6 July 2012 Fundamental Equity Analysis of Assa Abloy AB...Assa Abloy (Assa) is a Swedish company...

6 July 2012 Fundamental Equity Analysis of Assa Abloy AB

Yordanov, Independent Equity Research 1

Preface

This independent equity research is a sample that support my equity analytical skills and therefore is a for a

widely-based usage. I claim no rights on this analysis. The company has been chosen due to its high-quality

reporting standards and the simplicity of its business model. Those two factors enforce my in-depth

understanding of the business and therefore enhance my visibility over the long-run.

I have noted in advance where I have used excerpts of information. The reason behind is not to omit an

important information that might be vital for a decision-making. Also parts of some sections (especially one

for competition and markets) are based predominantly on Assa Abloy’s annual reports and their opinion

about the market and competitive environment. This must be taken into consideration, since using

predominantly one source of information might be misleading. It is important to remark that I have used

neither sell side equity reports, nor special (subscription based) industry analyses. In this respect, the

analysis can be significantly improved (or spoiled) having those two in hand.

This fundamental analysis is not suitable for short-term investing decisions. You will find no added-value if

you are such an investor. This analysis is only suitable for long-term investors who base their decisions on

fundamentals, not technical analysis.

Krasimir Yuriev Yordanov

Independent Equity Analyst

Date: 11.08.2012

“You have made quite a report. It looks like you've put in a lot of time and have come up with a

detailed analysis”.

Michiel Bootsma, Senior Investment Manager at ING IM



Fundamental Equity Analysis of Assa Abloy AB

Content

Page

1. Summary

3

2. Company’s Snapshot – Key Ratios 4

3. Strategy 5

4. Market Presence 5

5. Value chain 11

6. Products 14

7. Cost-efficiency 17

8. Competition 20

9. Significant risks 24

10. Management 32

11. Shareholders

37

12. Additional Financial Data 43

13. Recommendation

50

14. Bibliography 51

15. My Investment Principles 51



1. Summary

Assa Abloy (Assa) is a Swedish company operating in the security business that produces opening door

solutions. It’s market capitalization is currently around SEK 77,8 billion. Its business model is simple, in a

way that the company does not diversify horizontally. Assa Abloy is strictly focused only on products

needed to open, manage, and close doors and entrances. From another hand, the Group is geographically

diversified around the globe, giving Assa a competitive edge in terms of market presence and reach to

emerging markets. Along with that, part of Group’s strategy is also product leadership. There is a major

industry shift from mechanical to electromechanical and hi-tech opening door solutions, where Assa Abloy

seems to lead the pace. The company is strongly exposed to those fast-growing segments, giving it once

again a competitive advantage.

Assa Abloy sells through complex distribution channels aiming to reach its end-users, mainly commercial

and residential customers. The nature of their business and variety of end-users require opening door

companies to be very active in their relationships with the middle-men.

Growth is achieved by combination of organic development and acquisitions which have accelerated in the

past few years. Therefore, continues restructuring is needed to lower the cost of production and to achieve

synergy effects within the Group. Cost-efficiency is the third pillar of their corporate strategy and the one of

much attention. Assa Abloy CEO, Johan Molin, has done a good job in positioning the company at good

place for further development, but COGS are difficult to manage. Company’s profitability has not changed

significantly since he took place in 2006, but Johan Molin is the one responsible for accelerating sales

through good products positioned on the right markets. One of the biggest risks for the company is losing its

current CEO.

Competition. World’s security market is very fragmented. Opening door solution providers operate mostly

on their domestic markets, but Assa Abloy along with 4 major of its competitors, is well geographically

diversified. In terms of reach to emerging markets Assa seems to hold the leadership.

Company’s shareholding structure is well diversified. Largest shareholders have always been strategic one,

whereas big part of company structure is in hand of small shareholders. It is meaningful to note there are no

large investment banks with major stakes into the company, which might mean two things: 1) either they

don’t even follow the company (and therefore could be misprices), or 2) they simply consider it as an

overpriced investment. Both ways are important to be revealed.

Assa Abloy operates in a market that is strongly independenet from government regulations. In my view,

that significantly decreases the uncertainty and enhances visibility.



In conclusion, the company is well-positioned for further growth but it reveals signs of overpricing. Its

valuation multiples are high which might shows the market has already recognized Assa Abloy’s growth

potential. Moreover, the acquisitions acceleration suggests that sustaining the same high growth rates in the

future might be challenging.

2. Company’s Snapshot – Key Ratios

Source: Own estimations, Assa Abloy





3. Strategy

Assa Abloy’s strategy is continuously adapting. Since the new CEO took place in late 2005 the Group made

its strategy more distinctive. Even though the company had responded to the crisis very well with an actual

no sales decline, the management came up with a new strategic plan in 2009. Company’s strategy is divided

into 3 core pillars: market presence, product leadership and cost-efficiency.

Source: Assa Abloy, Annual Report 2011, page 37



4. Market presence

4.1 Security Market

Assa Abloy estimates total security market to be worth over EUR 250 billion. The segment in which the

Group is active accounts for around 15 percent of the total market. Moreover, the company estimates their

market share of 10 percent of that segment in which they are positioned. Assa Abloy (AssaAbloy)

represents their opinion about the industry this way:

“Globally, the lock market is still fragmented. However, the market in each country is relatively

consolidated, as companies in the industrialized world are generally still family-owned and leaders on their

home markets. They are often well-established and have strong ties with local distributors. In less developed

countries, however, established lock standards and brands are less common.” (15)

Source: Assa Abloy, Annual report 2011, page 14

My calculation shows that their estimations about the market size and

shares differ slightly but I can assume those approximations to be

reliable.

Source: Own estimates

4.2 Assa Abloy market position

Company’s strategy aims focusing on profitable commercial segment with high proportion of aftermarket

sales and increased share of fast-growing electromechanical products. Emerging markets are expected to

continue growing significantly faster than mature markets in a foreseeable future, and therefore remain

company’s main focus.



