| 2015 | 2016 | ||||||
| Price: | 19.50 | EPS | 1.46 | 1.75 | |||
| Shares Out. (in M): | 2,304 | P/E | 13.3 | 11.1 | |||
| Market Cap (in $M): | 44,928 | P/FCF | 13.3 | 11.2 | |||
| Net Debt (in $M): | 1,654 | EBIT | 4,786 | 5,268 | |||
| TEV (in $M): | 46 | TEV/EBIT | 9.7 | 8.5 | |||
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Investment Thesis: ABB is well positioned to succeed in its two main lines of business: power (40% of revs) and factory automation (60% of revs), and both markets will show substantial growth in coming years. The current valuation represents an attractive entry point for a quality business with a clean balance sheet and good long-term growth prospects.
Company Overview
Zurich-based ABB Ltd. is a global leader in power infrastructure equipment and factory automation. I believe the company is a strong player in its two key markets and is quite cheap for such a quality company. The long-term outlook for ABB’s markets is quite favorable, even though the recent stock price action suggests otherwise.
The company operates in five segments:
Discrete Automation and Motion: Includes drives, motors, inverters, robots and most equipment for general industrial automation. ~22% of revs/~28% of EBITDA
Low Voltage Products: Includes switchgears, breakers, control products, wiring accessories or numerous other products designed to protect electronics, improve efficiency, and increase safety for primarily industrial use. ~17% of revs/~23% of EBITDA
Process Automation: Sells equipment designed primarily to automated specific industrial processes in industries such as oil & gas, mining, chemicals, paper & pulp, and marine. ~19% of revs/~17% of EBITDA
Power Products: Sells a wide range of products such as breakers, transformers, capacitors and surge arrestors to utilities to aid in generation, transmission, and distribution. ~24% of revs/~25% of EBITDA
Power Systems: Provides turnkey solutions to utilities for power generation, grid systems, substations, and network management. These projects include design, engineering, supply, installation and testing. ~18% of revs/~7% of EBITDA
The company was formed from a merger between Swedish Asea AG and Swiss BBC Brown Boveri AG in 1988, but Asea traces its roots back to 1883. ABB is a true multinational with 34% of revenue coming from Europe, 29% from the Americas, 27% from Asia, and 10% from Middle East/Africa.
Power
The power grids in the developed world are old and decrepit according to numerous sources. In addition the growth of “non-base load” renewable energy is putting new strain on energy transmission and distribution systems. See:
United States:
http://www.infrastructurereportcard.org/a/documents/Energy.pdf (2013) ASCE gives U.S. electric infrastructure a D+
http://www.asce.org/uploadedFiles/Issues_and_Advocacy/Our_Initiatives/Infrastructure/Content_Pieces/failure-to-act-electricity-report.pdf This is a more detailed look at the U.S. electric infrastructure from ASCE
http://www.ferc.gov/industries/electric/indus-act/transmission-grid.pdf (From 2002, so a bit dated)
“There is growing evidence that the U.S. transmission system is in urgent need of modernization.”
http://congestion09.anl.gov/documents/docs/congestion_study_2009.pdf (from 2009)
Highlights the key areas of congestion in the U.S. grid.
Europe:
“To meet EU energy and climate goals, major investments in the electricity transmission infrastructure are necessary. This investment challenge, however, is unprecedented in size and pace and means a significant financing challenge”
http://ec.europa.eu/energy/mff/facility/doc/2012/connecting-europe.pdf
“The EU’s energy infrastructure is ageing and, in its current state, not suited to match future demand for energy, to ensure security of supply or to support large-scale deployment of energy from renewable sources. The upgrading of existing, and development of new energy transmission infrastructures of European importance, will require investments of about EUR 140 billion in electricity and at least EUR 70 billion in gas.”
While developed world governments and utilities have been slow to spend on electrical improvements so far (very little in the way of fiscal stimulus has been forthcoming), in the coming years such spending will be a necessity that cannot be avoided. We also believe that fiscal spending on electric infrastructure financed with low interest debt is a good investment for most countries.
The emerging markets are working hard to provide electricity to their citizens, yet according to the IEA (http://www.worldenergyoutlook.org/resources/energydevelopment/accesstoelectricity/) over 1 billion people globally have no access to power. Almost every economy has come to depend on consistent power supplies thanks to the rising importance of PCs and electronics generally. Emerging economies have a significant need to spend on power infrastructure.
In terms of recent performance, ABB’s power products business has been healthy while its power systems business has been under-earning due to poor performance on a number of large projects which management is trying to address.
