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Order Momentum expected to pick up!!!
We recently met the management of ABB India in order to understand the recent
development in the company and the future outlook. The key takeaways of the
meeting are:
9MCY10 profitability hit due to Rural Electrification projects, Execution delay in large
long cycle projects and Forex hit
During 9MCY10, ABB’s profitability declined by ~77% due to the consistent losses in rural
electrification (RE) project coupled with execution delay of large long cycle projects. Also
the company has made provisions of ` 571 mn on account of Forex loss in 9MCY10. ABB
entered into rural electrification work in beginning 2008 (~10% of CY09 sales). RE
projects, characterized by low-voltage distribution work, require tremendous amount of
sub-contracting as the work is largely outsourced. The company could not effectively
manage these projects and had to suffer losses even as working capital worsened. Till
date, the company had exited RE business to the tune of ` 8 bn and we believe that it will
take at least few more months to completely exit out of the RE business. The current
exposure in RE business is ` 2 bn. These three factors resulted in the sharp decline in
profitability for the company.
Order Inflow momentum expected to pick up
The Company reported an order backlog of ` 91.8 bn at the end of quarter ending
September 2010, up 14% YoY. Order inflow during the first nine months declined by
~22% to ` 49.5 bn YoY. However, 3QCY10 started witnessing pick up in order inflows of
~7% to ` 20.3 bn. Of the Order book of ` 91.8, ~ 40% is from Industrial, 50% is from
Power and the rest is exports. We expect pick up in the company’s power sector order
book, as the company stands to benefit from the substantial investment planned in the
T&D sector over the next few years. With the Industrial capex revival, we expect the
company’s automation sector order book to pick up.
Our View:
ABB India’s performance has been lackluster in the last two years in terms of moderate
financials and order book. The key catalyst for ABB’s dismal performance has been the
slump in industrial capex (40% exposure for ABB) and strategy to exit RE business leading
to non booking of revenue and increase in costs due to penalties, etc. However, with the
overall momentum picking up in the Industrial space coupled with expected orders in the
T&D segment, we expect the order inflow to pick up. During 9MCY10, the company has
reported an EPS of ` 2.7. We do not have rating on the company. However, based on the
current prospects of the company, we expect the company to report an EPS of ~` 5 in
CY10.
BUSINESS OVERVIEW
ABB Ltd. (ABB India), a 75% subsidiary of $31.8 bn ABB, Switzerland, is the dominant player in the Indian power and industrial automation sector. ABB India employs over 6,000 people, has 14 manufacturing units, is a global engineering and operations centre and group corporate R&D facility. It has a countrywide marketing and service presence spanning 30 marketing offices, a network of over 850 channel partners and eight service centers.
Power Technologies (55% of revenues)
Power Technologies offers turnkey solutions for substations, distribution automation, network management and power products that cover a wide spectrum of technologies across the T&D segment. The company’s strength lies in setting up High Voltage Direct Current (HVDC) transmission lines, substations up to 400 kVA and switchgears, mainly medium & high voltage switchgear. ABB has impressive track record in winning HVDC projects in India and has done majority of the HVDC transmission projects so far. It is a market leader in APDRP projects.
Automation Technologies (45% of revenues)
Automation Technologies covers two broad segments: industry products (such as motors and drives, panel, etc) and process automation (instrumentation). ABB is one of the dominant players in the industrial automation and process technologies industry and has significant penetration across several industries such as metals, automotive, oil and petrochemicals, pharma, paper, etc. ABB India has also been designated as the regional centre of excellence for metals and cement industry applications within ABB Group.
Historical performance CY10 till date has been a moderate year for ABB due to the company’s strategic decision of exiting from the rural electrification business and also due to the delay in execution of its existing turnkey projects and slowdown in order inflow. This resulted in ~2.7%, ~80.8% and 77% decline in Sales, EBITDA and PAT respectively in 9MCY10. ROCE and ROE declined to 24% (45% in CY08) and 16% (29% in CY08) in CY09 respectively. ABB India reported robust revenues and PAT CAGR of 36% and 40% respectively over the period CY03-08. It has consistently recorded high operating margins over the same period (excess of 40% and reported 12.3% EBITDA margins in CY07) owing to its impressive product mix which allowed the company to maintain margins, control working capital and tide over cyclicality in projects segment Over the past few years, ABB India has undergone a significant change in line with business restructuring exercise undertaken by the parent. The group has exited power generation and transportation businesses in the past ten years, once contributing to significant part of the company’s growth. Today, ABB is focused on T&D and automation businesses worldwide. ABB’s capability in providing cutting-edge solutions like High Voltage Direct Current (HVDC), flexible AC transmission systems (FACT), SCADA, distribution control systems, etc, is unchallenged. In the past 10 years, ABB’s key to sustainable growth in the Indian T&D space is the aggressive launch of new products such as 400 kV Circuit breakers, new high-tension transformers, LT capacitors, etc. In the past five years, ABB has made investments to the tune of US$ 150 mn in setting up new capacities for key products across ranges. The company has also set up a 500-strong global engineering centre in Bangalore, to support ABB Group operations. ABB’s ROCE has improved from 26% in CY03 to 45% in CY08, even though cash and investments were 53% of total capital employed and the company underwent US$ 150 mn investment programme during CY04-08. Improvement in productivity has also helped the company improve ROE from 18% in CY03 to 29% in CY08. We believe that the company will be able to further improve returns over next three years, with stable margins, effective utilization of liquid assets (doing capex in productive assets) and robust business environment.
Future Prospects Transmission and Distribution sector will see substantial investment. T&D investments, being back-ended, will witness a significant spurt over the latter half of the 11th Plan period. ABB’s strength lies in the high voltage AC and DC transmission systems, high voltage substations. ABB has a high degree of success in projects that it bids for and it will continue to enjoy high share in bankable projects. We believe that Industrial investment (muted in CY09 due to credit crisis) are picking up. We attribute this to three key reasons: demand picking up, strong corporate balance sheets and low interest rates. We believe metals, autos and oil & gas industries will remain at the capex forefront for the next few years, benefiting ABB’s Automation businesses. Since last one year, India’s transmission infrastructure has been focused on high voltage technology such as high voltage direct current (HVDC), 765 kV and later 1200 kV transformer. ABB has a proven experience and expertise in undertaking these projects and we believe it to be a strong contender going forward. ABB India has been and will continue to get a wider role to play in the overall network of the parent. The company has also set up a 500-strong global engineering centre in Bangalore, to support ABB Group operations. Results are there to prove the point. Exports revenues have reported CAGR of 12% over the period CY03-08. Although as % of sales, exports have declined from 20% in CY03 to ~8% in CY09.This is primarily due to increase in demand in the domestic market. The current order book for ABB stands at ` 91.8 bn, a 35% CAGR over the last five years. We believe that the increasing momentum in the power and industrial space over the next five years will boost the order book of the company. Key Risks: Macro-risks will remain predominant concerns in the near term that may affect valuations. Beyond this, any additional negative in the power policy may act as a sentiment dampener.
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