Assa Abloy is playing a role of market consolidator (more into the acquisition section). Also the company

tries to lead the pace of market penetration, especially in emerging markets. Most of Assa’s competitors are

focused predominantly on their domestic markets (more into the competition section), whereas significant

effort of Group strategy is to focus on new market penetration. Most of those geographical expansions come

from acquisitions.


The natural protection against weak markets (as the Group has shown during the crisis) is through global

diversification. As you can see in the Division analysis there is a major shift towards Asia, where actually

the growth comes from. Since the crisis came mature markets are weak and both growth in sales and EBIT

are coming from Asia. Emerging markets accounts for some 25% of group’s sales (which includes East

Europe, Asia, South America and Africa). That is compared to 9% seven years ago (2004th

).

Note: The following paragraph with divisional presentation consists information (is an excerpt) directly

taken from Assa Abloy’s annual report (AssaAbloy). I have decided not to restate it in order not to omit

important information.

“Assa Abloy is divided into three regional and two global divisions. The regional divisions manufacture

and sell mechanical and electromechanical locks, cylinders and security doors adapted to the local market’s

standards and security requirements. The global divisions manufacture and sell electronic access control,

identification products and entrance automation on the global market.

1. EMEA - EMEA division manufactures and sells mechanical, electromechanical and electronic locks,

cylinders, security doors and fittings in Europe, the Middle East and Africa.

2. Americas - Americas division manufactures and sells mechanical and electromechanical locks,

cylinders, security doors and door frames in North and South America.

3. Asia Pacific - Asia Pacific division manufactures and sells mechanical and electromechanical locks,

cylinders, high-security doors and hardware in China, Asia, Australia and New Zealand.

4. Global Technologies - Global Technologies is produces electronic security solutions. The division

consists of two business units: HID Global whichdeals with secure identification and access control

solutions, and ASSA ABLOY Hospitality which operates in electronic lock systems and safes for

hotels and cruise ships.



5. Entrance Systems - Entrance Systems division is a produce entrance automation products,

components and service. The product range includes automatic swing, sliding and revolving doors,

air curtains, gate automation, garage doors, industrial doors, docking solutions and hangar doors.”

(38-9)

Summary


Divisional information throughout the years




Note the CAGR development in the last 3 and 5 years of the corresponding division compared to the Group.

As you can see weakness in Europe and Americas and rapid growth in Asia, keep in mind that most of the

Entrance Systems divisions sales are coming from mature markets.


Assa Abloy estimates the global door market to be worth around EUR 80 billion. Another important market

for the company is the entrance automation market. It includes industrial doors, systems for loading docks

and garage doors as is estimated at EUR 15 billion, according to the company.

Forecast for division development

As global markets recover I do expect more growth in EMEA and Americas (approximately 1% per year).

As the number of employees decreased since 2006 from 70% to 40% of total, this trend is ought to continue.

In the next 10 years this percentage might stabilize to 20% and remain so for the years afterwards. I have

weak forecast regarding Asia’s development. However, as some warning signs of decreasing growth rate of

Chinese economy are current I should be more cautios. As the sales growth has been 25% per annum in Asia

Pacific division this might lower to 15-20% for 10 years ahead.



4.3 How is the company selling?

The company has been taking significant efforts to unite its sales force so that one sales person to offer all

Assa’s product range. Also, as the company reports 80% of Group products are double-branded with the

local brand endorsed by the Assa Abloy brand. 20% are sold under global brands Yale, HID, Abloy and

Mul-T-Lock focusing on emerging markets (look below).


More about different products in the products section later on.

4.4 Customers

Assa Abloy is selling predominantly to commercial customers (75%), making it more or less B2B player.

The rest 25% comes from residential market. The commercial segment comprises of institutional and

commercial end-customers (referring to schools, hospitals, universities, airports and large office buildings).

Installers and locksmiths are two of company’s main sources of distribution and installation (you can read

more into the value chain section).



The consumer market (25%) differentiates by the fact that private customers need extensive advice and

assistance. Most of the sales are coming from replacements and renovations. For the consumer market the

company distributes major part of its products in cooperation with door and window manufacturers.


Assa Abloy has competitive edge from its competitors by the composition of aftermarket- new constriction

sales. Assa is well-protected from weak real estate construction market due to its heavy exposure to the

aftermarket. This has protected Group sales from decline during the real estate burst. For the future such a

structure should stabilize and secure growth, compromising with slower pace.

5. Value chain

In today’s security market, manufacturers of security product, such as Assa Abloy, mainly reach their end-

customers through a variety of distribution channels. Many of the Group’s products are sold in small

volumes to a large number of end-customers.

Source: Own estimations, Company

5.1 Inputs

The company buys materials (discussed in the expenses section), but mostly stainless steel. Therefore,

market price development of stainless steel is influencing the business but the correlation is somewhat

controversial (As you can also see in the material cost analysis section).

In high-cost countries the shift form full production to final assembly continues. Therefore, the company

must buy more components (mostly from suppliers from Asia) ready to be assembled. In low-cost countries

the company is focusing on full production due to the low costs of production and personnel.



5.2 Distribution channels

Source: Assa Abloy, Annual report 2011, page 18-9



Assa Abloy has a very complex distribution channel structure. Its distribution network is consisted of many

parties involved. As the market being still fragmented almost all around the globe the company is using the

following distribution channels. I have ordered them by distance and complexity of services to the end-users.

From designers and

projectors

Wholesaling Professional consultants Retailing/ link to

residential customers

Architects

Door and window

manufacturers

Distributors

Building and lock

wholesalers

Security consultants

Security system integrators and

Security installers

Hardware and security stores

Retailers

Do-It-Yourself

Locksmiths

Source: Own estimations

5.3 End-users

End-users are mostly commercial customers with 75% of Group sales. The residential market holds some

25%.

