| ABB Ltd (ABB IN) Management strikes an optimistic chord on the conference call | Underweight Price: Rs823.85 05 May 2014 Price Target: Rs480.00 PT End Date: 31 Dec 2014 | |
On the post result conference call, we noted a distinct positive shift in ABB’s commentary on growth and business outlook. Management is fairly confident that they are well-positioned to change gears into growth mode and improve profitability. The optimism is premised on the following arguments: (a) strategic focus on cost & product competitiveness, productivity improvement and supply chain have allowed ABB to address a wider spectrum of opportunities without sacrificing profitability, (b) past problems are well behind (e.g., low-margin rural electrification jobs) and ABB has invested in building capacity committed to the long term; they are at an inflexion point well poised in a scenario of an early market recovery, (c) economy is better poised for growth now, the order pipeline is significantly better than last year, stalled projects are beginning to revive and the post election scenario appears more promising.
· Management paints a benign order inflow outlook picture. After reporting 29% YoY growth in Mar-q order inflows, management commentary was quite upbeat. Base orders drove the high order inflow growth; ABB managed double-digit growth on large orders too, though off a low base of Mar-q last year. Although management claimed to be cautiously optimistic in the near term, they were quite positive of the long-term outlook. The order pipeline is almost double that of last year. ABB sees the T&D side of the business recovering faster than industry. The preference for cash over revenue and base orders has caused the order backlog to shift toward products over projects (70:30 mix of products & projects). Both export and service revenues are expected to grow (exports grew in double digits in 1Q), although management did not quantify targets.
· Segmental color. (a) Power products: High growth segment, benefited from launch of new products and exports growth (now 25%-30% of segment revenue). The Agra-NE HVDC order is progressing well and the company booked 765kV orders from PGCIL and NTPC in 1Q. The segment has seen distinct improvement in profitability over last several quarters to 10.1% EBIT margin in 1Q; (b) Discrete Automation & Motion: Received a Rs800mn order from CLW (Indian Railways) - there is clear visibility on traction, wind and solar. They are seeing a mild recovery in metal orders too. However, the segment is worst affected by industrial slowdown and capacity underutilization, which is taking a toll on margins; (c) Process Automation: well placed to offer solutions in the cement and metals industry, awaiting a return of growth, (d) Low voltage products: Management views this as a growth segment in India due to rising urbanization which shall keep demand high for switches and circuit breakers, (e) Power systems: Large orders are getting postponed due to general elections and are likely to materialize in 2Q now. Management sees a strong pipeline from central and state government utilities and even some progress in stalled projects.
· Commentary pointing toward potential easing in working capital pressures. As of Mar-q, debt level is Rs4bn, down from Rs6.2bn at the end of CY13. Working capital pressures will ease once stalled projects begin to move and the site is made available to them for execution. Management believes that the quality of receivables in their balance sheet is high, everything is recoverable and it’s only a question of timing.
· Cost management on track, yielding margin improvement: Management believes they have done a satisfactory job in a difficult market environment. OPM improved to 6% (up 140bps YoY), but is clearly below where they want to be and ABB’s margins will benefit from an uptick in the market. The increase in other expenses to sales in Mar-q to 16.6% (up 280bps) was a conscious decision flowing from higher overheads post commissioning of new facilities, higher travelling expenses owing to export push, etc.
· Implied ask to meet our CY14 estimate still high. Mar-q result is unlikely to result in a reversal of the earning downgrade cycle in the stock unless there is reason to extrapolate Mar-q order inflow growth for the entire year. The implied ask on our balance CY14 estimate is 10% top-line growth keeping allowance for an uptick in short cycle orders, 6.4% OPM (+134bps YoY) and PAT of Rs2.3bn, up 78% YoY.
