace & Defence will not be analysed due to the nature of the business and the limited number of companies in the Nordics in this industry. 

The total number of companies in the Nordics in the Electrical Equipment (8) and Industrial Conglomerates (4) is low. They also have many similarities with Machinery. The three industries have therefore been reviewed together under Industrial Manufacturers. The number of Machinery companies in the Nordics are 29 which makes a total of 40 Industrial Manufacturers.       

An initial analysis of the key financial metrics, return on capital employed and operating margin (EBIT) showed that the median operating margin was substantially below the threshold for both Machinery (7.4%) and Electrical Equipment (7.1%). Further analysis showed that it was mainly the non-Swedish companies that were bringing the operating margin down. The median operating margin for the 13 Swedish Machinery companies is 13% whilst it’s only 5% for the 15 non-Swedish companies. The median operating margin for the 4 Swedish Electrical Equipment companies is 9% and only 4% for the non-Swedish companies. The non-Swedish companies were therefore excluded from the analysis. The 4 Industrial Conglomerate companies are all Swedish. As a consequence the number of companies include in the analysis are 21.    

The 21 companies have been listed in table 1 below in order of revenue 2022 per industry. The company’s business has been indicated as well.

The industrialisation in Sweden started during the second half of the 19^th century. The main factors contributing to the Swedish industrialisation were: 

• Cheap labor, bigger population cohorts than the agricultural industry could absorb 
• The construction of the Swedish railway network 
• Access to raw material such as iron and wood 
• International business boom   
• Scientific discoveries and standardisation 

There had been a tradition of small scale iron production for several centuries. At one point in time there were 500 small ironworks throughout the country but in the mid-19^th century before the industrialisation started 90% of the population lived in the countryside and had agriculture as their main source of income.    

Several of the companies analysed such as Atlas Copco, Sandvik, SKF, Alfa Laval, Epiroc (former part of Atlas Copco), Trelleborg, ABB were all founded in the early stages of the Swedish industrialisation. These companies have been around for 100 – 150 years and have a tremendous wealth of manufacturing tradition and experience. 

The Swedish industrialisation is a true success story. As the Swedish market was often too small for any meaningful economy of scale the Swedish companies became dependent on export early on and had to learn how to compete on an international market in order to succeed.  
This Swedish industry in a broader sense basically transformed the country from a poor farming society on the fringes of the civilised world to one richest countries in the world in a matter of 100 years. 

During these 100 years the industrial companies have had to survive a number of challenges such as world wars, the great depression, recessions, digitalisation and various other crises and changes. As Sweden became a high labor cost country some industries like the ship building and textile manufacturing fell victim of its high production costs. The companies that adjusted and moved much of their manufacturing to lower cost countries survived and many of them became truly global players ranking among the largest companies within their industry or sub-industry. 

Although many of these companies have the majority of the manufacturing operations outside of Sweden the headquarters have remained in Sweden and experience and know how have remained in the company and become part of its culture, as well as the countries culture. 

The manufacturing industry currently faces many changes and new challenges such as increased focus on ESG, electrification, Internet of Things, Artificial Intelligence (AI), automation, lack of skilled labor, protectionism and trade wars, real wars,…etc.  This analysis will look at the potential impact of these changes and challenges as well as the opportunities that some of these changes and challenges bring. Changes such as AI can also be seen as opportunities to make the companies even more competitive and profitable.

The industry’s high level value chain can be seen in figure 1 below. 

The first step Innovation & Product Development is very important as it will lay the foundation for the commercial success of a new product. If the product is customer specific the customer may be involved in the design phase or give design specifications. The customer involvement is of particular importance when the company is a contract manufacturer.   

Different and sometimes conflicting objectives such as functionality, quality and costs have to be considered. To remain competitive it’s crucial that the company gets this step right. The products may also need to be patented to prevent any replication or copying.   

To go through this step does not necessarily have to mean a completely new innovation. It’s more likely to be an improvement or new version of an existing product.  

The manufacturing process must be established and suppliers sourced prior to starting full scale production of the new product. The manufacturing often happens in several steps. Although the company is making products through a manufacturing process they may still purchase some or several of the components that go into their final product. Atlas Copco for instance would buy the bearings that go into their compressors from a bearing supplier like SKF. 

Many of the suppliers will be located in China or other Far East countries. This adds more complexity to the supply chain and longer lead-times. This was exacerbated by the various lock downs during the Covid pandemic as supply chains were severely disrupted with delays and cost increases for the manufacturers as a consequence. 

Once components have been manufactured or purchased they will be delivered to an assembly plant/ line where the final product will be assembled. Testing will take place and documentation prepared. The product will also be packed. 

