Sandvik shares drop as mining gloom squeezes margins

* Q1 order intake 22.5 bln SEK vs forecast 21.6 bln

* Says mining slump deepened in Q1

* Q1 EBIT 2.5 bln SEK vs forecast 2.6 bln

* Shares down 3.3 pct, drop from 11-month high (Recasts with CEO comment, adds share price, detail)

By Johannes Hellstrom and Niklas Pollard

STOCKHOLM, April 25 (Reuters) - Swedish engineering group Sandvik AB (Other OTC: SDVKF - news) suffered a further drop in demand for mining equipment in the first quarter, the company said on Friday, highlighting the impact of a squeeze on investment in the mining industry in response to weak metals prices.

Sandvik shares were down 3.3 percent at 92.25 crowns by 1237 GMT, making them the top loser in the STOXX Europe 600 Industrial Goods & Services Index. The decline knocked the stock from an 11-month high reached the previous session.

Posting quarterly earnings that fell slightly short of expectations, Sandvik said customer caution had hit equipment orders across its mining business, which accounts for roughly a third of group revenue.

Sandvik and rival Atlas Copco AB (Other OTC: ATLCF - news) account for more than half the global supply of underground mining gear.

Deep spending cuts by mining heavyweights such as Rio Tinto (Xetra: 855018 - news) and BHP Billiton (NYSE: BBL - news) , brought on by softer metals prices and investor anger over poor returns, has seen order intake reach its lowest ebb in years at mining gear makers.

"Of course these lower volumes are going to cause further ... issues within our mining production system," Sandvik CEO Olof Faxander told a conference call.

Sandvik said its operating margin had narrowed to 10.4 percent in its mining business in the quarter from 14.6 percent last year, roughly in line with analyst expectations, but Faxander flagged that further pressure on profitability was on the cards.

"So in the near term that could mean something like a couple of percent (off) ... the EBIT margin for the mining business area with the very low volumes that we are looking at," Faxander said.

Caterpillar Inc (NYSE: CAT - news) , the world's biggest maker of mining and construction gear, earlier this week cut its 2014 sales guidance for its mining unit, saying it saw a decline of about 20 percent compared with its previous outlook for a drop of 10 percent.

MARKET REACTION

Order intake at Sandvik Mining fell 4 percent sequentially in the quarter compared with the fourth quarter and 15 percent over the year-ago quarter.

Analyst Peder Frolen at Handelsbanken Capital Markets said the weaker mining business and overall concerns over profitability were the main reasons for the fall in Sandvik (Stockholm: SAND.ST - news) shares.

"I think it's in everyones' estimates that we are in a cyclical recovery, so given the valuation multiples a lot of focus turns to profitability. So I think the market is acting in a correct way here," Frolen said.

Before their Friday decline, Sandvik shares had risen some 24 percent through the past nine months, leaving them on a multiple of 15.5 times 12-month forward earnings estimates, according to Thomson Reuters Datastream, a premium to the 13.5 times multiple for the STOXX Europe 600 index of blue chip stocks as a whole.

Sandvik said adjusted operating earnings fell to 2.48 billion crowns from a year-ago 2.70 billion, just below a mean forecast of 2.58 billion in a Reuters poll of analysts.

The group is in the midst of a drive to cut costs and boost efficiency, in part by closing 25 of its 150 production plants. The efforts have yet to yield a major boost to operating margins that stood at 11.9 percent in the first quarter.

Analysts had seen the margin rising to 12.2 percent from a year-ago 11.6 percent. (Additional reporting Tricia Wright; Editing by Alistair Scrutton and David Holmes)