Factory Automation
Factory automation should only increase in the future. For instance, ABB has already replaced human drivers in certain mining applications in Australia and done an entirely automated mine in Brazil. As the cost of labor rises in places such as China, the opportunities to replace labor with smart automation increase. You don’t need to read the detailed report mentioned below to see the punch line that factory automation is a significant growth industry (8%+ CAGR forecasted 2013 through 2018):
With humans having a variety of health cost, reliability/fatigue, and safety issues, it is no wonder that companies are replacing manual labor with automation when they can. Sure the downturn in mining has had a negative impact as mining is a great industry to replace human labor with automation (mostly for safety reasons), but almost every manufacturing industry sees good benefits from automation.
The recent performance of the factory automation business has been lackluster as it has been weighed down by a drop in revenue as miners and commodity producers tone down their capital spending. I expect this headwind to continue for a few years, but not indefinitely. Order trends have recently perked up in these lines of business with orders up 55% y/y in Q3 for process automation and 12% y/y for discrete automation and motion.
Competition
There is no question about it, both the power business and the factory automation business are competitive businesses. One should expect them to remain competitive, but ABB has established a solid position in almost all its markets. ABB strives to have #1 or #2 market share in each of their specific sub markets. ABB has #1 market share globally in the following markets: transmission & distribution, distributed control systems, gearless mill drives for mining, industrial motion (motors & drives), electric propulsion for ships, terminal automation for ports, and large industrial turbo chargers.
In power ABB competes with Eaton Corporation, Legrand, Mitsubishi, Schneider, Siemens, Leviton, Rittal, Hyundai, Hyosung, Crompton Greaves, Larsen & Toubro and Bharat Heavy Electricals, Alstom, Emerson, General Electric, Prysmian and Nexans.
In automation ABB competes with Alstom, Fanuc Robotics, Kuka Robot Group, Rockwell Automation, Schneider, Siemens, Yaskawa, SMA, WEG Industries, Emerson, Honeywell, Invensys, Metso Automation, Voith, and Yokogawa Electric Corporation.
Valuation
ABB’s valuation is, simply put, undemanding.
The stock trades at 13.3x 2015 EPS estimates of $1.46. On an EV/EBITDA basis the stock similarly appears reasonably cheap at 7.9x ’15 EBITDA estimates. The company threw off FCF of over $3.05 billion in the LTM, implying a healthy 6.6% FCF yield on a TTM basis and it should be ~ 7.5% FCF yield for 2015. These valuations seem reasonable for a business that has consistently generated ROICs north of 15% (although this has been pressured closer to 10% recently by near-term challenges in the power systems business).
I can easily imagine this business being worth 15 or 16x EPS and growing EPS at a 10% CAGR for the next several years. Indeed the comapny's EPS growth targets for 2015-2020 are a 10-15% CAGR. It is not hard to imagine this as a $30+ stock in a few years.
Capital Allocation
Capital allocation is fairly shareholder friendly. The company pays an approximately 3.5% dividend annually. In addition the company committed in September to buying back $4 billion of stock over the next two years, a move which should be quite accretive to remaining shareholders at current prices. It works out to a buyback of roughly 9% of the company at current prices. This is not a company that is hoarding excess capital to the detriment of shareholders.
Activist Target?
Another interesting idea is whether ABB may one day become an activist target. It seems to me that there is little logical reason to keep the automation and power businesses together under one roof. While they may share some overlapping industrial customers, separate incentives for the power and automation management teams would probably help drive results. The investment thesis doesn’t bank on it, but I would imagine that ABB could become an activist target if its valuation and performance don’t improve under the new management team which came in during fall of 2013.
Conclusion
ABB is a true multinational with a strong position in the global power and factory automation markets. It has a clean balance sheet, shareholder-friendly capital allocation policy, boasts high returns on capital, and sports a reasonable valuation. It should make an excellent long-term investment.
Risks:
Fiscal spending on infrastructure projects has been tight for years. Perhaps Europe or the U.S. will be willing to try fiscal stimulus as it becomes clear that growth is less than desired, but there are certainly no guarantees.
ABB serves many industrial businesses and is, thus, subject to economic cycles. (e.g. ABB serves mining and commodities businesses which have been reducing capital spending recently.)
ABB has faced a few years of struggling to drive growth and particularly margins. New management seems to have a realistic plan to get things growing and margins expanding again, but time will tell if they execute as promised.
Acquisitions are part of the ABB game plan. If they acquire too aggressively, it may stretch the balance sheet. Management seems to have been prudent so far, but it merits watching.
The energy industry is changing with the rise in solar, natural gas, etc. and decline in things like coal. ABB’s power business should be well positioned to benefit from the change, but if certain customers’ balance sheets become threatened (e.g. coal-driven utilities) as a result of the changes, it could also cause problems.
There a number of potential catalysts for ABB.
1) I think if the ECB finally delivers on QE, that will be good for ABB stock, because even though it is a multinational it is largely percieved as a "European" company.
2) If management makes meaningful progress on improving power systems profitability which has been depressing earnings, the street will likely come around to the name quickly.
3) Could an activist agitate to split the company up? Maybe.
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