The packed product is typically stored in a warehouse or shipping area before being shipped to the customer. Manufacturers that make standard products, and not for a specific customer like SKF, Trelleborg or Sandvik, will store many of their products in a regional distribution center. The products would then need to be transported from the factory to the distribution center. From the distribution center it will then be shipped to the customer when ordered. Bigger products or products that are made for a specific customer or made to order, like an underground drilling rig from Epiroc will be shipped directly to the customer. If it’s a big piece of equipment or one that uses advanced technology, like an ABB robot, the company may send a field engineer to the customer to help with installation and/ or to make sure that the customers employees are being properly trained on how to best use the equipment.    

Most industrial manufacturers would use several different sales channels depending on the products, type and size of the customer as well as market. For a big OEM or industrial user there will be a direct sales relationship between the company and the customer. If the customer is big the company is likely to appoint a Key Account manager. For smaller customers and spart parts demand the company will use an indirect channel and work through distributors, wholesalers or agents.  

The product marketing efforts in an industrial manufacturing company has the advantage that the demand for the product already exists. The marketing therefore tends to be factual and focused on the needs of the customer business. The marketing also tends to use direct methods such as face-to-face meetings. Product quality, service and price will be the main deciding factors.  

If the products are made to stock and not for a specific customer order, accurate product forecasting is essential. The forecasting process is being complicated by the fact that the demand depends strongly on the business cycle. It makes it very difficult to get the forecast right with the risk of either producing too much and creating obsolescence or not producing enough and losing valuable sales. 

Many of the companies covered in the analysis have a large aftermarket business. No matter how good the quality is, parts eventually wear out and have to be replaced. A cutting tool or a drill will be subject to a tremendous stress when being used and can only be sharpened so many times. The equipment that the manufacturer has sold to the customer will need regular service and maintenance. The service and aftermarket business in general have higher margins than the OE business. It is however not a viable long term strategy to only focus on the after-market. OE manufacturing requires continuous technical development and advancement which is necessary for long term success. To some extent the OE business feeds the Aftermarket business. The company thus needs to find a good balance between the OE and Aftermarket business that gives a good balance between technical prowess, sales volumes and margins.

To get a better understanding of the industry’s long-term financial performance a selection of financial ratios has been calculated for all the 21 companies over a 10-year period, from 2013 to 2022. Tables with all the details as well as calculation methods can be found in Appendix 1. This period should be long enough to compensate for the exceptional pandemic year 2020 and short enough to make it relevant for giving an insight into the industry’s future potential. 

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Profitability: ‍

To assess profitability Gross Margin and Operating Margin (EBIT%) have been used. The average gross margin for the 10-year period 2013 to 2022 can be seen in graph 1. The gross margin varies a lot depending on the type of company. 

The gross margin thus varies very much depending on the company’s business model. The median gross margin for all 20 companies is 37.6%. 4 companies, AQ Group, Duroc, Garo and Hanza Holding do not report Cost of Goods Sold. The gross margin therefore only consider the material costs as being part of the cost of goods sold. The gross margin for these 4 companies is thus overstated. If these 4 companies are removed from the calculation the median gross margin becomes 35.3%.

For the remaining 17 companies the gross margin varies between 12% for Note and 43% for Absolent Air Care. Both Note and Nolato (16%) are contract manufacturers which generally tend to have lower gross margins because of the nature of their business model. Companies that have a high degree of aftermarket and service business such as Atlas Copco generally tend to have higher margins.    

If we instead look at the development of the median gross margin per year during the same 10 years (2013 – 2022) for the 17 companies, see graph 2, one can see that there is a positive trend during the period. The median gross margin has increased by 3.5% between 2013 and 2022. The gross margins came down by almost 1.6% from 2021 to 2022. The gross margin reached its highest value during the 10 year period in 2021, which was a great year of recovery after the year of the Covid outbreak and lockdowns. In 2022 most companies increased their sales revenue thanks to price increases but they also saw their costs of goods sold increase even more which led to reduced margins. 

If we move on to the average operating margin (EBIT), graph 3, we can see that we have even bigger variations between the various companies. The median operating margin is 11.4% but the margins vary between around 2.5% for the worst performers and around 20% for the top performer.  

As for gross margins it’s also worth looking at the development of the operating margin during the last 10 years. In graph 4 the median operating margin per year for the period 2013 – 2022 has been shown. The operating margin shows a positive trend throughout the period. 

The median operating margin has increased by 3.4% between 2013 and 2022. As for the gross margin the operating margin peaked in 2021 and then fell by almost 2% in 2022.  

By looking at the difference between the gross margin and the operating margin one can also form a view of the size of the Sales and Administration costs (S&A) and the Research and Development costs (R&D). The average margin difference for the 17 companies (that report COGS) during the 10 years varies between 5.1% for Nolato and 30% for Absolent. The median is 20.4%, meaning that S&A and Research cost makes up 20.4% of the revenue. The contract manufacturers generally have low S&A and R&D costs which to somewhat compensates for the low gross margins. Nevertheless the contract manufacturers still end up having the lowest operating margin.  