Source: Assa Abloy, Annual report 2011, page 19 and official webpage

Comment. Due to lack of sufficient information about the relationships with their distributors and suppliers

I cannot continue deepening the analysis in this section. What we can assume with a high confidence is that

Assa Abloy has been doing well in finding best approaches of reaching end-users, has used variety of

channels on different markets and therefore possess experience to continue doing so, and also decreasing

sales expenses witness the company (referring also to Johan Molin – the CEO) has found and is finding

better ways to sell cheaper to end-users.




This graph shows that even if the selling expenses are decreasing in relation to sales, they are still growing

in actual terms but with slower pace. CAGR in nominal values of selling expenses for the last 3 years is

some 4%.

6. Products

Highlights

R&D increases; More engineers employed - 20% cumulative growth since 2007; Global common product

platform; Fewer components; products from the last 3 years to exceeded 20% of sales for two consecutive

years.

6.1 Product overview, classes and divisions


Assa Abloy is focusing on maintaining product leadership through implementation of the latest technologies

into door opening solutions. As Johan Molin – the CEO - says that Assa has strong competitive edge mostly

because they respond faster to the changing door opening market conditions towards usage of

electromechanical locks and technologies. Their competitors seem to still predominantly focus on

mechanical locks – more about that in the competition section. Assa Abloy management argues the company

will be protected through its innovative products at least in a foreseeable future. It is notable to mention that

the number of installed doors in the market fitted with some form of electromechanical solution is estimated

at 3 to 5 percent. The company predicts rise to some 20% in the years to come (not verifying when), which

should lead to further market development. However, as the company penetrates new emerging markets,

which might demand cheaper products, this shift towards expensive electromechanical solutions could be

slower than expected.

The Entrance automation system is a new separate division since 2011th

. Its Head Juan Vargues has

significant insider equity holding valuing to SEK 14,7 million as for the end of 2011th

. Entrance automation

division unmerged from electromechanical locks, access control and identification technologies, taking

almost half of the division’s sales. It contributed also from Assa Abloy’s largest acquisition ever –



Crawford, which is heavily exposed to industrial door business and exposure to China. Entrance Systems

division targets SEK 20 billion of sales until 2015, which accounts to 24% annual growth. I consider this as

hardly possible, if not achieved through acquisitions.

Forecast for products development

Mechanical locks – in the next 10 years I do expect mechanical locks to continue decreasing. The rate

should sustain at around -5% per year but as Assa continues penetrating emerging markets this slide might

slow down. The reason is that more and more customers from emerging markets will be willing to buy but

their income will allow relatively cheap products as mechanical locks are. For the next 10 years mechanical

locks class should sustain between 25-30% of group sales.

Electromechanical locks – this product class will accumulate the decrease coming from mechanical locks. I

do expect them to sustain the growth levels of some 6-7% per year.

Entrance automation – in my view this is one of the product classes with brightest prospects. First, the

company wouldn’t separate it if they didn’t expected rapid growth in the years to come. Electromechanical

locks and Entrance automations should become the largest products classes in 2022.

Security doors and hardware – moderate growth of 1-2% can be expected for the future as well.

6.2 Products

Assa Abloy offers products and services for opening, closing, and managing doors and entrance solution.

The company is strictly focusing on door solutions and in this respect is not penetrating other market

segments from the security industry.

However, note that in actual term all products types are growing, including mechanical locks. The latter is

decreasing only in relative terms.




Assa Abloy reports the sales by product class. However, there is no further distinction and in this respect I

have classified them by type.

1. Old Fashioned door opening solutions

(Padlocks & Combination locks,

Mechanichal locks and hardware)

2. High-tech door opening solution

(Electromechanical & electronic locks,

Acces control and identification, mobile

keys, Aperio online access management,

Hi-O networked access control, Keyless

entry & virtual keys, RFID credentials,

tags & readers, Smart cards &

credentials)

3. Door automatics

4. Security solutions (Security doors and

other doors, Hotel locks & security)

5. Door Closers (Door closers, Exit devices

and panic devices)

Most of the products have life-cycle of 10 to 15 years, according to the company.

6.3 Importance of products leadership

Part of Group strategy is product leadership by which to achieve its target for organic growth of 5% per year.

This long term shift towards more sophisticated opening door solutions creates higher demand for R&D. As

witnessing, R&D costs as percentage of sales increases gradually mainly because of the greater number of

engineers employed.




For a second consecutive year the sales of products developed in the past 3 years exceeded 20%. The target

is 25% stressing on the importance of R&D to sustain growth rates. Assa Abloy is a great example of a non-

technological company that benefits from technological development. The company is simply implementing

latest technological innovations into their business in order to sustain and maintain that product superiority.

7. Cost-efficiency

This is the third pillar of Assa Abloy’s strategy. To sustain cost-efficiency the Group must restructure

constantly to integrate acquired companies and achieve synergy. Also, to accelerate its market development

goals to penetrate new markets, and product leadership, the company must continue acquiring into the future

as well. This process sustains the need for continues restructuring programs too. That has been the case since

2006. There have been more than four restructuring programs aiming 1) closure of production units in high-

cost markets 2) to lay off employees in high-cost markets, 3) switch from full production to final assemble in

high-cost markets, 4) integration and synergy effects from acquired companies, all in order to increase its

operating profit margin.

Results:

Total number of employees has been decreasing in high-cost countries: CAGR for 5 years of -4% in

EMEA and CAGR for 5 years of -7% in Americas. This has led to significant decrease in total

remuneration costs as percentage of sales mostly because of the production shift in Asia. From

another hand, about 49% of the number of employees are still working in high-cost countries (West

Europe, North America, and Australia), compared to 34% five years ago. And if the percentage of

employees is 49%, the percentage of remuneration spent on those high-cost employees must be

significantly higher (I assume some 70%) of total remuneration expenses. This reasoning strengthen

the magnitude of this shift from full production to final assemble in mature markets. However, note

that final assemble in high-cost countries as percentage of total production remains low. I do assume

those two trends will continue in foreseeable future lowering remuneration expenses further down.

