ABB India - Margin woes continue to hurt :: Macquarie Research,

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ABB India
Margin woes continue to hurt
Event
 ABB India reported its 2QCY11 results which were much below our and
consensus estimates due to lower margins. We retain our negative outlook on
the company and maintain our Underperform with a revised target price of
Rs420 (from Rs488 earlier).
Impact
 Revenue growth without margins: Revenues at Rs16.9bn were up 17%
YoY, while EBITDA margins (adjusted for forex fluctuations) at 5.6% were
down 210bps YoY and 30bps QoQ. Revenue growth was driven both by
power systems and automation which grew by 14% and 21% respectively.
 Margins to remain under pressure in CY11, medium-term target to reach
8-10%: Loss-making legacy rural electrification orders continue to hurt
margins for the company (Rs230mn revenues). ABB could continue to have a
painful period in 2HCY11 as Rs470mn rural electricity orders are left to be
executed. Domestic manufacturing of circuit breakers and transformers could
help ABB compete with players like Siemens and Crompton Greaves. The
management maintains its medium-term target to attain an 8-10% margin.
We revise our margin estimates downwards: In 1HCY11, EBITDA
margins for ABB (adjusted for forex fluctuations) have been 5.5%. We are
now building in a 6% margin for CY11 (v/s 9.8% earlier). Similarly, for
CY12-13, we are now building in 8.6% and 9.2% margins (v/s 9.9%
earlier) as we remain uncertain about the rebound in margins.
 Order inflow growth driven by short-cycle orders: ABB reported 45%
growth in order inflow at Rs18bn driven by short-cycle orders. Management
indicated that it continues to witness robust activity in short-cycle projects and
some delay in long-cycle projects. ABB will be looking to book US$150mn of
Powergrid’s HVDC order which ABB Global won in CY10. We are currently
building in 25% order inflow growth in CY11.
Earnings and target price revision
 We reduce our CY11/12 EPS by 42% and 14%, respectively, to factor in lower
margins. We reduce our target price by 14% to Rs420.
Price catalyst
 12-month price target: Rs420.00 based on a PER methodology.
 Catalyst: delay in normalisation of margins
Action and recommendation
 Stock at unrealistic 42x CY12E PE despite factoring in strong turnaround:
We believe ABB is trading at unrealistic multiples of 42x CY12E EPS. We think
the market expects the parent to eventually de-list the company and that is the
only reason keeping the stock at the current elevated levels. Amongst the MNC
capital goods pack, Siemens (SIEM IN, Rs875, N, TP: Rs831) is trading at 24x
FY12E EPS and Cummins India (KKC IN, Rs607, Not rated) is trading at 15x
FY12E, Bloomberg consensus estimates, with better earnings profile. We retain
our Underperform on ABB with a revised target price of Rs420