Table 1: Mar-q results and implied ask for balance CY14
Rs. in mn, year-end Dec
1QCY14
|
1QCY13
|
% YoY
|
4QCY13
|
% QoQ
|
Bal CY14E
|
Bal 9MCY13
|
% YoY
|
CY2014E
|
% YoY
| |
Sales
|
18,100
|
19,644
|
(7.9)
|
21,749
|
(16.8)
|
62,624
|
56,673
|
10.5
|
80,723
|
5.8
|
Expenses
|
(17,020)
|
(18,739)
|
(9.2)
|
(20,544)
|
(17.2)
|
(58,588)
|
(53,782)
|
8.9
|
(75,608)
|
4.3
|
Stock
|
(104)
|
241
|
(143.1)
|
(253)
|
(58.9)
|
904
|
559
|
61.8
|
800
|
0.0
|
RM
|
(12,233)
|
(14,572)
|
(16.1)
|
(15,013)
|
(18.5)
|
(45,081)
|
(39,413)
|
14.4
|
(57,314)
|
6.2
|
Employee
|
(1,681)
|
(1,702)
|
(1.2)
|
(1,878)
|
(10.4)
|
(6,238)
|
(5,068)
|
23.1
|
(7,919)
|
17.0
|
Other expenses
|
(3,002)
|
(2,706)
|
10.9
|
(3,401)
|
(11.7)
|
(8,173)
|
(9,859)
|
(17.1)
|
(11,175)
|
(11.1)
|
Operating profit
|
1,080
|
905
|
19.4
|
1,205
|
(10.4)
|
4,035
|
2,891
|
39.6
|
5,115
|
34.8
|
Other income
|
189
|
183
|
3.3
|
297
|
(36.4)
|
736
|
791
|
(6.9)
|
925
|
(5.0)
|
EBIDT
|
1,269
|
1,087
|
16.7
|
1,501
|
(15.5)
|
4,772
|
3,682
|
29.6
|
6,040
|
26.7
|
Interest
|
(221)
|
(198)
|
11.7
|
(288)
|
(23.3)
|
(579)
|
(814)
|
(28.8)
|
(800)
|
(20.9)
|
Depreciation
|
(274)
|
(246)
|
11.3
|
(270)
|
1.5
|
(776)
|
(787)
|
(1.4)
|
(1,050)
|
1.6
|
PBT
|
774
|
643
|
20.3
|
943
|
(18.0)
|
3,417
|
2,082
|
64.1
|
4,190
|
53.8
|
Tax
|
(257)
|
(213)
|
(358)
|
(28.2)
|
(1,084)
|
(743)
|
45.9
|
(1,341)
|
40.3
| |
Reported Net profit
|
517
|
431
|
20.0
|
586
|
(11.8)
|
2,333
|
1,338
|
74.3
|
2,849
|
61.1
|
Extraordinary items
|
0
|
210
|
0
|
0
|
(25)
|
0.0
| ||||
Adjusted net-profit
|
517
|
641
|
(19.3)
|
586
|
(11.8)
|
2,333
|
1,314
|
77.6
|
2,849
|
45.8
|
Key ratios (%)
| ||||||||||
RM / Sales
|
68.2
|
73.0
|
(479)
|
70.2
|
(203)
|
70.5
|
68.6
|
198
|
70.0
|
32
|
Employee / Sales
|
9.3
|
8.7
|
62
|
8.6
|
66
|
10.0
|
8.9
|
102
|
9.8
|
94
|
Other exp / Sales
|
16.6
|
13.8
|
281
|
15.6
|
95
|
13.1
|
17.4
|
(435)
|
13.8
|
(262)
|
OPM
|
6.0
|
4.6
|
136
|
5.5
|
43
|
6.4
|
5.1
|
134
|
6.3
|
136
|
PBT Margin
|
4.3
|
3.3
|
100
|
4.3
|
(6)
|
5.5
|
3.7
|
178
|
5.2
|
162
|
Tax rate
|
33.2
|
33.1
|
15
|
37.9
|
(471)
|
31.7
|
35.7
|
(398)
|
32.0
|
(308)
|
Order inflow & backlog
| ||||||||||
Order booking
|
19,820
|
15,310
|
29.5
|
16,660
|
19.0
|
53,221
|
51,855
|
2.6
|
73,041
|
8.7
|
Order backlog
|
78,760
|
82,290
|
(4.3)
|
77,090
|
2.2
|
69,408
|
77,090
|
(10.0)
|
69,408
|
(10.0)
|
Segment results
| ||||||||||
Revenues
| ||||||||||
Power Products
|
5,739
|
4,421
|
29.8
|
6,439
|
(10.9)
|
17,696
|
16,883
|
4.8
|
23,435
|
10.0
|
Power Systems
|
4,766
|
7,519
|
(36.6)
|
6,763
|
(29.5)
|
18,369
|
16,331
|
12.5
|
23,135
|
(3.0)
|
Discrete Automation & Motion
|
4,353
|
4,531
|
(3.9)
|
4,973
|
(12.5)
|
15,707
|
13,706
|