There is still much room for improvement here taking into account still high percentages: 52% of

total purchases of raw materials, components and finished goods in high-cost countries, 49% of

employees is still employed there, and respectively at least 70% remuneration expenses goes to those

employees in high-cost countries.




Forecast for number of employees

I do expect number of employees in Asia to reach 60% of total in 10 years from today.

Switch from full production to final assembly in high-cost countries has been unsuccessful. As you

can see the change in production structure have not changed when it comes to final assembly. It

means that this process is yet to be unleashed. The management keep repeating how important that is

and how this switch is a major component to achieve better cost-efficiency. However, I don’t see

positive results yet. From another hand, due to this major shift to Asia Pacific full production in high-

cost countries decreases.

Source: Assa ABloy

Operating profit margin keeps at the same level regardless of restructuring programs. It is important

to note on the shift in cost structure. As you can see in the following chart operating expenses have

decreased, indeed, significantly. This is mostly due to unified sales force and lower administrative

expenses. However, note that the lack of operating profit margin development is caused by increased

COGS. By looking at the expenses by nature we spot obsolete direct material costs. That is the

highest increasing cost among all and most influential in the total cost structure.





More about costs can be read in Availability and price fluctuation of raw materials section.

Commentary on Assa Abloy’s Stategy

First, I do think Assa Abloy has adapting its strategy to respond on current market conditions. As the

markets were strong in Europe and North America prior to 2008 the Group benefited since more than 70%

of sales have came from there. Back in 2008th

, the company was not that well diversified geographically.

When mature markets started weakening, Assa started shifting both production and sales force to Asia. As

we can see in the excel file (divisions sheet), Asia division gained importance, but with slight delay. It took

one and a half years for the management to shift and start earning from Asia (which really started in 2010th

).

Even with that delay in responding to changed market conditions Assa Abloy’s management showed they

know how to update company’s strategy to meet current demand. That is one important message.



Second, when having the right markets a company needs to offer the right products. As you can see more in

the competitors analysis Assa Abloy is leading the pace of innovation and hi-tech opening door solutions.

Today, mechanical locks accounts to less than 40% of Group sales. Still most competitors from the security

market are strongly dependent on mechanical solutions – an industry that is growing at global’s GDP. In

comparison, electromechanical solutions and entrance automations grow 2-3 times faster. It has been that

way for a many years now giving the change to all competitors to start shifting. Assa has been responding to

that among the fastest. That is a second strong message from the company and its management. They know

their market and focus on products that will be important into the future.

Third, cost-efficiency drive but results lag behind. Since the new strategy was adopted in 2009 the company

put a strong accent on cutting its costs. Most of geographical changes to increase efficiency have been made

in 2009-2010. This process actually started back in 2006 when the new CEO renewed restructuring

programs. However, I cannot see major change in operating income margins now, compared to the past. Still

the company seems to have heavy expenses and those efforts of shifting production to low-cost countries

and updating plants in high-cost countries from full production to final assembly do not turn into respective

results. And as COGS are still 60-64% of sales, selling and administrative costs have declined significantly.

That is a result from united sales force since 2009, which now corresponds to 80% of products sold under

Assa brand. Another important cost R&D has been gradually increasing – which I consider as a good sign

helping company to sustain its product innovative position. In my view, the strongest negative effect on

cost-efficiency is the high rate of acquisitions, which all have to be restructured once acquired. Acquisitions

are part of Group strategy meaning that never-ending restructurings must be made in order to lower cost in

different subsidiaries. And since the acquisitions serve the first two strategic objectives: to gain market

presence and to sustain product leadership, it harms the third one -cost-efficiency.

8. Competition

8.1 Security market overview

Assa Abloy is decomposing the security market to the following segments. Products supplied by the

company accounts to some 15% of the whole EUR 250 billion of security market estimated in terms of size

(more about that in the strategy section). However, the company considers security industry to be still

fragmented in a global perspective. As Assa Abloy (AssaAbloy) states: “Some countries have one strong

manufacturer with a large share of the local market. These companies often focus on their domestic market

and have relatively limited international operations.” (15)



8.2 Direct competitors

There are four major competitors that partly operate in Assa Abloy’s segment: Ingersoll-Rand, Stanley

Black & Decker, Dorma and Kaba. Two of these (Ingersoll-Rand, Stanley Black & Decker) are based in

the USA and two (Dorma and Kaba ) in Europe. As we can witness into the analysis later on that these direct

competitors are almost predominantly exposed to their domestic markets. However, compared to the market

these are the companies having most international presence.

Comment: It is worth saying that since Johan Molin took place Assa Abloy is not reporting in-depth

analysis of the competitive environment. Therefore, much of the information is since 2005 when the last

extensive presentation of the competition has been presented. Also, due to lack of industry analysis

availability I have used all publicly available sources. This section can be significantly improved with access

to security market researches.

I have compared the main characteristics of Assa Abloy with four of its main competitors Ingersoll Rand,

Dorma,Keba, and Stanley Black & Decker.

Source: Own estimations, Company, Ingersoll Rand, Dorma, Keba, Stanley Black &Decker

It is obvious that Assa Abloy is better positioned to meet future demand, especially compared to Ingersoll

Rand. Dorma is not a public company and therefore there is insufficient financial information.



First, Assa is better protected from construction market downturns (like the one from be beginning of the

crisis). The reason behind is smaller percentage of new construction compared to aftermarket sales for Assa

Abloy (33%). Ingersoll Rand account for much higher (53%) and also strongly dependent on the U.S

market. The difference is significant giving Assa a competitive edge under weak market scenarios. This has

proved during the crisis by the fact Assa had no sales decline at all.