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Growth: 

Growth measured as the Cumulative Annual Growth Rate, CAGR, for the 20 companies have been shown in graph 5. The CAGR varies considerably between 0.1% for ABB and 23% for Absolent Air Care, with a median CAGR of 9%. Some of the bigger companies such as  

Atlas Copco, Sandvik and ABB have made some major divestments during the period which has reduced the CAGR. For many of the other companies acquisitions have been a contributing factor to the CAGR.    

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Leverage:

The leverage ratio measured as Net Debt to EBITDA in 2022 for the 20 companies is shown in graph 6. Leverage is generally low with a median of 1.5. There are only two company with a Net Debt to EBITDA value above 2.00, which is Trelleborg with Net Debt to EBITDA value of 3.35 and Nederman with 2.17. The leverage for Trelleborg went up from 1.23 to 3.35 in 2022. This was mainly caused by a bridge loan at the end of the year to finance an acquisition. 

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‍Capital Efficiency: 

To assess capital efficiency, or how good the companies in the industry are at allocating it’s capital, the return on capital employed (ROCE) has been used. As can be seen in graph 7, the ROCE varies a lot between the companies. The average return of capital per company for the last 10 years varies from 7% for Duroc and Hanza Holding to 31% for Garo. The majority of the companies, or all except Duroc and Hanza Holding to be exact, have a ROCE well above 10% and the median ROCE is 18%.  

If we look at the trend for the ROCE for the 10 year period the picture we get is that the ROCE seems to have peaked in 2017. Graph 8 shows the median ROCE for the 21 companies per year for the last 10 years. ROCE peaked at 21.6% in 2017 and has been in a falling trend since then. The ROCE fell as low as 15.1% during the first pandemic year 2020. It then recovered considerably during 2021 to fall again in 2022 to the same level, 15.1%, as in 2020. This seems counter intuitive as the operating margin has been in an upward trend during the 10 year period. 

However, by comparing the increase in operating income (the numerator in the ROCE ratio) in 2022 to 2017 with the increase in capital employed (the denominator in the ROCE ratio) for the same period it becomes clear that the most companies have increased their capital employed more than they have increased operating income. The median increase in operating income was 51% and the median increase in capital employed was 125%. If one looks at the asset side of the balance sheet it becomes clear that there has been a similar increase in intangible assets or goodwill for the period. The median increase in intangible assets was 129%. Many companies have thus had to pay a goodwill for their acquired growth which have increased the capital employed more than the operating income.  

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‍Conclusions:

The overall financial performance, measured as return on capital, of the industrial manufacturers is very good. All companies with the exception for 2, or 90% of the 21 companies analysed, have a ROCE well above 10%. ROCE does however seem to be in a falling trend since its peak in 2017. One contributing factor to that is the buildup of goodwill due to acquisitions. 

Operating margins are generally comfortably above 10%. The main exception to this are the contract manufacturers who tend to have margins below 10%. The low operating margins are compensated for by a relatively lower level of assets, mainly lower intangible assets, compared to traditional manufacturers. Thanks to low levels of intangible assets or goodwill most of the contract manufacturers manage to still achieve a good ROCE. 

Growth is strong overall, though in some cases it is mainly driven by acquisitions. As we have seen acquisitions have in many cases required paying a premium which has had an adverse effect on ROCE.  

Leverage is generally low.

The manufacturing industry faces many changes and challenges today (November 2023) and in the near future such as inflation, increased interest rates, risk of recession, increased focus on ESG, Internet of Things, Artificial Intelligence (AI), automation, lack of skilled labor, wars, protectionism, trade wars, …etc. These topics have been reviewed more in detail below. 

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Inflation, interest rates and recession: 

As a consequence of the mayhem the Covid-pandemic caused on supply chains we have experienced inflations rates that we haven’t seen in the developed world since many decades.  Subsequently central banks have increased interest rates to levels that we haven’t seen since before the financial crisis in 2008. As these higher interest rates start to bite there is a risk that we will go into a recession.   

Although we thought the inflation specter was gone forever and interest rates would always stay low, the inflation levels and interest rates we are experiencing at this moment (November 2023) are not unusual. Companies have historically managed to thrive also with interest rates even higher than the ones we are currently experiencing. In addition it seems that the inflation and interest rates have peaked and the bigger risk is that of recession. Should there be a recession central banks are likely to reduce interest rates. 

The industrial manufacturers have relatively low debt levels and increased interest rates are not likely to be detrimental to their bottom lines. It may, however, make companies less keen to make debt financed acquisitions. 

