ABB Stock: Premium Transformation Story But Valuation Unjustified (NYSE:ABB)

ABB (NYSE:ABB) is a leading provider of industrial automation solutions. The company is currently undergoing a significant transformation, focused on improving the quality of its earnings, streamlining operations, and capitalizing on growth opportunities in industries such as electrification, smart cities, electric vehicles, and robotics. This transformation is expected to position the company for long-term success and growth.

In this article, we will systematically examine the company’s business fundamentals, strategy, risks, financials, and valuation to help readers arrive at a more informed position to assess the risk and rewards of owning the stock.

Note: This article is for educational purposes only and does not constitute financial or investment advice. Please do your own due diligence and consider your unique financial needs and constraints before buying any stock.

Business

ABB is a publicly traded company that engages in industrial automation and technology to drive productivity and sustainability. The company has a 130-year history of excellence and a 105,000-strong workforce. It operates in over 100 countries, generating revenue in multiple currencies and managed through four business areas: Electrification, Motion, Process Automation, and Robotics & Discrete Automation.

ABB has undergone significant transformation since Bjorn Rosengren became CEO in early 2020. Under his leadership, the company has optimized its portfolio through a combination of additions and subtractions, improved the quality of its earnings, and implemented a streamlined operating system (ABB Way) to take advantage of key industry trends such as the electrification of everything, smart cities, electric vehicles, robotics, and industrial internet of things. This comprehensive internal restructuring has been successful in improving the company’s performance.

Markets: Its exposure to customers is geographically balanced and caters to multiple end-markets and segments. The company’s portfolio is well-positioned to benefit from growth drivers such as urbanization, labor shortage, shift to electrification, automation, and robotization, as well as data and digitalization trends.

Operating Model: The company’s operating model is decentralized, with divisions representing the highest level of decision-making and closest to customer needs. The divisions prioritize stability and profitability before growth, with two-thirds of them, representing 60% of group revenues, now on a growth mandate. The company’s focus in 2022 is on accountability, transparency, and speed within all divisions, with a target to make annual productivity improvements of at least 3%. The corporate functions focus on strategic, financial, and governance activities with a headcount of 800 employees.

Competitive Advantage: ABB has a strong competitive advantage through its core competencies of decades of domain expertise, cutting-edge technology and innovation, and the ability to scale operations and distribution. The company has a long history of leadership in power and automation technologies, and deep domain expertise through its long-term presence in various vertical markets and close relationships with customers and partners. The company continuously evolves its offering to remain relevant and a trusted partner to customers.

The company’s software is a key differentiator and 60% of its R&D workforce is focused on software development. The majority of ABB’s businesses are market leaders within their respective segments, which is critical for price leadership and profitability.

Strategy: ABB has aligned its business portfolio to more attractive growth markets, focusing on discrete industries and transport and infrastructure, which offer better growth opportunities. Additionally, the company has increased the proportion of sales from short-cycle businesses, reducing the risk and volatility in earnings.

The company’s strategy centers around resource efficiency in electrification and automation. The responsibility for growth has been transferred to the divisions which are closest to customers and have the best insights into current and future customer needs. The company expects to see a continuous shift in its growth profile as more divisions transition from stability and profitability to growth. The company’s products and services are supported by strong sustainability megatrends, with a focus on sustainable transport, electric vehicles, and alternative fuels.

ABB’s goal is to create superior customer value through its comprehensive, modular offering that combines traditional products and services with software-enabled products, systems, and digital services.

Risks

Macro Sensitivity: The company sensitive to global GDP and a prolonged global economic recession may put pressure on the company’s multiple and revenue. As a geographically diverse company, a recession of a more global nature may affect ABB’s performance more than that of its peers.

A downturn in industrial production, coupled with a decrease in global automation spending as a percentage of overall capital expenditure, could negatively impact the industry, leading to delays in projects. Furthermore, sustained pressure in emerging markets, particularly those with lower labor wages, could result in delays in automation implementation across various sectors.

Additionally, significant and lasting changes in commodity prices, such as oil and natural gas, could have a significant impact on various applications, such as upstream, midstream, and downstream. For example, a sudden increase in domestic natural gas projects could make LNG export facilities less attractive and cause delays or cancelations of planned domestic chemical facilities. Meanwhile, sharp declines in oil and gas prices could lead to reduced production activity and decrease demand for midstream logistics and downstream processing applications.

M&A Risk: There is a risk of capital deployment missteps by management as they aim to be more nimble through M&A opportunities. While we anticipate that the company will remain disciplined in their decisions, there is a possibility that poor choices may negatively impact the internal turnaround story.

China: China holds significant importance for ABB, as it represents approximately 17% of the company’s sales. ABB has established a strong presence in the region with local leadership by Chinese nationals. Although tensions between the U.S. and China may pose some concerns, they are less impactful for ABB as it is not a U.S. based company. However, if geopolitical tensions escalate more broadly, ABB may be faced with difficult decisions.

Financials & Valuation

ABB’s projected growth rate over the next several years is relatively moderate, with consensus forecasts predicting a 0.7% increase in revenue for 2023 and 3.3% for 2024. Earnings per share are expected to grow more significantly at a rate of 13.2% and 7.2% respectively.

The company currently trades at a forward 12-month consensus earnings per share of 21.5x, and a 13.5x multiple on an enterprise value to forward EBITDA basis. These multiples are slightly above the middle of the company’s five-year range. Additionally, the free cash flow yield is relatively low at 4.6%.

While the current valuation of ABB may not be considered excessively high, there is concern that it may not be fully justified. This is due to the fact that the company lags behind its peers — for example, Schneider (OTCPK:SBGSF) (OTCPK:SBGSY) — in areas such as industrial software and digital solutions, and has a limited presence in attractive markets such as building automation and data centers.

Conclusion

ABB is undergoing a transformation to improve its performance and operations. The company’s margins and earnings quality are expected to improve as a result of portfolio reshaping efforts. However, achieving topline growth remains a challenge, which may make it difficult to justify its premium valuation. Despite this, the company’s efforts to optimize its portfolio and improve earnings quality, combined with its strong competitive advantage and focus on growth markets, may be enough to justify the premium valuation in the long term.