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ABB (NYSE:ABB)

2012 Earnings Call

February 14, 2013 9:00 am ET

Executives

Joseph M. Hogan - Chief Executive Officer

Eric Elzvik - Group Chief Financial Officer

Analysts

Andreas P. Willi - JP Morgan Chase & Co, Research Division

Ben Uglow - Morgan Stanley, Research Division

Mark Troman - BofA Merrill Lynch, Research Division

Daniela Costa - Goldman Sachs Group Inc., Research Division

Jeffrey T. Sprague - Vertical Research Partners, LLC

Fredric Stahl - UBS Investment Bank, Research Division

Olivier Esnou - Exane BNP Paribas, Research Division

James Moore - Redburn Partners LLP, Research Division

Martin Wilkie - Deutsche Bank AG, Research Division

Operator

Ladies and gentlemen, good morning or good afternoon. Welcome to the ABB Q4 and Full Year Results 2012 Conference Call. I'm Selina, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. After the presentation, there will be a Q&A session. [Operator Instructions] At this time, it's my pleasure to hand over to Mr. Joe Hogan, CEO of ABB; and Mr. Eric Elzvik, CFO of ABB. Please go ahead, gentlemen.

Joseph M. Hogan

Good morning and good afternoon. It's Joe Hogan here with Eric, as is mentioned. Starting with Page 2, our Safe Harbor statement; and Page 3, which is just a quick summary, so we will quickly go to Chart 4. And as our headline says, we're raising our dividend. We have really solid growth in cash, but we think improved geographic scope and some successful M&A this year and carryover from the previous year has really helped us. And so if you take a look in -- we feel we've delivered reasonable results through the cycle. We took significant actions in 2012 to adjust our geographic and portfolio balance, especially when you think of Thomas & Betts and especially in the context of North America, too. We're now in the range of $9 billion to $10 billion in that geography, which is the largest region that we have within the business.

On an organic basis, we delivered a decent top line and profitability in what we feel is a tough market. Furthermore, we addressed some critical issues in our Power Systems business with a one-off charge of $350 million. We feel -- we hate, as I mentioned before, the idea of this kind of a write-off, but we feel that the business is well positioned in going forward in the sense of delivering higher returns and also returns without the risk that we've experienced before.

We also executed on our strategy to develop our disruptive technologies. When you look at our direct-current hybrid high-voltage DC breaker, which is really the -- one of the biggest breakthroughs ABB's had in a number of years. And then thanks to our solid cash generation, we have a proposal to increase our dividend to shareholders. So on a balance, good performance operationally and we've made further progress in executing our strategy.

If you move to Chart 5, I think most people that follow ABB know our 5 strategic planks of our platform is the competitiveness piece, the megatrend side, expand core, disciplined M&A and exploit disruptive opportunities overall. Again, on the drive competitive piece, we've demonstrated our ability to execute on costs and we've delivered consistent results in the market. We saved more than $1 billion in 2012 and we'll continue to push this extremely hard. And we feel this is in the DNA of ABB now and we want to make sure that we continue with that.

We continued our -- to position ourselves to capture opportunities arising from the emerging economies, including China, India, Brazil and Saudi Arabia. We have the strongest and deepest emerging markets presence among our peers with a whole value chain embedded in these local markets, and we feel that gives us a significant advantage of being closer to the market and being able to move at the speed of these local markets.

We're also investing in countries like United States, Sweden, Switzerland. We've taken steps to build our core business through our region-for-region strategy. And then I've talked before about we're pushing hard on our DC technology, not just with circuit breakers, but also with DC technology in areas like ships and also data centers.

So moving to Chart 6, and that's the full year 2012. I think most people on the phone have probably gone over these statistics already, but for the year, a little north of $40 billion of orders, which is up 4% in total and about flow [ph] organically. Order backlogs increased 5% in local currencies. Revenue, up 3% on an organic standpoint, up 7% in total to about $3.34 billion. Our operational EBITDA, down last year, minus 8% overall and obviously that was disadvantaged from the charge that we took in the third quarter -- I mean in the fourth quarter of $250 million in EBIT side. There's also a negative mix that impacts that margin piece also in some of our shorter cycle businesses, that reflects like in low-voltage products and also drives that hurts that piece. As we already mentioned in -- about the dividend, and Eric will come back on to that later on in this presentation to talk about it. Overall, we turned in a really strong cash performance in Q4, and brings us the free cash to net income conversion of about 94%. That benefited, of course, from the negative impact on net income from the PS reset. But even adjusting for that, the cash conversion rate was 85% or above, which again in this environment, we think, is a good result.

The cash return overall was 12%, mainly reflects the T&B acquisition. We said before, achieving our target above 20% for our 2015 plan is going to be very much dependent upon the timing of those acquisitions and if we do those, the size of the acquisitions, too.

