ABB

Disappointing results over several quarters and the sharp run-up in the stock of ABB after the announcement of an open offer, have resulted in the stock trading at very steep valuations, far higher than peers and not supported by current fundamentals.



From Rs 673 just before the announcement of the open offer in May, the stock has rallied close to 30 per cent. As the run-up seems driven by the offer, investors can use the opportunity to exit the ABB stock. At the current market price of Rs 875, the stock discounts its estimated per share earnings for CY-11 by 32 times.

ABB's Swedish parent has announced an open offer to acquire up to 22.89 per cent of the paid-up share capital of the Indian unit. This would amount to a minimum acceptance ratio of 48 per cent.

In other words, investors who tender 100 shares would have at least 48 shares accepted under the offer. However, given that the current market price is just 3 per cent below the offer price, investors may as well sell their shares in the market.

Margin pressures

After managing the slowdown in 2008 quite well, ABB suffered in the calendar year 2009. While revenues declined by about 9 per cent to Rs 6,237 crore, net profits fell sharply by 35 per cent to Rs 355 crore due to non-operational costs as well as other operating cost over-shoots.

Lower sales, fixed cost-overruns in certain projects, additional costs incurred as a result of exiting rural electrification business and extraordinary costs as a result of impact from fair valuations of foreign forward exchange and embedded derivative contracts, resulted in the profit decline.

While some of the expenses may not affect future profits, there are other operational concerns that can dent profit margins.

For one, the company has incurred some cost-overruns as a result of which margins dipped steeply in the December 2009 quarter. In the March quarter too, the power systems division suffered operating losses even as the power products segment witnessed 4.5 percentage points dip in operating profits to 8.3 per cent, suggesting that cost pressures may continue. Risks of additional cost overruns therefore remain.

The power systems division (transmission and distribution) also witnessed lower revenues as a result of the company's decision to exit the rural electrification business as it perceived risks of delayed cash flow.

While the margin in the rural electrification tends to be unattractive, this business could have provided high volumes. Besides, deferment of deliveries by some clients in the private sector also led to lower revenues and profitability. Nevertheless orders received by this segment grew by a healthy 31 per cent during the year ended December 2009. As the company has been selective in undertaking projects in this space, profit margins could once again improve.

Higher competition

However, the profitability of the other key division, power products (mostly transformers, switchgears and circuit breakers), may move down as the company may see dip in realisations as a result of increasing competition.

While high-end transformers traditionally enjoyed lucrative margins with very few local players manufacturing the same, the scenario has changed with players from China and Korea now increasingly bagging domestic orders. Order flows in the power product segment during 2009, in fact dipped marginally to Rs 2370 crore.

Overall, ABB closed CY-09 with 8 per cent higher orders while order backlog at Rs 8,480 crore, was about 1.3 times CY-09 sales. This is a reasonable show, considering what the company has otherwise undergone on the financial front.

The increased control and focus of the foreign parent, post this issue (parent stake can increase to 75 per cent), could also mean higher export opportunities, as a result of more outsourcing by the parent. However, the stock valuation is stiff and may not quickly decline, given the moderate earnings growth prospects for the medium term.

Stocks in the power equipment/engineering space, at more reasonable valuations, may provide higher upside. The open offer closes on July 27.

via BL