ABB Could Be Caught Between Long-Term Trends And Near-Term Macro Headwinds

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Not dissimilar Eaton (ETN), Schneider (OTCPK:SBGSY), aliases Siemens (OTCPK:SIEGY), ABB (NYSE:ABB) is leveraged to beardown tailwinds crossed automation and electrification, including building, factory, and process automation, grid modernization and conveyance electrification, and robotics. Relative to those companies, though, I still spot ABB arsenic a comparative underperformer successful position of execution, peculiarly free rate flow, and I judge guidance cannot spend to telephone “job done” connected nan advancement already made.

I do expect further betterment successful nan operations, which possibly is simply a structurally bullish position, though 1 I judge is supported by nan actions taken already nether nan CEO’s tenure. I besides expect very patient underlying maturation successful nan halfway addressed markets, though ABB is much exposed to short-cycle trends and is still much exposed to much commoditized parts of its markets (“more machines, little software” is simplistic, but not wholly inaccurate). Valuation present is a small much favorable than for immoderate of its peers, but adjusting for quality, I’d opportunity nan basal statement is nan aforesaid – ABB shares aren’t precisely inexpensive today, but still leveraged to charismatic semipermanent markets.

Earnings, Then And Now

ABB’s 4th fourth results were mixed, pinch modestly amended than expected revenue, a small weakness successful adjusted operating margins, and a humble shortfall successful orders, including a book-to-bill ratio that fell beneath 1.0 for nan first clip since mid-2020.

Overall integrated gross maturation of 16% was beardown compared to nan emblematic business this 4th (up astir 10%), while 180bp EBITA separator betterment (to 14.9%) and 16% EBITA maturation were still beautiful bully moreover if nan second was a small short of expectations.

In nan Electrification business, 16% gross maturation was beautiful overmuch successful statement pinch nan adjacent group, including Eaton and Siemens astatine 15% and Schneider astatine 17.5%. Motion gross grew 20%, amended than 15% astatine Siemens and 19% astatine WEG (OTCPK:WEGZY). Process gross roseate 6%, connected par pinch Emerson (EMR), but astir half nan maturation seen astatine Honeywell (HON) and Siemens. Finally, Robotics and Discrete Automation grew 23%, outperforming Fanuc (OTCPK:FANUY), Rockwell (ROK), and Siemens, and conscionable hardly lagging Yaskawa (OTCPK:YASKY).

I will besides statement that these comparisons are, astatine best, a wide brush. These companies don’t compete successful nan nonstop aforesaid markets aliases merchandise categories and don’t coming their results successful identical ways. Consequently, nan takeaways are much of nan “general trends” variety, but I would reason that extracurricular of process automation, ABB is performing astatine aliases supra adjacent levels. Process could beryllium explained by a comparative deficiency of package leverage and nan company’s peculiar end-market exposures.

Looking ahead, analysts expect a important slowdown successful nan business successful nan first quarter, pinch gross maturation successful nan 3% to 4% range.

Machine automation, possibly nan astir short-cycle of each of ABB’s businesses, was rather anemic successful nan 4th fourth and I’ll beryllium very funny to spot really this business performs arsenic a “tell” connected nan broader marketplace for short-cycle business capex successful 2023. Likewise pinch Motion, arsenic aggregate companies did study slowing trends successful nan 4th quarter.

Electrification and process automation should clasp up better. Electrification does person immoderate near-term vulnerability to weaker residential and non-residential new-build activity, but building retrofit request has stayed strong, and request successful areas for illustration conveyance charging and utilities continues to beryllium healthy. With process, ABB is little leveraged to oil/gas, but marine, mining, and renewable power should stay healthy. I would besides expect to spot a prime up successful nan China business unless nan institution is losing stock to rivals for illustration Supcon astatine a faster complaint than I judge to beryllium nan case.

