A Little More on Iscar, Its Reputation, Its Major Competitor

The Iscar transaction has been widely lauded in Israel. A little more information has come out about the profitability of this company.

Link

If what is described in this link is accurate, Iscar enjoys very high net margins somewhere in the 25% area. From my own due diligence of Iscar distributors that I have spoken to today, the company does enjoy an excellent reputation for its innovation. As the blog suggests and Buffett appeared to confirm on Saturday:

"Iscar is an amazing business run by a visionary family that attracted Buffett as much for its management skills as for its existing business."

The product is highly regarded and the company does appear to keep very careful tabs on the practices of its distributors to ensure a high level of customer service.

During the Berkshire meeting, Charlie Munger described Iscar as the second biggest company, but the best. This raises the issue of just who is the biggest and what do their economics look like.

It appears that the largest company selling carbide metal cutting tools is Sandvik, a well-established Swedish company whose division Sandvik Tooling and Seco Tools appear to be the major Iscar competitors. Sandvik does trade as an ADR in the pink sheets SDVKY.PK

Though perhaps not regarded by Charlie as “the best” they certainly ain’t terrible! Check out these operating margins over time:


Year……………Sandvik Tooling…………… Seco Tools

2005……………21.2%.....................................22.36%
2004……………20.1%.....................................19.48%
2003……………12.64%...................................17.35%
2002……………15.2%.....................................17.15%
2001……………17.9%.....................................18.48%
2000……………20.22%..................................19.55%

The strategic goals for Sandvik sound very similar to the strengths that Mr. Wertheimer described at the Berkshire meeting:

1. -Strong focus on the enhancement of customers’ overall machining economy.
2. -Comprehensive brand and product portfolio for all types of metal cutting.
3. -Considerable expenditure on R&D in close cooperation with customers.
4. -Market leader with a strong global presence and extensive operations in rapidly growing markets.

Some of the drivers of business that Sandvik cites are certainly important drivers for Iscar's business:

1. -The growing demand for lighter components in more difficult-to-machine materials increases tool consumption.
2. -Increased environmental awareness creates a greater demand for more durable tools that can perform metal machining without the use of environmentally adverse cutting fluids.
3. -The current globalization trend favors Sandvik Tooling since international customers prefer suppliers with a global presence.
4. -The industrial expansion in such regions as Asia and Eastern Europe impacts positively on the business area, which has an extensive presence and market share in these areas.
5. -Growing awareness of the crucial significance of tools to the customers’ total production economy increases the demands for competence and knowledge of the customers’ processes – a strong competitive edge for Sandvik Tooling.

The total size of the metal cutting industry is estimated by Sandvik to be about SEK 100 billion or about $14 billion of which some 75% is related to carbide tools. There appears to be a trend toward metal cutting and away from grinding.

The returns on capital for Sandvik including less profitable operations in materials technology and mining and construction are very impressive as well:

2005…………..23.7%
2004…………..20.5%
2003…………..13.4%
2002…………..15.4%
2001…………..17.4%
2000…………..20.3%

Sandvik Tooling in 2005 accounted for one third of Sandvik sales but 46% of the operating profits.

The cyclicality that one would expect for a business whose customers are automotive, engineering and heavy industry does not appear to be very significant. The profitability is very respectable. And in Berkshire, apparently we own the better competitor!

Sandvik demonstrates very high quality attributes as you can see, but offers them at an EV/EBIT of only about 13 times. I would regard this as being quite reasonably priced. But given the valuation of Berkshire at a significant discount to intrinsic, and now owning an even better competitor, I am hard pressed to consider it in my portfolio.

Disclaimer: I, my family and clients have a current position in Berkshire Hathaway. None of us have a current position in Sandvik.