14.6
|
20,060
|
10.0
|
Low Voltage Products
|
1,815
|
1,414
|
28.4
|
2,058
|
(11.8)
|
5,969
|
5,355
|
11.5
|
7,784
|
15.0
|
Process Automation
|
2,891
|
2,803
|
3.1
|
3,458
|
(16.4)
|
9,964
|
9,678
|
3.0
|
12,855
|
3.0
|
Revenue mix (%)
| ||||||||||
Power Products
|
29.3
|
21.4
|
27.2
|
26.1
|
27.3
|
26.9
| ||||
Power Systems
|
24.4
|
36.3
|
28.5
|
27.1
|
26.4
|
26.5
| ||||
Discrete Automation & Motion
|
22.3
|
21.9
|
21.0
|
23.2
|
22.1
|
23.0
| ||||
Low Voltage Products
|
9.3
|
6.8
|
8.7
|
8.8
|
8.6
|
8.9
| ||||
Process Automation
|
14.8
|
13.5
|
14.6
|
14.7
|
15.6
|
14.7
| ||||
EBIT Margin (%)
| ||||||||||
Power Products
|
10.1
|
5.0
|
513
|
9.4
|
74
|
7.3
|
8.8
|
(146)
|
8.0
|
1
|
Power Systems
|
4.9
|
4.0
|
88
|
1.6
|
328
|
4.4
|
3.9
|
49
|
4.5
|
56
|
Discrete Automation & Motion
|
4.4
|
7.5
|
(309)
|
7.8
|
(343)
|
11.5
|
6.7
|
489
|
10.0
|
313
|
Low Voltage Products
|
4.3
|
3.8
|
47
|
4.3
|
5
|
7.3
|
3.7
|
359
|
6.6
|
287
|
Process Automation
|
7.1
|
6.4
|
73
|
10.3
|
(320)
|
5.3
|
5.5
|
(21)
|
5.7
|
0
|
Source: J.P. Morgan estimates, Company data.
Investment Thesis
We like the fact that ABB has managed to improve gross margins in CY13 after a prolonged lean period to 29%, a tad above 2008 levels when growth was in double digits. So the EBITDA margin decline between 2008 and 2013 was a function of capacity underutilization. There is ample room for operating leverage if top-line growth picks up fuelled by an uptick in order inflows. There is overcapacity in power equipment manufacturing while the ordering environment is expected to be weak. We like the story but high valuations remain an overriding concern (~60x 1-year forward P/E) – the market seems to be pricing in a steep improvement in top-line growth and margins, well ahead of our base case.
Valuation
We have factored an incrementally benign risk appetite into our valuation. Our DCF-based Dec-14 PT of Rs480 implies 36x CY14E EPS. Our terminal year (CY18) EBIT margin is 9%. ABB is trading at 61x CY14E and 45x CY15E P/E, against estimated RoE of 10% and 12%, respectively, while it’s a long way away from its 9-12% margin days of 2000-08.
Rs B
|
Rs/share
| |
Sum of FCF
|
16
|
75
|
Terminal value
|
88
|
415
|
Enterprise value
|
104
|
490
|
Less: Net-debt/ (Net-cash)
|
(2)
|
(11)
|
Net present Equity value
|
102
|
480
|
Source: J.P. Morgan estimates
Upside risks to Rating and Price Target
(1) Low free float ex-LIC of ~15.5% could lead to stickiness in stock price despite high valuations.
(2) Sharper-than-expected pick-up in profitability; management remains non-committal of the time frame over which margins will reach high single digits.
(3) If order inflows stage a strong recovery i.e., >25%.