There is also a silver lining in the current economic climate. As company valuation has fallen since markets peaked at the end of 2021 the asset prices have come down which will make acquisitions cheaper.  

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Sustainability and ESG reporting:

It’s enough to read through a recent annual report of an industrial manufacturer to understand that sustainability and ESG reporting (Environment, Social and Governance) have become a priority for manufacturing companies. 20 – 30 pages devoted to sustainability for the bigger companies is common. 

Sustainability reporting is mandatory within the EU and it’s important for several stakeholders to get an insight into how the company is performing. Customers want to understand how sustainable their suppliers are and what they do to become more sustainable. 
People considering joining a company may want to know how sustainable their employer is. 

Taking care of the nature and environment as well as social justice and emancipation have always been part of the Swedish society’s trademarks. This has also influenced the corporate culture of the Swedish companies as their managers have been brought up in this spirit. The underlying philosophy of sustainability is therefore nothing new to Swedish companies and even if they still have long ways to go reach their target levels they are clearly well prepared. 

This should make the Swedish companies better prepared in the event of future new schemes to make companies pay for the externalities they cause. In the EU, the so called Polluter Pay Principle has been in place for many years. Another example is the EU WEEE directive (Waste Electrical and Electronic Equipment) which obliges the producer to organise the take-back and recycling of old electrical and electronic equipment. Similar schemes could be put in place for other externalities. The challenge lies in the establishment of a fair and easy to implement charging mechanism for the externalities another and the work to establish such mechanisms or methodologies is still in its infancy.

The area where some Swedish companies seem to have failed is in Governance. Several Swedish global groups have had to pay substantial fines (several billion Swedish krona) because of involvement in price fixing cartels. Ericsson, one of the world’s biggest telecom equipment manufacturer, has paid more than $700m in settlement and criminal penalty charges to the US justice department for bribes in various Asian countries.

The increased sustainability focus that the companies are experiencing is not only a duty to fulfil but it’s also a business opportunity. The efforts to reduce global warming and climate change
will benefit companies like for instance ABB that makes products for electrification or Alfa Laval that makes heat transfer products that reduces energy consumption.    

Finally the companies sustainability focus and success are very important to attract and retain young employees. To attract and retain the best people will become essential for companies that want to become the winners of tomorrow.   

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Technological advances such IoT, AI and Automation:

Technological advances such as the Internet of Things (IoT), Artificial Intelligence (AI) and Automation offer great opportunities for companies to improve both efficiency and control. IoT or interconnectivity of machines and equipment as well as automation are nothing new to industrial manufacturers and generally Swedish companies tend to be open to and early to adopt technological changes. At the moment of the writing (November 2023) the initial hype about AI seems to have abated but the progress that has been made during the last couple years in AI is impressive. It’s hard for anyone to know with certitude what the long term impact will be on industrial manufacturing. It is however likely that it will allow companies to improve in several areas such as administration, forecasting, quality, resource efficiency, maintenance, control,…etc. For companies that have a habit of early adoption of technology AI could give them a competitive edge, at least initially. 

The key factor for succeeding in this areas is likely to be the ability to attract and retain the most competent professionals.

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Supply chains: 

For many decades supply chains have evolved to become faster, more cost efficient and holding less inventory. In particular the implementation of lean and JIT principles aimed at making away with inventory almost completely. At the same time supply chains have become more global. After the Covid pandemic breakout it became clear that supply chains had also become more sensitive. 

The pandemic wreaked havoc on global supply chains. This caused delivery delays, stockouts, raw material costs to increase and shipping rates to skyrocket. Many companies then oversupplied their inventories since they didn’t know when they would get the next deliveries. Once the supply chain issues started being eliminated companies began trimming their inventories. This caused ripple effects throughout the supply chains. The lasting impact on the supply chain is likely to be that companies will carry higher safety stocks and consequently increase inventory levels. 

Global supply chains are now more or less back to normal. If we look at the companies analysed we can see that they managed to navigate the supply chain chaos quite well. They have generally managed to pass on the increased costs to their customers, albeit with some delays. Gross margins suffered during the first year of the pandemic, 2020, but has since recovered well. Operating margins were barely impacted. In absolute numbers the operating margins did however fall 2020, as sales revenues fell. 

It's also worth noting that at least the bigger companies are truly global players and have the majority of their production outside of Sweden. They often manufacture in the biggest markets or regions where they operate. This reduces the vulnerability to future supply chain shocks. This also reduced the impact of protectionism with potential trade barriers or increased tariffs.  

Another supply chain trend that gained momentum during the mayhem of the Pandemic is reshoring or near sourcing which means that companies in Europe and US bring back production that was previously exported to Asia, mainly China, for labor cost reasons. With increased automation and use of AI the labor cost advantage of the Asian producers could be reduced considerably. If one consider the long lead-times, increased inventory, increased transport costs, supply chain disruption and reduced control, the overall optimal production location may be closer to home or to ‘reshore’ the production.   