Second, and maybe most importantly, Ingersoll Rand rely on 79% of its sales from Mechanical locks (note

that this is only fraction of their Security Technologies division which is the peer division-competitor of

Assa). Even though Ingersoll Rand is technologically-based company by nature, its update towards

electromechanical solutions seems to lag behind. Still mechanical lock market is much larger but as

witnessing from the Assa Abloy division analysis it is growing 6-7 times slower than electromechanical

locks for the Group. I also witnessed that electromechanical division of Assa Abloy is growth approximately

twice the rate of the whole electromechanical market.

Third, Assa Abloys is better exposed to different markets, mostly Asia. If Ingersoll Rand is market leader in

North America and Assa Abloy in Europe, then Asia is still underpenetrated market by international players.

It is still very fragmented as well. Mature markets (North America and Europe) combined account for 76%

of Assa sales, whereas the same percentage for Ingersoll Rand is 88%.

Where Assa Abloy lags behind

First, operating margin of Assa is much lower. Also the security division of Ingersoll Rand has much higher

margin that rest of divisions. And even if when climate solutions (not in the periscope of Assa) are their core

division the company will not neglect its most profitable Security Technology division since the operating

margin is so high. From another hand, operating margin of Americas division for Assa Abloy is also about

20% - the highest among other divisions. In this respect, we may conclude the margins on the American

market are slightly higher for all opening door companies operating there.

Second, another bad sign of profitability for Assa is the fact Dorma better utilize its operations by generating

more revenues per employee. One reason is Assa’s high number of employees in Asia which generate less

revenue per person, whereas Dorma operates strongly in Germany. It is also its largest market. However,

considering those two competitive weaknesses of Assa Abloy we might suggest there is a problem with

efficiency and extensive costs.



8.3 Ingersoll Rand overview

Ingersoll Rand is the strongest competitor of Assa Abloy on an international level. The company is strongly

exposed to the North American market and also it differs from Assa Abloy with its strategy of vertical

diversification (compared to Assa which I consider strongly focused on door opening solutions only).

Comment. Ingersoll Rand is strong but their core business is not security technologies. Just the opposite,

small fraction from residential solutions and security technologies divisions are directly product-related

competitors of Assa Abloy. Net revenue of EUR 1,2 billion for Security Technologies (compared to Assa

with EUR 4,7 billion in total). Keep in mind that 19% of residential division also directly competes with

Assa. That accounts to 0,3 billion more. In total Ingersell Rand sales EUR 1,5 billion (in current exchange

rates) compared to EUR 4,7 billion of Assa Abloy. Therefore, to conclude, Assa is three times the size of

Ingersell solely in the opening door solutions market.

Security Technologies division – peer division to Assa Abloy

Source: Ingersoll Rand (Rand)

Note they are still predominantly on mechanical solutions. That’s a bit strange having in mind their

technological capacity.

Comment. As they have variety of products for home and offices I might expect their strongest strength to

be full technologization of homes – connecting all electronic devices within a single remote control,

including the door opening and security. Moreover, as the markets almost everywhere are fragmented I do

expect technological leaders (specialized in electromechanical solutions) to gain shares in the foreseeable

future. Old-fashioned mechanical producers will compete with each other in an era of dying market.

Competition for mechanical solutions will be too high and which will eat the profits. Most players will not

be able to switch into electromechanical solutions since they will not have the sufficient technology to do so.

Hundred of thousand local mechanical lock producers will close. Those trends support Assa Abloy’s

competitive position for the next at least 5-10 years in terms of technological superiority. That must keep

competitors at bay and provide Assa with profits in a foreseeable future.



8.4 Dorma overview

Dorma is a German premium player that is not yet a public company. Therefore, there is insufficient

financial data.

Note. This section an excerpt from Dormas’ (Dorma) official web-site. The purpose is to present briefly the

company:

“With an international workforce of around 6,600 employees, the Group realised sales of €944.4 million in

fiscal year 2010/11 (June 30). The DORMA Group headquartered in Ennepetal, Germany, operates on an

international scale with companies in 49 different countries.

Dorma is active in the business segments: Door Control, Automatics, Glass fittings and accessories,

Security/Time and Access (STA) and Movable Walls. The company sees itself as the trusted global partner

for premium access solutions and services.”

Comment. Dorma business almost completely overlaps with this of Assa. They are strongly exposed in

Germany- their domestic market, and pretend to be premium player. The numbers of employees account to

only 16% of the workforce of Assa (which is 41070) but the sales are some 20% of ASSA. It means they

capitalize workforce better to generate higher revenues. Since the beginning of 2011th

Dorma has a new

executive management, including new CEO. Therefore, their results are yet to be revealed but their new

strategy aims by 2020, the revenues to rise to €2 billion (accounting for some 10% CAGR until then) and

return on sales to double. This would turn their global workforce to over 10,000 people (some 25% of

today’s Assa Abloy workforce).

Forecast on competition

I do see that Assa Abloy is currently well protected from competition. It operates strongly on new hi-tech

opening door markets like electromechanical solutions and is well protected from downturn in real estate

markets. Having those two important reasons I do see next 5 years to be pretty relived from competition

which can allow the company to have higher profit margins.

9. Significant Risks

These are the most significant risks as the company resents them. I will focus only on those I consider most

important (those with Red dots). Competitors are covered in the separate section, more about Brand

positioning can be found in the strategy section. Here I will focus only on Acquisitions, Raw materials and

Currency risks.



Source: Own estimations, Assa Abloy, Annual report 2011, page 63

9.1 Acquisition of new businesses


As we can witness the acquired growth accelerates in the last few years. This increases the risks of

integrating those businesses and the overall synergy effect is challenged. The acquired growth in percentage

is highest in 2002, 2010, and 2011. Note that since the current CEO - Johan Molin took place in 2006 (his

first full year) the company started accelerating its acquisitions rates. The average growth rate from the last 3

years is 8% - the highest so far.

