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Administration Report • Financial objectives and dividend policy

Financial objectives and dividend policy

SKF's overall financial objective is to create value for its shareholders. Over time, the return on shareholders' investment should exceed the risk-free interest rate by around five percentage points. This is the basis for SKF's financial objectives and SKF's financial performance management model.

Financial targets

SKF's long-term financial targets were announced in October 2010. The targets are:

  • an operating margin level of 15%
  • annual sales growth in local currencies of 8%
  • a return on capital employed of 27%

Strategy

SKF's business strategy for achieving long-term profitable growth and attaining financial targets includes:

  • keeping a clear and dedicated customer focus
  • developing new products, solutions and services
  • creating and capturing more value by applying the SKF platform and segment approach
  • strengthening the product portfolio through greater investment in R&D and through acquisitions
  • focusing on rapidly expanding segments and regions
  • reducing capital employed and fixed costs
  • attracting, retaining and developing the right people.
Operating margin, Changes in sales in local currency, Return on capital employed

Financial performance management model

SKF's financial performance management model is a simplified, economic value-added model, called Total Value Added (TVA), promoting a greater operating profit, capital efficiency and profitable growth.

The TVA profit is the operating profit, less the pre-tax cost of capital in the country where business is conducted. The pre-tax cost of capital is based on a weighted cost of capital with a risk premium of 5% above the risk-free interest rate for the equity part and on actual borrowing cost. The TVA profit performance for the Group correlates well with the share price trend over a longer period of time. Variable salary schemes are primarily based on this model.

Financial position and dividend policy

The capital structure target is a gearing of around 50%, corresponding to an equity/assets ratio of around 35% or a net debt/equity ratio of around 80%. This underpins the Group's financial flexibility and its ability to continue investing in its business, while maintaining a strong credit rating. On 31 December 2010, the gearing was 48.6% (49.3), the equity/assets ratio 36.0% (35.8) and the net debt/equity ratio 80.5% (68.9).

Gearing: Loans plus net provisions for post-employment benefits, as a percentage of the sum of loans, net provisions for post-employment benefits and equity, all at year end.

Equity/assets ratio: Equity as a percentage of total assets at year end.

Net debt/equity: Total short-term financial assets excluding derivatives minus loans and provisions for post-employment benefits, as a percentage of equity, all at year end.

SKF's dividend and distribution policy is based on the principle that the total dividend should be adapted to the trend for earnings and cash flow, while taking into account the Group's development potential and financial position. The Board of Directors' view is that the ordinary dividend should amount to around one half of SKF's average net profit calculated over a business cycle.

If the financial position of the SKF Group exceeds the targets stated above, an additional distribution to the ordinary dividend could be made in the form of a higher dividend, a redemption scheme or a repurchase of the company's own shares. On the other hand, in periods of more uncertainty a lower dividend ratio could be appropriate.

Dividend

Due to the strong performance, cash generation capacity and outlook, the Board has decided to propose to the Annual General Meeting an increase in the dividend of 43%, giving a dividend of SEK 5.00 (3.50) per share. This proposal is subject to a resolution by the Annual General Meeting in April 2011.

Repurchase of the company's own shares

The Board proposes that the Annual General Meeting should resolve to authorize the Board, until the next Annual General Meeting, to decide upon the repurchase of the company's own shares. The intention of this proposal is to be able to adapt the capital structure of the company to its capital needs in order thereby to contribute to increased shareholder value. According to the proposal, the authorization will involve Class A shares as well as Class B shares. The maximum number of shares to be repurchased will be such that the company then holds a maximum of 5% of all shares issued by the company. The shares may be repurchased by operations on the NASDAQ OMX Stockholm AB. The proposal is subject to a resolution by the Annual General Meeting in April 2011.

The Annual General Meeting in April 2010 resolved to authorize the Board, until the next Annual General Meeting, to decide on the repurchase of the company's own shares. In 2010, no repurchases were made and the company owns no SKF shares.

Credit rating

On 31 December 2010, the Group had an A minus (A-) rating with stable outlook for long-term credit from Standard and Poor's and an A3 rating with stable outlook from Moody's Investors Service. SKF intends to keep a strong credit rating, which is reflected in its capital structure targets.

