ABLZF - ABB: Stable Prospects Likely Baked Into The Stock

2023-09-07 04:28:56 ET

Summary

• Ongoing portfolio restructuring positions ABB to capitalize on growth opportunities in electrification and automation. Well-positioned to benefit from stimulus spending worldwide.
• Good 1H 2023. Strong order backlog should support near-term performance.
• Competitive risks, particularly from European rival Siemens.

Good financial performance from ABB (ABBNY) on the back of strong execution of order backlog. Although order growth is slowing as customer orders normalize, high order backlog can support near term outlook.

Ongoing portfolio restructuring better positions them to capitalize on industries with secular medium term growth opportunities, specifically electrification and automation. Worldwide presence enables them to benefit from stimulus spending worldwide. Valuation appears fair.

Company overview

ABB is an engineering company that manufactures and sells electrification, automation, robotics, and motion products covering hardware systems, digital services and software which are sold both separately and combined as scalable solutions. ABB has operations in approximately 100 countries around the world and according to the company, the majority of their businesses are market leaders within their respective segments.

The company's business segments are as follows:

Electrification: this segment provides electrical distribution and management technologies, solutions and services such as medium-and-low voltage electrical components switchgear, digital devices, enclosures, breakers, power conversion products and charging solutions for electric vehicles, among others. About half of revenues are generated from sales to distributors, a quarter from forest sales to end users, and the remaining from sales to original equipment manufacturers (OEM). With around $14.1 billion in revenues in 2022, this is ABB's biggest segment.

Motion: this segment provides products, systems, and services for motion control. Products sold include motors, generators, and drives for a variety of industrial customers including food and beverage, HVAC, water and wastewater, power generation, and transportation to name a few. The segment generated $6.7 billion in revenues in FY2022.

Process Automation: this segment offers a range of integrated automation, electrical motion, and digital systems, solutions and services to optimize productivity, energy efficiency, sustainability and safety of industrial processes and operations. The segment generated revenues of $6 billion in FY2022.

Robotics & Discrete Automation: this segment provides robotics, machine and factory automation products, software, solutions and services. This is ABB's smallest segment with $3.2 billion in revenues generated in FY2022.

Q2 2023: Modest order growth due to destocking amid easing supply chain bottlenecks, margins expand

After a 6% growth in FY2022, ABB's order growth has been modest so far this year, partly due to normalizing customer order patterns along with easing supply chain constraints. High comparables from last year was another contributing factor. Orders declined 2% in Q2 2023, a slowdown from the 1% growth recorded the previous quarter as falling order intake in Asia, Middle East and Africa (led by declines in China) failed to offset order growth in the Americas. Orders were flat for 1H 2023.

Continued execution of the order backlog supported revenue growth during the quarter with revenues up 13% on a reported basis (17% on a comparable basis which excludes the impact of foreign currency fluctuations). For 1H 2023, revenues were 13% to $16 billion.

Profitability continued to improve, with gross margins increasing to 35% for 1H 2023 from 32.2% the same period last year. Operational EBITA improved to 16.9% from 14.9% in the same period last year.

Although order growth has been flat so far this year and likely to remain weak for the rest of the year (rival Siemens expects customer normalization trends to continue over the coming quarters), a strong order backlog should support near term performance (order backlog was up by double digits for three out of four business areas in 1H 2023, only Robotics & Discrete Automation saw its backlog decline, down 3% in 1H 2023). Management expects comparable revenue growth of at least 10% for FY2023 (dipping slightly from the 12% comparable revenue growth in FY2022) and operational EBITA margin to be above 16%.

Free cash flows amounted to $711 million in 1H 2023 (already exceeding the $525 million free cash flows generated in FY2022), a considerable improvement from the same period last year when free cash flows were negative. The improvement was partly helped by a lower cash outlay inventory. As supply conditions improve and the company works through their inventory, FY2023 free cash flows could be materially better than last year.

Portfolio restructuring underway to focus on electrification and automation opportunities

ABB continued to make progress on simplifying their portfolio to better focus on growth opportunities in electrification and automation. Recent divestments include their engineering consulting business, their power conversion unit, their turbocharging business Accelleron , and their remaining stake in Hitachi Energy (the latter of which is expected to generate $1.2 billion in positive net cash flows).

Further portfolio restructuring plans include divesting their emergency lighting business and unplanned IPO of their e-Mobility unit.

Acquisitions are a key pillar of the company's long term strategy with plans to make 5 or more bolt-on acquisitions over the coming years. Leveraging their worldwide distribution network and strong brand, ABB is well positioned to organically scale these small strategic acquisitions and capture market share while expanding their addressable market. Notable among them is their acquisition of smart home solutions provider Eve Systems which strengthens their product offering for the consumer home builder markets which they currently have a relatively low exposure to (about half of ABB's revenues are currently generated from industrial customers i.e., factories and production facilities and a third from transport and infrastructure customers which includes both residential and non-residential customers according to their FY2022 annual report).

Ongoing divestitures could free up cash to support acquisition plans while channeling operating cash flows towards CAPEX needs. In FY2022, ABB generated around $1.4 billion in divestitures, and spent nearly $300 million on bolt-on acquisitions.

For FY2023, management expects CAPEX needs to be higher than last year's $762 million (which was invested in upgrades and maintenance of existing facilities in developed markets and expansion of production capacity in emerging markets the highest of which were in China and India.

Well positioned to benefit from industrial economy growth drivers stemming from stimulus programs

ABB's global presence positions them well to capitalize on stimuls programs around the world. India is on the cusp of a private CAPEX cycle which bodes well for ABB's fifth biggest market. ABB's India orders rose 7% in Q2 2023. In America, the Infrastructure Investment and Jobs Act should drive demand for industrial goods. Order growth has been lacklustre in China, ABB's second biggest market but stimulus programs from Beijing could jumpstart industrial activity in the country, presenting a not insignificant medium term tailwind for ABB.

Risks

Competitive risks

German industrial giant Siemens (SIEGY) is on an aggressive expansion path with plans to spend over $2 billion on a global investment plan. R&D spending is expected to increase more than $500 million this year, roughly 9% more than last year's $5.5 billion in R&D spend. For perspective, ABB's R&D spend is about a quarter of Siemens' at $1.2 billion, at around 4% of revenues, ABB's R&D intensity is lower than Siemens' 7.8%. Siemens' is aiming to expand their TAM by 7% annually between 2022 and 2027, and grow faster than rivals which include ABB, and increase market share. Siemens' may have scale advantages over ABB in the battle for market share.

Conclusion

ABB has a hold analyst consensus rating .

ABB's share price has appreciated 42% over the past year and the company's forward P/E of 18 currently is roughly on par with the sector median's 18.

ABB has so far generated free cash flows of roughly $711 million in 1H2023 and $1.7 billion over the past 12 months. Taking their current market cap of around $69 billion, this roughly translates into an FCF yield of under 3%. The company's prospects appear largely baked into the stock and could be viewed as hold.

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