Current management conveys acquisitions will be part of Group’s strategy in the future as well. Therefore, I

consider the risk of acquisitions to be Strong.


Note that in 2011 solely the Group acquired companies for the value of 33% of its sales. Also, 1/5th

of the

Goodwill is generated in 2011.



In the following graph we can see the acquisition payments in the Cash flow Statements as well. Red being

the Cash flow from investing activities and the fraction of the CFI which is paid for investments in

subsidiaries (in orange in the next chart) shows the quantification of the acquisitions throughout the time. By

average above 60% of the CFI is spent on investments in subsidiaries, excluding 2011 where this percentage

is much higher.

Source: Own estimations, Assa ABloy


Up-to-date acquisitions seems to well-fit the Group’s structure and objectives for market penetration and

product leadership. Expenses for acquisitions generate expenses for restructuring since most businesses must

be restructured to cost-efficiency or final assembly in high-cost markets.

By looking at the chart below we can witness that restructuring payments are small but increasing factor

from the total cash outflows. Note the direct correlation between Restructuring payments and the acquired

growth in %. Since 2006 we can notice that the higher the acquired growth, the higher the restructuring

payments. However, unknowingly why that excludes 2011th

once again.




9.2 Availability and price fluctuation of raw materials

Commodities used as components

The Group is exposed to price risk related to purchases of certain commodities (primarily metals) used in

production.Assa does not enter into financial commodity hedge contracts. The most important metal used is

Stainless steel.




Forecast of expenses by nature

I do expect restructuring costs to continue increasing mainly due to further acquisitions that are expected.

Also due to that remuneration of employees must decrease but not as fast as it has been decreasing.

Potentially it might reach 25% in 2022. I have no visibility of direct material costs development and

therefore will decline forecasting it.

Source: http://wwwestainlesssteelcom/usstainlesssurchargesshtml

It is important to note that correlation between AKSteel 316 price and direct material costs is weak. There

must be other factors which I don’t know about to influence the direct material costs.

And since the remuneration of employees keep on decreasing (tackled by manufacturing shift to low-cost

countries) the material costs keep on increasing as a fraction of both expenses and sales. Component supply

is outsourced to external suppliers in low-cost countries. That is an effort to decrease total cost of production

but material costs increases due to the fact those components are purchased in a ready-to-use condition, but

most importantly at higher price.


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AKSteel 316 Price development ($)

http://wwwestainlesssteelcom/usstainlesssurchargesshtml



Inventory efficiency

A good sign towards higher efficiency is the faster work in progress utilization. There is a graduate

downward trend showing the company progress its processes faster over time.


Source: Own estimations

Summing all those reasons I consider risk of raw materials and their costs as very high.

9.3 Currency risk

Note. The next three paragraphs are excerpts from Assa’s annual

report (AssaAbloy) and represent their opinion about currency

risk:

Source: Company, annual report 2011, page 111

“Translation exposure is primarily related to earnings in USD and EUR. This type of exposure is not

hedged. Currency risk in the form of transaction exposure, i.e. the relative values of exports and imports of

goods, is fairly limited in the Group, though it is expected to increase over time.

Transaction exposure. Currency risk in the form of transaction exposure, or exports and imports of goods

respectively, is relatively limited in the Group. The main principle is to allow currency fluctuations to have

an impact on the business as quickly as possible. As a result of this strategy, current currency flows are not

normally hedged.

A general weakening of the Swedish krona leads to an increase in net debt, but at the same time increases

Group equity. At year-end, the largest foreign net assets were denominated in USD and EUR.” (65)



Along with Assa Abloy’s market penetration development the currency risk is increasing. As you can further

look at the excel file (sheet divisions), there is a major shift both in terms of revenues and EBIT coming

from emerging markets. This process will continue increasing the currency risk even further into the future

and as company expands geographically the effect will be significant.


The exchange rate effect on sales growth is strong. Its significance seems to decrease over time, which

contrivers with my assumptions. The mean of y-o-y change in exchange rate effect on sales growth is

decreasing over time. However, note 2009 when the contribution was 9% - highest ever. This percentage

strongly affects the mean for the last 3 years, deflating significantly its value. However, as the currency risk

is not hedged, greater geographical diversification inevitably will increase that risk further.


Currency dependence trends

The US dollar importance is decreasing over time. These findings are supported by the Americas division

weakening (in terms of EBIT and sales) and due to USD sales as percentage of Group sales. 1/4th

is still

coming from the US but this fraction gradually tends to decrease. China has been growing with some 40% a

year in the past 9 years and therefore their Yuan becomes from major importance.





Sensitivity analysis of currency risk

In the worst case scenario if SEK weaken compared to all other currencies the net effect on Income before

tax will be 11%. That is hardly likely especially having in mind that in the past 10 years the SEK has been

pretty stable compared to both USD and EUR. By looking at the exchange rates graph we spot several years

of abnormal changes which tend to smoothen over time However there might be some years when EUR or

the USD to influence the Income before tax with (I suppose) up to 5%. More than that is hardly likely.

Source: Oanda (Oanda)

Source: Own estimations Source: Assa Abloy, annual report 2011, page 111



10. Management

The group has been successful in the past 5 years strongly because of Johan Molin – the CEO. He took place

in December 2005 and his full first year was 2006. Prior to him obviously unsuccessful CEO was managing

the company for three years – from 2003 to 2006. As results witness Johan Molin continued the growth prior

to 2003 and also protected to company from downside during the crisis.


Sales growth has been accelerating (mostly due to acquisitions) which is spotted in the Mean-9, 5, and 3.

Red flag is the accelerating COGS too (more about that in a separate analysis section). However, he has

stabilized the net profit margin between 7 and 11%.





And if net profit margin has been increasing over time, slow synergy effects of acquired subsidiaries has

decreased the generating of revenues per assets. There is a negative correlation between the total asset

turnover and current year acquired growth. The more company acquires the less revenue is generated as %

of assets. That is what has happened in the period 2002-2003 and 2010-2011th

. Financial leverage has been

decreasing correspondingly with the gradual equity increase over time, especially since Johan Molin took

place.



