ABB

Investors can consider reducing exposure to the stock of ABB on rallies linked to the broad markets. Disappointing revenue growth for three consecutive quarters, pressure on profit margins, decline in revenue growth in its key segments and slowing order intake are suggestive of the company yielding to macro economic pressures. The slowdown in capex spending of many key client sectors, also suggests a slowdown.

While we are positive about the long-term business potential in the segments in which ABB operates, the medium-term picture appears less inspiring due to the reasons stated above.

At Rs 438, ABB’s price-earnings multiple of 20 times its annualised earnings for CY-2008 exaggerates the earnings potential over the next 6-12 months. Investors in ABB may lose out on superior opportunities in stocks such as Larsen & Toubro or BHEL, which provide better earnings visibility at attractive valuations over the medium-term.
Brakes to relentless growth

For the third-quarter ended September 2008, ABB’s sales were 10 per cent higher than a year ago numbers. The sales growth for the first and second quarters stood at 17 per cent and 15 per cent respectively. The company has attributed the a slowdown in revenue growth to projects with longer execution cycle. While ABB is prone to lumpiness in in revenues, the growth this time around, appears to be the slowest for the company in the last few years. This, coupled with the mild decline in revenues in some key segments, pressure on margins and decline in net profits, cast doubt on the earnings growth prospects.

Recurring net profits for the September quarter fell by over 20 per cent, adjusted for forex gains. Even as lower revenue growth led to a decline in operating profits, operating profit margins (OPM) took a hit on account of higher input prices and certain projects not reaching the ‘profit accounting’ stage. Absence of price escalation clauses in some projects dragged OPMs to 8.8 per cent in the September quarter, from 12.6 per cent a year ago. Interestingly, this is among the lowest OPMs for the company in the last eight quarters. The company had clocked over a 11 per cent OPM in the first two quarters of March and June when revenue growth had been moderate.

While ABB could gain some breather on the raw material cost front with commodity prices cooling down significantly, the management has indicated that this may not provide sustained relief as it may have to resort to product price cuts. Such a move may also be be inevitable to boost volumes on the back of a weakening capex spending by industries.
Segment performance

ABB’s power systems segment, a key revenue driver, has seen a mild dip in the September quarter. MNC players such as ABB and Siemens have depended primarily on large orders with superior margins to support growth. As a move to diversify itself and capitalise on the largely volume-driven Indian market, ABB has commissioned a new plant in 2008 to gain market share in small transformers. While profitability on the venture could be thin, it could be compensated by strong volumes, given ABB’s superior technology.

In the automation segment, while revenue from automation products grew at a healthy pace, process automation remained stagnant. Profits from both these segments were also under pressure. Capex spending in sectors such as cement, steel and oil and gas were key triggers for the automation division’s growth. With commodity prices trending downwards, a slowdown or postponement of spending in these sectors could result in lower order inflows for the division.
Order inflows

Order inflows for the September quarter were 13 per cent higher at Rs 1,889 crore. This has been, however, the slowest growth in the last couple of years now.

Although, there has been a delay in a spending in key power reform programmes such as Accelerated Power Distribution and Reform Programme (APDRP), the opportunity in this area nevertheless remains. While order inflows in the next couple of quarters could be more tempered, an increase in Government spending and revival of corporate spending (on lower interest rates) could revive ABB’s order kitty.

The probability of higher order inflows from export markets too appears low in the near term. ABB’s export market has so far contributed only about 10 per cent to its revenues. While its parent has been planning to utilise the Indian unit as a global outsourcing hub, these plans may take time to implement with the global economic slowdown slowly morphing into a recessionary trend.

Despite ABB being one of the few cash-rich engineering companies, its management has aired concerns over funding issues .

The company is reportedly surveying various options, including fixed deposits, to meet working-capital requirements. This could increase borrowing costs for a virtually zero debt company.