War finally is unfortunately not a new problem but Russia’s invasion of Ukraine has brought back an old specter in Europe that we thought we had put to rest forever. Besides the immense human tragedy, the war initially also had a major impact on energy prices in Europe. Several companies saw their energy bills skyrocket and even had to shut the production temporarily. In addition any sales revenue companies had from Russia and Ukraine basically disappeared. Compared to the total company sales revenue the impact for most companies has typically been limited to 1% or 2% and hopefully a future free Ukraine will become a bigger market once the country has to be rebuilt again. 

A much bigger disruption would be a Chinese invasion of Taiwan. Many of the bigger companies have a substantial amount of their revenue in China (5-23%). It’s not the aim of this analysis to assess the likelihood of a Chinese invasion of Taiwan and hopefully the Russian disastrous invasion of Ukraine will be a strong warning signal against an invasion. Such an event would have a far bigger impact on world trade and not only affect supply chains of industrial manufacturers but most commercial activities.

The strategy that most or at least the bigger manufacturers seem to follow to respond to these supply chain challenges is regionalization or having manufacturing in the region where the sales take place, e.g. produce in the US to fulfill the US demand and so on. The majority of the demand would thus be produced in the region where it’s being sold.   

As we have seen there are several factors that risk having a decelerating effect on the globalization of trade. There are even talks about an oncoming deglobalisation. It’s however important to keep the big picture in mind. The underlying forces for trade, specialisation and exchange go back to the hunter gatherer society and is likely to prevail. It’s true that the globalisation has seen periods of decline because of wars and foolish interventions of populist rulers but it has always recovered and restarted.   

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Skilled resources: 

First it was the steam driven machines, then it was the electricity driven machines, then it was the computers, then it was the robots and now it’s AI that will eliminate all the jobs and drive people into destitution and famine. The thing is that it never happened and it will likely not happen this time either. In fact most companies have problems finding enough qualified employees. What is true is that the role of the workers in the factories have changed over time and become much more demanding whilst many of the more menial and dangerous jobs have been eliminated. Going forward one of the main factor that will make a company a winner is its ability to attract and retain skilled resources.               

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Conclusions: 

The Swedish industrial manufacturers face many challenges but also many opportunities in the near to midterm future. In the bigger picture many of the challenges seems to be part of the life of doing business. Many of the Swedish manufacturers have 100 – 150 years’ experience of going through these type of challenges and still managed to thrive. There is no reason why they would not manage to overcome them this time. In fact they are more likely to conquer these new changes and challenges and benefit from the opportunities they create.

The industrial manufacturing companies are selling their products in many different market segments. Their business therefore tend to follow the ups and downs of the business cycle. Some of the companies such as SKF are even used as a predictor or proxy for how the business cycle is going to evolve.

Judging from the forecast from various market research institutes the future looks promising for the industry and in particular for electronic equipment. The latter is expected to benefit hugely from the forthcoming electrification of our society. 

The global electric equipment market is expected to grow by 10% – 11% per year in the coming years. Exactitude Consultancy expects a CAGR of 11% for the period 2023 to 2029. Econ Market Research expects a CAGR of 10.2% for the period 2023 to 2031.

The growth prospects for the industrial machinery are more moderate but still promising. The industrial machinery market is expected to grow between 3.6% and 6% annually between 2023 and 2032 based on forecasts made by Global Market Insights (6%) and Business Research Insights (3.6%). The actual growth will vary between the different market segments and some companies are very dependent on specific segments whilst others are more segment agnostic. Epiroc or big parts of Sandvik are very dependent on the mining industry whilst Trelleborg and SKF sell to customers in most market segments.

Industrial conglomerates typically depend on many market segments and it is less meaningful to talk about an overall CAGR for conglomerates. Lifco for instance has a dental business (25%), a demolition and tools business (29%) and system solutions business (46%) that covers an entire range of industrial niche markets.

There are many secular trends that are expected to contribute to the growth of the industry. The main ones that are affecting industrial manufacturers are:  

1. Alternative energy sources 
2. Improved energy efficiency
3. Electrification of the society and transportation
4. Automation
5. Digitalisation
6. Need for metals for sustainable transition
7. Urbanisation
8. Scarcity of fresh water 
9. Clean and safe air quality
10. Service & aftermarket 
11. Outsourcing

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1. Alternative energy sources: 

Global energy consumption keeps increasing at the same time carbon emissions must be reduced to counter global warming and climate change. These challenges require both increased use of renewable energy sources such as sun, wind, water and hydrogen and improved energy efficiency. Hydropower (water) is an old energy source and solar and wind power have already been around for some time but it’s clear that in order to reach global climate targets the use of these energy sources will have to increase considerably.  
 