10.1 Incentives for the Executive Management

Johan Molin has strong stock incentive to increase shareholders value. Note, the last line in the following

graph, where his annual remuneration is only some 21% of the equity holding he possesses. He has SEK

126 million in equity holdings where his annual remuneration is some SEK 26,5 million. That incentive

program is strongly encouraging. Moreover, his fixed salary is only 44% of total remuneration. To sum,

Johan Molin is very well incentivized to continue performing well into the future.




Comment. One of the company key advantages is its great reporting standards (that is the reason why I

chose this company in particular). Assa Abloy has been in top 50 of companies with best reporting standards

including all financial information and statements in the past few years. It has not been that way prior to that.

This honor has been an effect of Johan Molin’s policy for transparency and honesty. If the management want

to be sincere with its shareholders, that is a great way to do it. I am strongly in favor of such managers and

therefore the company.

Comment. I must comment on the fact Johan Molin has been a CEO for more than 6 years already. His

capabilities of leading the group toward success are obvious. What I am cautious with is whether he will

continue being CEO into the future and whether his motivation to continue improving company’s value will

last for long. After six years (and that is only something we can hope) his internal drive for good

performance might decrease. However, there is no sign for that so far. Johan Molin is well positioned, 52

years old, successful CEO of Assa Abloy. In this respect, losing him might be a big risk for the group and

for us as potential shareholders.



10.2 Summary of MD&A


10.3 Other Executive Managers Incentives

Most of the executive managers have been employed by the group for a long time. The newest managers are

Carolina Dybeck Happe – CFO in 2012, and Johan Persson – Head of Asia Pacific division in 2009. All

others have been employed for at least 8 years. It’s also significant to note that huge incentive stimulus

difference between the CEO and other executive managers. As you can see in the summary most of them

have at least SEK 2m in equity possession compared to the CEO owning SEK 126 m.




Also notice that the most important divisions and their heads are not incentivized by importance. EMEA,

American, and Asia Pacific divisions contribute to the highest fraction of both sales and EBIT. However,

their Heads possess relatively small shareholding compared to other executive managers. That is not

desirable as long as there are other factors, which I don’t know about, reasoning that current incentive

structure.


Conclusion

I do consider the current executive management as one of the key strengths of Assa Abloy. As the CEO has

been leading the pace towards innovation, Assa Abloy’s shareholders have enjoyed increasing value of

equity. We must keep an eye on the new CFO – an important role into the company and the expected change

(in late 2012) in Chair of Board of Directors. These are two important events. If they don’t change

something dramatically and if Johan Molin sustain its drive for performance we should expect satisfactory

results. Management is the key role into the company.



11. Shareholders

12.1 Share capital

Note. These two paragraphs are an excerpt from Assa Abloy’s (Abloy) official web-site.

“ASSA ABLOY’s share capital at 31 December 2011 amounted to SEK 368,250,378, distributed among

19,175,323 Series Av shares and 349,075,055 Series B shares. All shares have a par value of SEK 1.00 and

provide the holders with equal rights to the company’s assets and earnings. Each Series A share carries ten

votes and each Series B share one vote. ASSA ABLOY’s Series B share has been listed on NASDAQ OMX

Stockholm, Large Cap since 8 November 1994.

The number of shareholders at year-end was 18697. Investors outside Sweden accounted for around 64

percent of the share capital and around 44 percent of the votes, and were mainly in the USA and the United

Kingdom.”

Source: Assa Abloy

Source: Assa Abloy



Source: Assa Abloy

11.2 Shareholders structure

Assa Abloy shareholding structure seems to be favorable. First it is very diverse meaning that in 2011th

top 3

shareholders accounted for only 24% of capital and 48% of votes. Top 10 shareholders account for 39% and

58% respectively. Those findings reveal the fact that Assa Abloy tend to have open policy for new

shareholders and no single policy-maker.

Second, there is no institutional shareholding from major investment banks. Most importantly there has

never been which might mean two things. Either the company is still undervalued (big players are not

following it), or simple they don’t consider it as a good investment. In my analysis I will not pay much of

attention on what others think about the stocks but this is one sign of strongly possible positive/negative

characteristic of the company. I tend to favor companies with no institutional shareholding especially from

global largest asset managers. If they are not following the company (it might be cause of the Swedish

Krone exposure which they’d better avoid) the upside potential can be encouraging.

Third, most of shareholders are Swedish-based which once again support the reasoning the Assa Abloy

might be undiscovered from international asset managers. Therefore if Swedish companies invest (and they

know Swedish public companies best) and nobody else is doing it, it can be a kind of insider joker for us.




Forth, the biggest shareholders are Investment AB Latour and Melker Schorling accounting for 42% of

voting rights altogether. Note what has happened in 2011th

. Sakl and Investment AB Latour merged and

voting rights of Invesmtnet AB Latour stroked by 14% to 30% in total. I consider that as a good sign since

both businesses have been long-term investors in Assa meaning they know the business well and they do see

potential. They are among the shareholders knowing best what is happening inside the company. They have

been with the business for a long time and I do expect them to sustain that major shareholding.

Few minor shareholding changes occurred since 2008 (since the crisis). By 3% both of Capital Group Funds

and Harris Associates increased their voting rights (accounting for 4 % and 5% capital increase

respectively), while Alecta and Oppenheimer Funds decreased their voting rights by the same percentage

(both decreased by 4% of capital). Most meaningful is the selling off by Alecta which has always been a

long-term investor (presuming they know the company well) but also have been trading 1-2% on year-to-

year base.





Interesting to mention is one fact concerning the liquidity. Between 15 and 20% of shares (as % of total

capital structure of Assa Abloy) possessed by top 10 shareholders change hand in a single year. That means

that up to 20% of Assa’s capital is traded by their largest 10 shareholders. It worth comparing with other

companies – something I have not done.




