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ABB: Valuation defies
weak fundamentals
With a scarcity of large orders and competition undermining
margin recovery, an earnings disappointment is on the cards
At 34.4x CY12e PE, we believe a significant takeover premium is
built in, despite ABB denying its parent will increase its stake
We lower our CY12-13 EPS estimates by 5-8%; this reduces our
TP to INR570 from INR590, which remains 12-16% below
consensus; reiterate UW
Investment thesis
ABB witnessed a significant decline in its order
intake in CY10, particularly in the power business,
where new orders fell by c45% for systems and
c33% for products. Consequently, we expect ABB
to deliver a single digit growth in revenues this year.
We expect order intake to pick up somewhat this
year (c13%), driven by improving demand for
discrete automation and low voltage products,
driving sales growth of c14-16% during CY12-13.
We note large orders remain scarce; however, the
company has highlighted in the previous quarters
that they expect a pick-up in large orders in the
second half of this year. If large orders materialize,
then there could be upside to our order intake
forecasts this year.
In addition to declining orders, the erosion in
margins has been a key detriment to ABB’s
earnings. EBITDA margins fell to c2.5% in CY10
from c9.4% in CY09 and the company continues
to suffer from pricing pressures. We expect
margins to improve to c6.4% this year and go
back to c9-10% level in CY12-13. We note that
our margin estimates remain optimistic at this
stage and in case the pricing pressure remains
intense, the recovery can get delayed.
We have trimmed our CY11-12 EPS estimates by
a low single digit rate driven by our cautious view
on execution. While our EPS estimates of
INR11.9 for CY11 and INR19.3 for CY12 remain
23% and 16% below consensus, we believe it may
be difficult for ABB to deliver on our estimates let
alone consensus expectations.
ABB remains expensive based on our new
estimates, trading at a 56.1x CY11e PE and
c34.4x CY12e PE versus its historical average 12-
month forward PE of 38.7x for the last five years.
We note, historically, valuations have benefited
from a regular increase in the parent’s stake in the
company; however, ABB has recently highlighted
to investors the parent company does not intend to
increase its stake further (i.e. beyond 75%). Hence
we believe the stock no longer warrants a
takeover premium and should be de-rated.
Our downward earnings revisions lead us to trim
our target price on the stock to INR570 from
INR590. Our target price is derived from our
preferred EVA valuation methodology and
implies that 12 months from now, the stock
should trade at a 12-month forward PE of 25.4x
on a 24-month forward EPS of INR22.4. We
believe ABB’s lofty valuation is at odds with its
weak fundamentals and reiterate our UW rating.
The key bull and bear factors related to ABB are
as follows.
Bull factors
Base orders have started improving in the last
couple of quarters
Restructuring benefits and relief from RE exit
should support margins from here on
Balance sheet remains under-levered and
could provide strong fire power
Bear factors
Sales growth likely to remain sluggish due to
weak orders in the last 18 months (excluding
the last quarter)
Visibility on the margin recovery remains
low, while expectations remain steep
Returns have deteriorated significantly and
working capital needs to be better managed
The stock remains unjustifiably expensive, in
our view, versus its peers and historical
trading average
Low probability of another open offer from
the parent company
Valuation
Our target price of INR570 is derived from our
preferred EVA valuation methodology, assuming
a target sales growth of c9%, through-cycle
operating return margin of c10.0% and WACC of
c11.7%. Our target price implies that 12 months
from now, the stock should be trading at a 12
month forward PE of 25.4x on 24-month forward
EPS of INR22.4.
Under HSBC’s research model, for stocks without
a volatility indicator, the Neutral rating band is
5ppt above and below the hurdle rate for India
stocks of 11%. This translates into a Neutral
rating band of 6% to 16% around the current share
price. Our 12-month target price of INR570
suggests a potential negative return of 14%
(excluding dividends), which is below the Neutral
rating band; hence, we reiterate our UW rating.
Risks
We highlight the key upside risks related to our
investment case for ABB below:
Significant pick-up in execution
Better-than-expected improvement in margins
Resurgence of large orders
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