2. Improved energy efficiency: 

Both solar and wind power have the great disadvantage that they are both intermittent. This mean that the energy produced by the sun or wind have to be stored. Hydrogen has the highest energy per mass of any fuel and renewable produced Hydrogen is expected to become a major energy carrier for storing and transporting energy.   

The actual consumption of energy needs to be reduced as well. More efficient heat transfer and the ability to capture and reuse heat. Generally companies that can make their products more energy efficient and thereby helping their customers to reduce their energy consumption are likely to reap benefits.    

3. Electrification of the society and transportation

To reduce carbon emissions a whole range of activities and equipment in society are being electrified such as cars, trucks and other vehicles, heating systems (heat pumps), railway electrification and garden equipment is expected increase the electricity consumption. 

To support this development the electrical infrastructure needs to be scaled up and enhanced. The means demand for new products and systems as well as increased capacity for anything between the electrical plug-in charger for the car to major distribution networks.

4. Automation: 

Automation of industrial processes and discrete manufacturing steps is nothing new but there are two trends that are likely to accelerate the automation and use of robots in the industry: 

1. Automation makes the cost benefit analysis more favourable to ‘reshore’ the manufacturing to the US or Europe. With increased automation the labour cost which was the main reason for moving the production to Asia in the first place becomes less important for the production costs.  
2. Before the outbreak of the Covid pandemic the conventional wisdom was that the robots would completely replace the humans with unprecedented unemployment levels as a consequence and the press were depicting one doomsday scenario worse than the other. Then the pandemic came, and they found something more exciting to write about. With the pandemic behind us we now realise that we have the opposite problem in the West; there are not enough qualified labour available to do the work. As there are not enough people to do the job we have no choice but to automate.      

Increased use of robots is going to benefit a company like ABB who is the second largest robot manufacturer worldwide, but it will also benefit companies like Troax who gets 60% percent of their revenue from machine guarding.  

5. Digitalisation:  

Digitalisation takes many dimensions such as the ‘Internet of Things’ or machine and equipment connectivity, access to analysis of big data, artificial intelligence,…etc. Although the industrial manufacturing companies don’t make digital products themselves the digital content of their products and solutions is becoming more and more important. To provide products and solutions that makes the digitalisation of their customers processes and operations becomes a high priority. 

Also the manufacturing processes of some of the building blocks of the digitalisation opens up opportunities for some industrial manufacturers. Atlas Copco e.g. has a vacuum technique business that provides vacuum equipment for the to the manufacturing of chips, one of the the main elements of digitalisation.   

6. Need for metals for sustainable transition

The ongoing transition to a more electricity powered society is expected to dramatically increase the world consumption of several metals like copper, lithium and nickel. This will require increased mining and extraction of these metals which will benefit the industrial manufacturers like Sandvik and Epiroc how have big mining businesses.     

7. Urbanisation 

The urbanisation trend in the world is not new but it has accelerated during the last decades, and currently more than half of the world's population live in an urban area (55% in 2017). By 2050 two thirds (68%) of the world's population is expected to live in urban areas. 

Expanding urban areas require major infrastructure developments and construction works which will benefit those industrial manufacturers that provide equipment for infrastructure and construction. 

Increased urbanisation also requires more metals like steel and zinc but also copper. This will again benefit companies with strong mining businesses.

Companies who have their main business in construction equipment and material will be covered in a separate industry analysis.

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8. Circularity - Scarcity of fresh Water 

Water is becoming a scarce resource. Demand for fresh water is increasing and at the same climate change is impacting Earth’s ecosystem. Products and solution that helps reducing water consumption and improve water quality or that makes the water more circular will benefit from this trend.

9. Clean and safe air quality

Many production processes have high requirements on clean air both for keeping the products free from particles and the machines and equipment free from debris. Foreign particles in a computer chip or on a medical device could have serious implications.   

What is becoming even more important is the need for companies to create a working environment for their employees that is safe and free from air pollution. A healthy and safe working environment is one of the most fundamental principles of the S (Social) in ESG.     

10. Service and aftermarket

Service and aftermarket per se are not a new trend but it offers good opportunities for profitable growth. Many of the companies analysed already has a strong business presence in service and aftermarket but there are benefits of focussing even more efforts on expending this business. 

Epiroc seems to be the company that has been most successful in capitalising on this business opportunity. In 2022 69% of their revenue were generated by their aftermarket business. In the last five years this business has been growing by 11% per year. This is reflected in the financial performance of Epiroc as they have both the second highest operating margins and return on capital of all the 21 companies.

11. Outsourcing 

The global market for outsourcing of manufacturing or contract manufacturing has shown significant growth over the past decades and is therefore nothing new. The main drivers for contract manufacturing are cost reduction, more flexibility, economy of scale and optimised resource allocation. What has changed over time is that sophistication, expertise and added value of the contract manufacturer have increased. 