12.3 Information about major shareholders

Investment AB Latour

Note. Parts of this section are an excerpt from Investment AB Latour’s (Latour) web-site.

“Business.Latour is a mixed investment company whose business concept is to invest with a long-term

perspective in sound companies that have their own products and that are considered to have a good

internationalisation potential. Latour is characterised by a deep respect for the know-how in good

companies. The company is e primarily active as members of the

board of a company.”

Shareholding in Assa Abloy. 44% of the Investment AB Latour

capital is invested in Assa Abloy in terms of market value. In

2011th

solely Investment AB Latour acquired 13% of the voting

rights in Assa reaching 30% in total. Gustaf Douglas holds 80% of

the voting rights in Investment AB Latour. He is the ultimate policy

maker. Latour buys Assa Abloy shares for the first time in 1988.

Source: Investment AB Latrour

A brief introduction is used from Wikipedia.org (Wikipedia)

“Gustaf Archibald Siegwart Douglas (born 3 March 1938) is a Swedish businessman and politician,

member of the Royal Swedish Academy of Engineering Sciences since 2007. Gustaf Douglas has made his

fortune from the security business which is his core competence.

In its latest annual report Latour presents its merger with Saki briefly this way: (Latour)

Merger between Latour and Saki. In 2011 Latour and SäkI merged under the name Latour - a company

capable of making major investments. The similarity between Latour’s and SäkI’s strategies facilitated the

merger. They also had similar core holdings and a somewhat similar owner structure.” (2)

Melker Schorling

Note. This is an excerpt from Melker Schorling’s (Schorling) official web-site.

“Melker Schörling AB (MSAB) origins from Melker Schörling's investment background which started by

investing into Securitas in 1987. MSAB as a holding company was founded in 1999. In 2006 the company

was listed at Nasdaq OMX Stockholm, Large cap. MSAB is an active holding company which works for



long-term industrial development. Currently, MSAB is a large shareholder in seven publically listed

companies, where all of them have a clear strategy and continued strong development potential.”

Assa accounts to some 13% of Melker Schorling assets. In 1994 the company first acquires shares of Assa.

It’s biggest holding (57%) is Hexagon. Founded in 1975, Hexagon is a leading global provider of integrated

design, measurement and visualisation technologies.

Comments regarding major shareholders

Even if Latour holds 30% of the voting rights it holds only 10% of the share B of Assa meaning that

predominant part of the shareholders hold small fractions of the company. Top 3 shareholders hold only

some 24% in 2011 up from 16% in 2010. That means the share price is strongly related to the public

opinion. Even if Latour and Melker Schorling do not trade (as they have always been long-term investors)

they hold only some 15% of Class B shares (which are listed). So, the multiples play significant role for the

price development. 61% of the stocks are traded by out of top 10 shareholders giving Assa a very

fragmented shareholding structure.



12. Additional Financial Data



Source: Own Estimates, Assa Abloy

13. Recommendation

I will make no recommendation for an investment. As stated in the preface section this analysis’ purpose is

to support my equity analysis expertise, not to be an investment recommendation. Moreover, giving one

might be misleading without decent valuation. I aim to provide you with the tools needed to make an

informed decision, not to recommend one.

End



Bibliography

Abloy, Assa. AssaAbloy.com. 2011. <http://www.assaabloy.com/en/com/>.

AssaAbloy. Annual Report. Stockholm: Assa Abloy, 2011.

Dorma. Dorma.com. 2011. <http://www.dorma.com/us/en/about-dorma/dorma-group/the-company/index.html>.

Latour, AB. latour.se. 2011. <http://www.latour.se/en/home>.

Oanda. Oanda.com. 2011. <http://www.oanda.com/currency/historical-rates/>.

Rand, Ingersoll. ingersollrand.com. 2011. <http://company.ingersollrand.com/Pages/default.aspx>.

Schorling, Melker. melkerschorlingab.se. 2012. <http://www.melkerschorlingab.se/en/about-msab/msab-in-brief>.

Wikipedia. Wikipedia.org. 2012. <http://en.wikipedia.org/wiki/Gustaf_Douglas>.

My Investment Principles

For a long time I have been shaping my analytical principles. I believe they will guide me through good and bad

times. I also know that if I firmly stick to them I will be rewarded and eventually do better over time.

1. Long-Term Fundamental Equity Approach

I am a fundamental equity analyst and I intent to analyze companies for at least 60 more years from today. That will

demand high degree of consistency and durability over time. The only way to maintain such sustainability is if I adopt

a principle that avoids me bothering from short-term ups and downs of the market. Therefore, I make thorough

analysis and look to completely understand the businesses I analyze. I am a fundamentalist and I have adopted a

long-term approach of equity research.

2. Understand the Business

There are many great businesses out there that I will never be able to analyze well. I can have high degree of

confidence only for businesses I fully understand. However, I will not limit my analyses based on industry or country

of residence. I am a generalist and the only vital limitation would be if I feel to understand well the business or not.

3. Patience and No Emotions

I will not allow losing client’s money and reputation while participating or being involved in market manias. For the

next 60 years there will be plenty of temptations for that. I will do my best to avoid them. Keeping emotions at bay is

from main importance. I am a long-distance runner and patience is to be appreciated especially at times when the

market is unprecedentedly overvalued.

4. Independence, Never Listen to Others’ Opinion

There are thousands of equity analysts all around the globe. Most of them use the same sources, listen the same

news, read the same papers. To avoid being with the crowd I will not be located in a major financial center, nor

communicating with sell-side analyst on a regular basis. As Einstein said: “It’s impossible to do the same thing and

expect a different result.” Therefore, I will take decisions based on my own judgment.

6 July 2012 Fundamental Equity Analysis of Assa Abloy AB...Assa Abloy (Assa) is a Swedish company...

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