Sandvik CFO: Organic investment has lowest cost and risk

How does a global engineering group view capital spending? In an interview with Nordea On Your Mind author Johan Trocmé, Sandvik CFO Cecilia Felton describes decentralised responsibility for investment and pursuit of profitable growth at the divisional level, with capital allocation and funding decided at the group level. The leverage target determines the room for acquisitions, with opportunities identified locally. There is a mandate from the AGM to return any excess cash to shareholders via share buybacks, but there is no current need, owing to ample investment opportunities in the group. 

Johan Trocmé (JT): Sandvik’s dividend policy is to pay out 50% of profits over time. How do you generally approach the balance between investing in the business and paying out money to shareholders? 

Cecilia Felton (CF): We have defined our dividend policy as a dividend payout ratio of 50% of adjusted earnings per share, through the cycle. Our long-term aim is to allocate capital to be able to maintain our dividend commitment and invest in sustainable profitable growth. We have taken into account the cyclicality, profitability and capital intensity of our business to have a balanced ambition to be able, over time, to distribute half of our profits to shareholders and still be able to pursue the value-creating investment opportunities that we see. 

JT: R&D and capital expenditure are two different ways of investing in the business. How do you make spending decisions at Sandvik? Centralised or local decisions or budgets? How are options evaluated, and who makes decisions?

CF: Sandvik has a decentralised operating model with more than 20 divisions, which are the highest operational-level units within the group. At the heart of our operating model are our divisional heads, who are managers with an entrepreneurial mindset and full responsibility and accountability for their respective divisions. I would describe them as the true stars of Sandvik. The focus for the divisions is cash generation, i.e. driving profitable growth and generating a good return on capital employed. Our divisions own and develop their strategies, and a key element of that work is the responsibility for identifying opportunities to drive profitable growth through organic investments and acquisitions.

Responsibility for capital allocation and funding lies at the group level. We aim to be number one or number two in the markets and segments where we are active, and we aim to ensure that all divisions in the group have opportunities to drive profitable growth while also contributing to a good shareholder return. In conjunction with strategy updates in our business areas and divisions, we carry out an annual capital allocation exercise. A natural part of the strategy work of the business areas and divisions is to evaluate what parts and units we can drive through organic means (capex and R&D), and where we see a need to acquire companies to be able to execute our strategy. 

Across the group, organic capital expenditure, including R&D, has the highest priority. The organic growth generated through expansionary capex and from launching new products and services tends to have both the lowest cost and the lowest risk.

JT: Timing of investments can be critical in a capital-intensive business. Are major capex projects in your business "lumpy" by nature, or can you spread investments out over time? How do you evaluate risks for major capex projects?

CF: Most of our capex is maintenance or EHS-related (environment, health and safety) capex, as it is vital to invest in and maintain the valuable business that we have. This kind of capex is not lumpy in nature, but is more incremental. And for the most part, Sandvik's business is unlike heavy process industries, which require big investment projects, such as for a brand new mill. For those industries, such capacity investments need to be big to have scale and be economically viable. But this is generally not the case for Sandvik's businesses today.

JT: How do you see acquisitions from a use of capital perspective? Is there a given amount to spend both organically and on acquisitions? Or are acquisitions evaluated as they become available, with funding then needing to be resolved if you go ahead?

CF: We evaluate how much financial fire power for acquisitions we have given our financial target for leverage not to exceed 1.5x. When we introduced our "shift to growth" strategy at the end of 2020, we got off to an accelerated start. At the time, we had a net cash position, but since then we have invested our excess cash and taken on some debt in our balance sheet. Since late 2020, we have made 26 acquisitions. We have had a 9% CAGR in total revenues since 2019, of which 5pp is organic growth and 4pp is acquisitions. Our leverage is now at 1.2x, which suggests that going forward both organic growth and acquisitions will be financed by the cash flow that we generate. We have healthy potential M&A pipelines in all of our business areas. 

JT: Do you have any thoughts on payouts other than the ordinary dividend? You have a leverage target of 1-2x. Would you consider any form of additional payout in a situation where you had substantially lower leverage for an extended period of time?

CF: Our dividend policy is intended to signal that we have a robust business with a capacity to pay out ordinary dividends throughout a business cycle. Many investors see this as a quality stamp. We have a mandate from the AGM to carry out share buybacks, but we don't currently have any programme in place. There is no obvious need for it at present, as we see plenty of attractive reinvestment opportunities in the group.