Progress Made… But Work Left To Do

Management deed its 15% EBITA target astir a twelvemonth up of schedule, but this would beryllium a mediocre clip for nan institution to remainder connected its laurels. First among issues is nan company’s comparatively caller mediocre way grounds of free rate travel conversion. There are plentifulness of ways to polish non-GAAP metrics for illustration EBITA, but while free rate travel isn’t precisely immune to tinkering, it tends to beryllium a harder number to inflate for extended periods of time. To that extremity I’d statement that caller results (FCF margin) person been beautiful poor, pinch a trailing 4 years of 2.2%, 8.7%, 3.8%, and 5.6%.

I do expect FCF separator to amended from here, I’m expecting adjacent to 10% successful FY’23 and a small complete 12% successful FY’27, but this is decidedly an area wherever ABB lags comparative to its adjacent group. Again, immoderate of this tin beryllium explained by business composition, but that is besides a guidance prime – Eaton, Emerson, Honeywell, Schneider, and Siemens person each been progressive successful remaking their business operation successful caller years, repositioning nan businesses toward maturation opportunities, while ABB has arguably been making much protect decisions, shedding lower-margin aliases lower-growth businesses (like high-voltage power), but besides shedding immoderate higher-margin businesses to amended liquidity.

I besides spot much room for operational improvements. Margins successful nan robotics business request to beryllium amended and I’d for illustration to spot nan institution return different measurement aliases 2 guardant successful position of activity successful emerging areas for illustration cobots. I’m besides going to hit a dormant equine present – I judge ABB has made immoderate questionable strategical decisions wherever package and digitization are concerned, and while location is going to beryllium a marketplace for motors for years to travel (and it’s a good, high-margin business leveraged to automation and electrification), I’d person liked to person seen much connected nan package side, arsenic good arsenic successful power systems for commercialized buildings, process automation, utilities, et al, and successful business IoT.

The Outlook

ABB is well-leveraged to nan semipermanent maturation of automation and electrification astir nan world. Companies are going to proceed to move to automation to thrust improved manufacturing efficiency, while different end-markets for illustration utilities will request accrued automation simply to support operational reliability. Automation will, successful turn, thrust request for electrification, arsenic will a move toward much sustainable, cleaner power sources (electricity complete on-site fossil fuels and grid-scale renewables), much conveyance electrification, and truthful on.

I’m looking for semipermanent gross maturation from ABB successful nan 4%-5% range, aliases a small beneath that of Eaton. While ABB has much leverage to automation, they besides person a batch of title and a batch of portfolio vulnerability that is astatine consequence of becoming much commoditized successful nan coming years. On nan separator side, I’m expecting ongoing betterment toward mid-teens FCF margins, but this is an area wherever I deliberation ABB still has thing near to beryllium to nan Street.

Discounting nan rate flows back, I judge ABB is priced for a precocious single-digit return that is simply a small amended than what I expect from Eaton, but I besides see Eaton a better-run institution pinch a amended wide operation of businesses (albeit not without challenges, for illustration its accepted auto/truck components). A 14x guardant EBITDA aggregate gives maine a $35 adjacent value, and while that is simply a premium to what underlying margin/ROIC would support, it’s not arsenic robust of a premium arsenic for names for illustration Eaton and Honeywell.

The Bottom Line

I’ve held ABB successful portion owed to what I judge nan institution tin become; location are fantabulous world-class businesses nether this umbrella, including highly competitory segments wrong Electrification, Motion, Process Automation, and Robotics & Discrete Automation. I’m encouraged by nan advancement guidance has made successful unlocking immoderate of that potential, and I deliberation location is room for much improvement. At this valuation, though, and pinch short-cycle markets weakening, I do spot a much humble risk/reward trade-off.

Editor's Note: This article discusses 1 aliases much securities that do not waste and acquisition connected a awesome U.S. exchange. Please beryllium alert of nan risks associated pinch these stocks.

Stephen Simpson is simply a freelance financial writer and investor. Spent adjacent to 15 years connected nan Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That past portion isn't wholly true. Probably.