Financing

SKF's policy is to have long-term financing of its operations. As of 31 December 2010, the average maturity of SKF's loans was 3.4 years. SKF has issued one note on the European bond market, with an outstanding amount of EUR 396 million and due date of 2013. Furthermore, SKF has issued two notes on the Swedish bond market, one with an outstanding amount of SEK 556 million and due date of 2011 and one with an outstanding amount of EUR 100 million and due date of 2015. According to the conditions of the notes, the notes' interest rate may increase by 5% in case of a change of control of the company (meaning any party/concerted parties acquiring more than 50% of SKF's share capital or SKF's shares carrying more than 50% of the voting rights). Similar conditions apply to three loans, one amounting to EUR 30 million and one amounting to EUR 100 million with a due date of 2014, and to a loan amounting to EUR 100 million with a due date of 2016. In addition, SKF has two term loans, one amounting to EUR 50 million with a due date of 2013 and one amounting to EUR 400 million with a due date of 2014.

Financial risks

SKF's operations are exposed to various types of financial risk. The Group's financial policy defines the main risks as currency, interest rate, credit and liquidity risks and defines responsibility and authority to manage them. The policy states that the objective is to eliminate or minimize risk and to contribute to a better return through active risk management. The responsibility for risk management and treasury operations are largely centralized to the SKF Treasury Centre, the Group's internal bank.

Currency risk

SKF is subject to both transaction and translation exposure. The Group's principal commercial flows of foreign currencies pertain to exports from Europe to North America and Asia as well as intra-European business. SKF hedges 75% of the estimated net USD exposure for three to twelve months. At year-end, the hedging with derivatives conformed to the Group policy. Translation exposure on Group accounts is hedged to some extent by borrowing in foreign currencies.

Interest rate risk

Liquidity and borrowing are managed at Group level. By matching the maturity dates of investments made by subsidiaries with the borrowings of other subsidiaries, the interest rate exposure of the Group can be reduced.

Credit risk

The Group policy states that only well-established financial institutions will be approved as counterparties. Exposure per counterpart is continuously monitored.

Liquidity risk

In addition to its own liquidity, AB SKF had committed credit facilities of SEK 3,000 million and EUR 500 million at year-end of which EUR 400 million were utilized in connection with the acquisition of Lincoln Industrial.

More details about risk management and hedging activities can be found in Consolidated financial statements, Note 28.

Internal control and risk management regarding financial reporting

The Group's systems for internal control and risk management in relation to the preparation of the Consolidated Financial Statement are described in the Corporate Governance Report under the heading “Internal control and risk management regarding financial reporting”, page 48.

Sensitivity analysis

Costs

This analysis shows how changes of a number of factors will affect the Group's operating profit. Calculations are based on year-end figures as well as on the assumption that everything else is equal.

Cost split 2010, operating expenses SEK 52,438 m
  • The annual cost of raw materials and components is around SEK 13 billion of which steel-based products account for the majority. An increase/decrease of 1% in the cost of raw materials and components reduces/increases the operating profit by around SEK 130 million. Steel scrap is a major ingredient in making bearing steel. A 10% increase/decrease of market scrap prices affects SKF's operating profit by SEK 110 million, which is already included in the figure for raw materials and components that impacts the operating profit.
  • An increase of 1% to wages and salaries (including social security charges) reduces the operating profit by around SEK 163 million.
  • A decrease/increase of 1% in interest rates has a positive/negative effect on the profit before tax of around SEK 100 million, based on the current position. The Group had net interest bearing liabilities of SEK 15,435 million on 31 December 2010.

Exchange rates

Translation effects: A weakening/strengthening of 5% of the SEK versus all major currencies has a positive/negative effect of the translation of profits in SEK of around SEK 400 million. Most of the profit is made outside Sweden, meaning the Group is exposed to translational risks, from all major currencies.

Transaction effects: A strengthening/weakening of 5% of the USD versus the SEK has a positive/negative net currency flow effect on the profit before tax of around SEK 250 million, excluding effects from hedging transactions. With regard to commercial flows, the Group is primarily exposed to the USD and US dollar related currencies.

Administration Report • Financial objectives and dividend policy

Administration Report • Sensitivity analysis

Net currency flows 2010 (SEKm)

Net currency flows 2010 (SEKm)

1) Other is a sum comprising 14 different currencies.

SKF_Treasury_275.psd

SKF_Treasury_413.psd

SKF Treasury Centre handles the lending and borrowing between the Group's subsidiaries, currency and interest rate risk management, cash management and the Group's netting system. The photos are from the Treasury Centre in Gothenburg, Sweden.



Financial objectives and dividend policy | SKF Annual Report 2010
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