HUBB - Hubbell: Electrified Operations

2023-11-13 13:27:51 ET

Summary

• Hubbell has experienced continued growth and margin expansion, driving shares higher and allowing for more dealmaking.
• The company's mission-critical and high-quality solutions, tied to megatrends like energy efficiency and digital technology, contribute to its long-term prospects.
• Hubbell's recent earnings growth and acquisitions, including the purchase of Northern Star Holdings, make it an interesting investment option, but the sustainability of high margins is a concern.

In the fall of 2021, I was not yet electrified with the prospects for Hubbell Incorporated (HUBB) after the company had embarked on a multi-year transformation into higher growth electrification and utility solutions activities.

Ever since, Hubbell has seen continued growth and margin expansion, driving shares higher, and providing fuel and financial room for more dealmaking. Hubbell seems to be on fire from an operating point of view and has sound long-term prospects, making me upbeat on the business in the long haul, although I am waiting for a dip before getting involved.

About Hubbell

Hubbell has a long history, which goes back all the way to 1888. Pre-pandemic, Hubbell has grown to a $4.6 billion business, split pretty evenly between utility and electrical solutions.

These often mission-critical and engineered solutions are typically of high quality, and used in settings in which reliability and safety are key. With customers often buying on repeat, and being less price sensitive, the business has been able to post solid operating margins in the mid-teens. Given a need for smooth and uninterrupted customer operations (as their operations typically see high failure and outage costs), customers often resort to quality offerings.

Many of these services are related and tied to megatrends such as energy efficiency, climate change, urbanization, and digital technology, all driving growth in the long run. Of course that did not mean that the business was immune to the pandemic. In fact, sales fell from $4.6 billion in 2019 to $4.2 billion in 2020 as adjusted earnings fell 7% to $7.58 per share. The company guided for a 6-8% recovery in 2021 sales, alongside an earnings recovery.

With shares trading at $210 in November 2021, the 55 million shares granted the business an $11.5 billion equity valuation and $12.8 billion enterprise valuation. This valued the business at demanding multiples, at about 18 times EBITDA and 25 times earnings. It was this high valuation and the fact that the company sold its commercial and industrial lighting business at a mere $350 million sales tag (at about 0.7 times sales) that made me cautious, even as I gave management the benefit of the doubt in its transition to higher margins and higher growth activities.

Another Move Higher

After shares traded around the $200 mark later in 2021, shares have actually long traded around those levels. In fact, Hubbell was still a $240 stock in April of this year, after which a momentum run during the summer sent shares to a high of $340 per share, after which shares have now settled at $290 per share again.

In January of this year, Hubbell posted its 2022 results. After 2021 sales were stuck at around $4.2 billion, with revenues held back by the lighting divestment, revenues grew by 18% to $4.95 billion in 2022. Operating margins rose some 160 basis points to 14.3% of sales, resulting in rapid growth on the bottom line with GAAP earnings up to $511 million, equal to $9.43 per share, with adjusted earnings even coming in at $10.62 per share. More so, the adjusted earnings numbers look quite clean, mostly adjusted for amortization expenses.

With net debt of $922 million barely surpassing the $858 million EBITDA number, leverage was in check as multiples had come down a bit with shares trading in the lower $200s. Furthermore, Hubbell guided for 5-7% sales growth for all of 2023, with adjusted earnings seen up to $11.00-$11.50 per share, making that valuations were on par with the wider market.

Following a strong first-quarter earnings report, the company hiked the full-year earnings guidance to $13.00-$13.50 per share, marking a very convincing hike. By July, Hubbell hiked the full-year earnings guidance to $14.75-$15.25 per share following the release of the second quarter earnings report. Such earnings momentum was the driver behind shares peaking in the summer, as corporate news recently was upbeat as well.

More Good News

In October, Hubbell announced a 9% increase in its quarterly dividend to $1.22 per share, for an annual payout of $4.88 per share. By the end of the month, the company announced a $1.1 billion deal to acquire Northern Star Holdings. Northern manufactures substation control and relay panels, the key to electric grid reliability. The deal will add some $400 million in sales, suggesting that about a 2.7 times sales multiple has been paid, as the price is equal to about 12 times EBITDA.

A day later, Hubbell posted third-quarter sales of $1.38 billion, up nearly 5% on the year before, as growth was much slower compared to an 8% growth rate year to date. The big gains are seen in operating margins which have risen to 20%, up a full five points on the back of pricing, among others. On the back of the strong results, the company hiked the lower end of the earnings guidance again, with full-year earnings seen at a minimum of $15.00 per share.

Net debt of $853 million will jump to about $2 billion following the deal for Northern Star, but as EBITDA trended above $1.2 billion per year already that should not be a major issue. In fact, including the nearly $100 million EBITDA contribution from Northern Star, leverage ratios are seen at just about 1.5 times.

With the own business posting earnings close to $15 per share, and Northern Star likely contributing to his, the story looks interesting again. Based on the lower end of the earnings guidance, Hubbell traded around 19-20 times earnings, as some upbeat performance and accretion from the deal could likely reduce the multiple to 18 times, all while leverage is in check.

And Now?

The truth is that I am very impressed by Hubbell, notably its margin performance this year and a nice bolt-on deal. The issue I have with this reasonable valuation is that the current 20% margins have risen 5% on the back of pricing, productivity, and cost initiatives, but I wonder (or perhaps fear) that this is not sustainable.

Given all this, I am a bit in doubt. A current 18-19 times earnings multiple looks interesting enough with a leverage ratio of 1.5 times, given the strong growth of the business and its long-term potential. This looks highly compelling, but my concern is that of non-sustainable margins, as a reversal of margins could push up earnings multiples quite a bit, making shares look quite expensive here.

Given all this, I am taking a wait-and-see approach, placing shares on my watch list although any reasonable pullback from current levels could be seen as a really nice long-term entry opportunity.

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