The opportunities for the contract manufacturers are to: 

1. Continue to add more value to the life cycle of the product
2. Focus their manufacturing expertise on the areas that are likely to benefit from global trends

Contract manufacturers like Note and AQ Group are likely to benefit from these opportunities

Conclusions:  

The growth prospects for the industrial manufacturers for the next 5 to 10 years look promising. In particular those companies that have products and services businesses that address one or several of the big trends in the society are likely to see the strongest growth.

So, should one invest in this industry? 

To make the characteristics of the industry more visible the information gathered so far has been summarised in an Industry SWOT analysis, see figure 2. 

The majority of the Swedish industrial manufacturers have a history of strong financial performance. They have a long tradition of innovating and adapting to a changing world as they have had to compete on the international arena from early on. The country has a strong engineering culture as many of the best and brightest young people have traditionally studied to get a Master of Science in engineering. 

The industry is dependent on the business cycle. As a consequence these companies’ financial performance will suffer during periods of recession. The fluctuation of demand in combination with long supply chains makes it challenging to forecast demand which leads to surplus inventory with risks of write downs or stock outs with lost sales. Looking back at the last 10 years most companies have, however, shown themselves to be resilient also during challenging times, during the Covid pandemic for instance. 

The future holds both opportunities and challenges for the industrial manufacturers. Technological advances such as automation and AI have the potential for improving productivity, quality and reducing costs. These advances will also open up new business opportunities. There are also other major global trends like the use of alternative energy sources, energy efficiency and electrification that provide new business opportunities for the industrial manufacturers. 

The recent macro-economic challenges such as high inflation, high interest and a potential recession are nothing new for these companies. Most of them have managed to pass on price increases to their customers albeit with a time lag. The inflation seems to have been tamed for this time which means interests have likely peaked. A possible recession as a consequence of the increased interest rates is nothing new to these companies as most of them have weathered both the great depression and the financial crisis. Many of the companies will also be helped by their big service and aftermarket businesses, which tend to be less impacted by the ups and downs of the business cycle.         

Swedish companies are relatively well prepared to respond to changes and new requirements brought on by the increased focus on sustainability and ESG reporting. It’s important for our society to implement these changes but it’s also important for companies’ ability to attract young talents. A strong sustainability agenda and culture are likely to be important factors for young employees to associate themselves with a company. 

By also staying in the forefront of implementation of new technologies the companies are likely to be best positioned to attract competence and talent. 

Supply chain disruptions due to tariffs, trade wars and real wars as well as black swans such as the Covid pandemic is nothing new to these companies. Some of these events are difficult to prepare for but the best approach is likely to be to have a global organisation with strong local or regional presence which allows flexibility to adapt to changing conditions.    

The risk of technologies or products becoming obsolete is always present but in contrast to consumer durables like mobile phones, things tend to change less rapidly for industrial manufacturers. We are not likely to do away with friction (SKF) or stop mining (Epiroc and Sandvik) anytime soon. This is not a reason to become complacent and competitors may come up with more cost-efficient way to produce the same products.  

So to answer the question if one should invest in the industry the answer is yes. 

The majority of the companies have a track record of strong financial performance and are well positioned to grow through their presence in market segments that will benefit from global trends. An initial high level assessment of the 21 companies to assess how attractive they are from an investment perspective has been prepared, see table 2 below. This is not to be seen as an investment recommendation but more a priority list of which companies to analyse, on an individual basis, first.   

It is said that one should never try to time the market but if we were to enter into a recession in the near future share prices are likely to come down. The prudent investor may therefore be better off keeping some of his powder dry until it one can see a clear trend shift in consumer demand. 

Having said that, share prices often start recovering already before the company starts showing clear signs of business starting to improve. Share prices are normally driven by future expectations and once investors start expecting that the companies performance will start improving they will start buying. 

Appendix 2: Financial ratios and methods of calculation 

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Calculation methods: 

1. ROCE, Return on Capital Employed, illustrated for 2022 =
   EBIT 2022/ ((Capital Employed 2022 + Capital Employed 2021)/2)
   Capital employed = (Total Assets - Short Term Liabilities – Deferred Tax Liabilities)
2. ROE, Return on Equity, for 2022 = Net Profit 2022 / ((Equity 2022 + Equity 2021)/2)
3. EBITDA = Earnings Before Interests, Taxes, Depreciations and Amortisations. Any non-recurring costs (e.g. restructuring) or non-cash profit (e.g. revaluation of forest assets) are eliminated from the costs/ earnings.
4. EBIT = Earnings before Interest and Taxes. Major non-cash profits (e.g. revaluation of forest assets) are eliminated from the earnings.

