SDVKY Sandvik AB (PK)

Sandvik AB (SAND.SK) has been making steel in the northern Swedish town which gives the engineering group its name for 150 years. But Jonas Gustavsson, the recently installed chief executive of Sandvik's specialty steels division, has less than three years to improve the unit's returns or prepare it for a full or partial sale.

Sandvik, founded in Sandviken in 1862, is hardly the first heavy-industrial group in Europe to question whether its steel business can stave off competition from lower-cost foreign rivals. But Sandvik's Chief Executive Olof Faxander said last September the group wouldn't tolerate Sandvik Material Technology's poor performance indefinitely.

"I'm perhaps not entirely calm, but I am quite confident that we will deliver on the goals we have stated," Gustavsson told Dow Jones Newswires in a recent interview.

Gustavsson said the specialty steels business has to improve its return on capital employed to around 17% from the current 7% by reducing costs by SEK500 million over a two year period and shifting its product mix more aggressively toward more technologically advanced and profitable products. Sandvik's overall ROCE was 16% in 2011 though it has a target of 25%. SMT still contributes around a fifth of Sandvik's annual revenue of 94.08 billion Swedish kronor ($14 billion) with the group's mining-equipment and machine-tools units the major contributors to revenue and profit.

Relatively low returns from SMT and Sandvik's construction unit explains why Sandvik stock trades at a discount to other Nordic engineering companies. Its shares are on a multiple of 12 times forecast 2013 earnings compared with 15 times at Alfa Laval, 14 times at Atlas Copco, and 13 times at Assa Abloy, according to Morgan Stanley.

On the cost front, SMT, which employs 8,200 people, is laying off 600 permanent staff and letting go of 180 temporary workers in the first half of this year amid plans to consolidate its Swedish steel wire and strip production in Sandviken.

Gustavsson, who took the reins at SMT last May, is also reviewing strategy. The unit, which makes a variety of industrial components from stainless and other steel alloys and titanium, has become a diversified business in its own right over the years. It supplies everything from equipment for nuclear power stations to parts for hair dryers and dish washers.

But the technology that is at the root of Sandvik's success, namely the mass-production of steel that founder Goran Fredrik Goransson helped pioneer, has come back to haunt it as competition from lower-cost Chinese and Indian companies has grown in recent years. With sluggish economic growth in Europe also a factor, SMT has struggled, particularly the higher-volume, lower-margin, consumer-orientated parts of its business.

"SMT hasn't really delivered good enough returns in the past 10 years," said Gustavsson. Order intake fell 19% in the fourth quarter from a year ago as high demand from customers in the oil and gas industry failed to offset weak demand in other sectors. The unit reported an operating loss of SEK841 million hit by SEK900 million in one-off impairment and restructuring costs. "Oil and gas continue to be strong, while it's still more difficult in standard or in consumer-related segments," Gustavsson said.

Gustavsson aims to make more of SMT's industrial expertise and reduce the number of standardized products and instead focus efforts on projects where the barriers to entry are higher for emerging-market competitors. Today, around half of the products that leave its steel mills are standardized.

"We are working actively to change this, this makes the upside to our business quite big," Gustavsson said. SMT aims to focus its resources on the oil and gas industry, which currently makes up around 30% of sales volumes. As energy companies explore for and produce oil and gas at increasing depths and in difficult conditions like the Arctic, SMT's high-performance metals should come into their own, Gustavsson said.

Gustavsson is prepared to sacrifice SMT's revenue growth to make the unit more profitable. "We will be quite tough with what orders we take in as we focus on profitability, so there will be no dramatic [top line] growth for SMT," Gustavsson said.

As the restructuring of SMT starts to bite this year, Gustavsson said investors shouldn't expect sudden change in the unit's fortunes. "There won't be any dramatic lifts at once, but I believe we will see an improvement step by step," he added. Gustavsson is optimistic the unit will make a profit in 2012. "We have good hopes about that," he said.

-By Katarina Gustafsson, Dow Jones Newswires +46-8-5451-3097; katarina.gustafsson@dowjones.com

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