JPMorgan is underweight on ABB,

Near-term pain remains. The foreclosure costs on ~Rs2B of legacy orders
from rural electrification business are yet to be incurred, negative impact
may continue through 1QCY11, as per company. Margins may continue to
be strained in power products and automation segments as we have not seen
any signs of lower competitive intensity. Sep-q PAT est. of Rs759MM
implies an 8.6% YoY dip. Our CY10 EPS est. is ~6% below consensus.
• Expectation of sharp recovery next year, will take PAT slightly above
CY08 level: The order inflows in 1H (Rs29B) were down 33% YoY. A
couple of large substation orders were slated to be finalized in Sep-q, and
2H inflows are likely to see a strong recovery, as per management. Healthy
revenue booking on long cycle orders (~50% of ~Rs85B order backlog) and
removal of rural electrification related overhang may lead to topline growth
recovery in CY11 (26% YoY est.), and PAT growth of 55%. However, we
note that the recovery is optical (on low base of CY09) and absolute PAT of
Rs5.6B would still be at CY08 levels.
• Irrational re-rating? As per Bloomberg, CY11 and CY12 consensus EPS
est. have been reduced ~17% and ~28% since Jan-10, while the stock has
delivered 20% returns over this period.
• Sustainability of high growth & margin recovery to historical levels is
doubtful: Based on our discussion with management, we infer that there are
concerns on excess capacity and competition, which may prevent recovery
in margins to historical peaks. Accordingly we model 10.5% sustainable
EBIT margin in the long term, ~100bps below CY07 peak. Our est. of
CY12-17 revenue CAGR is ~17% for ABB, slightly above Siemens
(16.5%) owing to its higher domestic focus.
• Valuation premium remains, RoE lowest in the sector: Our revised Sep-
11 DCF based PT of Rs765 (vs. Mar-11 PT of Rs700 earlier), implies 17%
downside, reiterate UW. The stock is trading at 33.4x FY12 fiscalized
EPS at a 22% premium to Siemens and 67% premium to CG. ABB's
RoE est. of 19% in CY12 is well below CG (27%) and Siemens (25.3%).
Key risk to UW: Ex-LIC free-float is just ~14%. Sharper than expected
growth, signs of easing competitive pressures are key upside risks.