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Appendix 3 – Detailed analysis of Nordic Capital financial performance 

Business Units: 

1. Kraft paper is used mainly for packaging such as bags. 53% of revenue 
2. Grease proof paper for food, e.g., muffins. 47% of revenue 

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Ownership:  

The company made an IPO in October 2020. Shanying International Holding is the biggest owner (through Sutriv Holding) with 48% of the shares and the votes. The other big owners are all institutional investors such as mutual funds. Prior to the IPO Shanying was the sole owner. They bought the company in 2017 from Holding Blanc Bleu and Petek GmbH.

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Growth: 

As seen in table 6 the average growth during the 8 past years has been 9.3%. Revenue fell during the Pandemic year 2020. It recovered a bit in 2021 and increased by 44% in 2022.
In chapter 6 Industry Financials we saw that the industry revenue increase YoY in 2022 was mainly due to price increases. In the case of Nordic Paper there was also an acquisition made at end of 2021. The acquisition of Glassine Canada Inc. added approx.. 440 MSEK to the revenue in 2022 or roughly 14% of the total revenue increase of 44%.

More than 90% of the company’s revenue is exported. In the period 2016 to 2022 the Swedish krona fell against most other currencies. E.g., the Euro gained from SEK 9.57 in December 2016 to 11.19 in December 2022. That’s an increase of 16% or a CAGR of 2.5% per year. 

If we instead look at tons sold the picture is a bit different. In 2016 the sales volume was 263 ktons. In 2022 after the acquisition of the Glassine Canada the sales volume was 285 ktons or an increase with 7.5%. The corresponding CAGR was 1%. If we make a high-level adjustment for the total sales volume in 2022 would be approx. 40 tons less or 245 tons which is less than the volumes in 2016! Volumes have actually decreased.  

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Profitability:  

The operating margin (EBIT) was in average 13.6% during the 8 years period as shown in graph 10.

Overall strong operating margins throughout the period but with quite poor performance during the pandemic years 2020 and 2021. 

One contributing factor to the strong operating margins are the relative low levels of depreciations of the assets.     

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Capital Efficiency: 

The high ROCE is driven by high operating margin (EBIT) and low capital employed. The capital employed, or the denominator in the ratio, is mainly corresponding to shareholders equity, long-term debt minus cash on hand. There has been very little change in the sum of this three between 2015 and 2019. In 2019 the company had no long-term debt. This changed in 2020 just before the IPO. The company then took a bank loan of 950 MSEK in order to pay the owners a dividend of 950 MSEK. This corresponds to almost 4 times the net result in 2020 or 40% of the market value of all shares. The ROCE has come down since then.  

If we look at the asset side of the equation one can see that the balance sheet value of the fixed assets hasn’t really changed since 2014. At the end of 2014 the value of buildings, land, machinery, equipment and ongoing constructions was MSEK 642. End of 2022 that value was MSEK 742 which includes assets of MSEK 100 though the acquisition of Glassine Canada. The company has only invested enough to cover the yearly depreciations. The value of the fixed assets in relation to the revenue 2022 was 0.17 (742/4440). The same ratio for Billerud is 0.69 or four times higher, as an example. According to an analysis of the IPO document made by Affärsvärlden in October 2020 (Svensson, 2020) prior to the IPO the company had identified a need to invest MSEK 1,200 in one of their factories (out of four). That was twice the amount of the total current value of their fixed assets. This investment hasn’t happened yet. All this points to a business that seems to have been ‘under invested’ for a long time.%. Nordic Paper seems to have prioritized high dividends to the owners and only invested the bare minimum to keep the operations running. This is concerning for the future. The MSEK 950 dividend the owners paid themselves just before the IPO would have been better spent investing in machinery and equipment. It’s also questionable how willing the banks will be to lend more money to Nordic Paper if they just use the money to pay their owners. 

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Conclusions:

Nordic Paper has been a veritable cash cow for the owners prior to the IPO. The investments seem to have been neglected as most cash has been distributed to the owners. To make matters worse the company has borrowed a substantial amount of money to pay the owners a huge dividend just before the IPO.

The strong growth rate seen in the period 2014 to 2022 has mainly been driven by acquisition and favorable currency and price movements. The underlying volumes or delivered tons have actually decreased (in the period from 2016 to 2022). The price and currency factors may also act in the opposite direction for the company if the Krona strengthens or prices fall. As a consequence, profitability would take a hit.  

As profitability has been reduced in 2020 and 2021 and debt has been added ROCE has been reduced as well. If one were to add the investments of MSEK 1,200 identified in 2020 to the capital employed the ROCE would fall even further.  

As the previous owner has maintained a 48% stake and the next 9 biggest owners that together hold 31.1% are all institutions the strategy of the company is not likely to change dramatically.

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