atlas copco--over weight---morgan stanley

November 19, 2007

Atlas Copco

Optimism in India

—

Nirvana at the CMD?

Quick comment:

We met management of Atlas Copco

India on Friday, who provided optimism regarding i) the

company's growth and return prospects but also ii) the

reception of tomorrow's CMD in Orebro, Sweden.

Firstly, management outlined how India should be the 3

rd

largest market within three years, adding 1.5-2% group

growth p.a. and fuel mix. India plays a key role in

explaining how emerging markets reached 40% share of

group orders YTD. Secondly, AC India, who hosted

global managers last week, emphasized that exports

from India to elsewhere in the world remains strong and

indicated that the group's performance was strong in

October. Investors are hoping for reassuring comments

from management at tomorrow's CMD. Our visit in India

strengthened our belief they can provide such respite.

Big in India...

India represents nearly 5% of group sales

(6

th

largest country in the group), including revenues that

are not booked through Atlas Copco India (of which

Atlas owns 84%). Orders have grown at 28% YTD (46%

last year). Margins are comparable with the group

average and have steadily improved, which is in contrast

to most industrials we met in the country.

...and getting bigger.

Sales in India are expected to

grow at a high 30-35%, which means they could exceed

those of Germany (ranked 3

rd

at an expected SKr 5.5-6

billion). If the targeted growth is achieved, it provides

1.5-2% base growth for the group. Moreover, notable

margin expansion is expected as a program to deplete

production costs is being ramped up. Based on these

indications, we see how India could represent 7.5% and

10% of group sales and EBIT by 2009, respectively.

Dynapac – only way is up:

Dynapac has c.1% market

share – the result of not having had local production.

The new plant will be finished in June 2008.

Management targets an 18-20% share in a few years in

a SKr 2 billion market that should boom over the coming

years. India is forecast to build a much-needed 20,000

km roads over the coming five years, essentially

doubling capacity.

Atlas Copco in India

India represent nearly 5% of group sales (6

th

largest country in

the group), including revenues that are not booked through

Atlas Copco India (of which Atlas owns 84% after the public

offer in 2003). YTD orders are split in Compressor (56%),

Construction & Mining (37%) and Industrial Technique (7%).

Orders have grown at 28% YTD (46% last year), driven by CT

in particular. Sales growth is expected to be an impressive

30-35%, which means they could exceed those of Germany

(ranked 3

rd

at an expected SKr 5.5-6 billion) and only be behind

China and the US. If the targeted growth is achieved, it would

provide 1.5-2% base growth for the group.

Margins are comparable with the group average at a high teen

level and have steadily improved (also YTD when adjusting for

costs in relation to the investments/relocation of new plants),

which is in contrast to most industrials we met in the country

that had experienced pressure from increased competition

combined by FX and raw material cost headwind. Moreover,

notable margin expansion is expected as a program to deplete

production costs is being ramped up. Based on these

indications, we see how India could represent 7.5% and 10% of

group sales and EBIT by 2009, respectively.

The key growth drivers include:

􀂃

Expansion of Dynapac:

Dynapac has c.1% market share

– the result of not having had local production.

Management targets a 18-20% share in a few years in a

SKr 2 billion market that should boom over the coming few

years. A new plant and cross selling with the rest of Atlas

established businesses are growth drivers. India is

forecast to build 20,000 km road over the coming five

years in a 10-year $250 billion program, which essentially

means doubling the country's road capacity. We learned

the hard way about this desperate need.

􀂃

Recent investments:

The new Dynapac plant for rollers

and pavers is expected to be inaugurated in Nasik in June

2008. Demand is said to be so strong that Atlas expect

revenues to ramp up very fast. The relocation to one large

and extended CT plant in Pune and one large CMT plant in

Nasik. Overall recent and ongoing investments exceed

SKr 100m.

􀂃

At the right place at the right time:

Atlas is exposed to

some of the fastest growing industries in the region. CT is

market leading but continue to favour from the growth in

the Indian manufacturing base. Moreover, Atlas is ramping

up its CNG (compressed natural gas) offering –

manufacturing started this year. Not only traffic is a major

issue, the transport sector represents 2/3 of pollutants.

Why CNG is likely to grow is easy to see – the cost of a kg

of CNG is about half of a litre of petrol. 6 major cities

already focus on expanding CNG usage (e.g. as only

energy source for public transport), while another 29

should do the same by 2009. CMT is driven by significant

private investments in coal mining and infrastructure

construction, while IT is boosted by 30-40% annual growth

in vehicle production and the transition from two to four

wheelers as the Indian population gets richer.

􀂃

Aftermarket and acquisitions:

With the strong

equipment demand, the share of aftermarket sales looks

unlikely to grow notably from the present 20-25% but

clients are increasingly outsourcing maintenance. Finally,

management states that they are actively looking for CT

and CMT acquisitions.

Quality at a low price: We remain Overweight

Atlas trades at 9.0 times 2008 EV/EBIT. The A and B shares

trade at 12.0 and 10.9 times P/E, respectively. We view the

valuation at a slight average discount to the Capital Goods

space as attractive given the 1) the superior returns (12m

rolling RoCE has been around 48%), 2) superior stability in

returns (the 2000-02 decline was only 270bps), 3) market

leading positions offering strong pricing power and 4) attractive

end market exposure (40% emerging market exposure).

On the other hand, we have struggled to identify a re-rating

catalyst. Acknowledging that Atlas management is not known

for giving too much away, we believe in welcomed messages

about sustained growth tomorrow during a period of mounting

fears that the 5 year bull run in Capital Goods is coming to a

very abrupt end.

Company Description

Atlas Copco consists of three business areas. Compressor

Technique division manufactures compressors, which supply

power to most manufacturing and process industries.

Construction & Mining Technique division produces drilling,

tunnelling and mining equipment, and Industrial Technique

division specialises in industrial power tools.

Capital Goods/Sweden

Industry View: Cautious

GICS Sector: Industrials

Strategists' Recommended Weight: 9.0%

MSCI Europe Weight: 10.1%