On Chart 7, just a few highlights. Americas, very strong both organically and of course, with the T&B as a contribution. Another good year in power with good refurbishment ongoing in United States and Canada and more investments coming for renewables. Automation was up about 10%, excluding Thomas & Betts, reflecting more robust growth in the U.S, as well as some specific investments we made in oil and gas.

In China, the political transition in China slowed down some decision-making around infrastructure investments, we believe, but we saw lower power orders. Automation demand fared a little better, especially with low-voltage products and also process automation.

India, we had a weak year in India, partly on the difficult comparison with the $900 million North-East Agra order that we booked in the fourth quarter of last year. Brazil is up double digits in all divisions, power orders related to wind and rail, oil and gas and drilling ships were all very strong.

U.K., biggest increase in low-voltage products, double-digit growth in all divisions except PS. And so for the U.K., the strength in the U.K. this year really surprised us in the sense that we look at it year-on-year. And our team has been executing well there and given the state of that economy, we're really pleased with our performance there.

Canada, we have a very large T&B exposure there now, but double-digit growth across most businesses, including a big rectifier order for $55 million on a FACTS order that we received.

Italy, it's no surprise that it's lower in all divisions except for process automation. I think it reflects more the weak macroeconomic environment there that we all know. And in Norway, down a little bit, it reflected big offshore ore -- or oil order that we had last year, but Norway continued strong for us overall.

So let's take a look at Chart 8, and that's the full year divisional performance. So starting with PP. PP grew its top line despite the market headwinds. Thanks to its broad product and geographic scope. I think as we talk about this at times, I think people don't appreciate the sense of the product to geographic scope in this business that gives us a huge amount of breadth in the sense of where to look for business and try to find it at the right margins and to push it hard. We also see more of the market and available profit pool out there, too. Margin continued to suffer from pricing and the order backlog as well and some negative product and regional mix, but we could offset this and most of that with great execution on costs, as we have been doing. And we've now delivered a steady operational EBITDA margin for 5 quarters in a row. [indiscernible] team have really done a great job on this, and so I know there's a lot of questions out there on power products, on pricing or whatever. But I think what we want to reiterate to you is that this is a business we feel confident will hold between 14.5% and 15%. And we look at that range going into 2013, too. We'll talk more about Power Systems in a few moments but it's worth noting that if you exclude the impact of the reset, the division came very close to hitting its original margin corridor in 2012.

In DM, that's Discrete Automation and Motion, and LP we generated growth despite the early cycle weaknesses of our investments in selling and R&D. And they are really helping to pay off in those business. And PA delivered a solid result, really, on the back of oil and gas and mining.

Now I hand over to Eric, and he'll walk you through the fourth quarter results.

Eric Elzvik

Thank you, Joe. Let's let look into the detail of the fourth quarter. I'm on Chart #10. We delivered a solid top line performance in a relatively weak economic environment in the fourth quarter. Orders were up 4%, including Thomas & Betts, and were flat, excluding Thomas & Betts, whereas the large orders were declining mainly due to the Indian order that you mentioned already. We had some quite strong performances again in robotics, as well as oil and gas and in mining. Service continues to grow faster than the average for the group, which means we increased the service share as we have said we would. It was 5% growth in orders for service in the fourth quarter on organic basis.

Thomas & Betts continued to perform very well. We had $600 million of revenues in the quarter and in excess of $100 million of operational EBITDA. On the maudian [ph] side, you already mentioned it, we executed well against our targets, mainly due or partly due to good performance again on the cost savings side where we had an excess of $300 million in the quarter. And last but not least on the cash side, we had a great quarter with $2.4 billion of operational cash flow from operations, which brought the yearly total very close to a year earlier.

Turning to the detailed numbers for the quarter. We achieved $10.5 billion order number for the quarter, up 4%, organic, flat. The base orders were up 8% including Thomas & Betts, and again flat organically, reflecting the oil recycle business slowing in some parts of the world.

On the revenue side, we have $600 million, T&B included, and the backlog is still growing to support growth in the coming quarters. It's up by 4%, as you see. The operational EBITDA margin, as well as net income were down, as you see on the chart, but if you exclude the PS reset charge, they were up or flat. We achieved a 14.8% margin excluding the PS reset on operational EBITDA level. You can also see that the foreign exchange impact on the numbers is very limited in this quarter. The numbers are very close to each other when you look in the dollar change as well as in local currency.

Looking at the geographical spread again now for the quarter, what you had before was for the full year, this is the quarter. Americas continued to perform very well, plus-22%, excluding Thomas & Betts. And that is because of very good performance in Canada and in Brazil, but also in the U.S, we were 8%, excluding Thomas & Betts. We had some good orders there on the cable side and -- but it is still a good performance in most areas in the American market.

Europe, plus-3% in the quarter with a big mix between the countries. We still think it's a good level in the difficult climate we have in Europe. And you can see some countries are sharply up like Finland, where we booked a cable order which we announced a short while ago, and also Russia is a highlight where all the divisions were growing at a good rate, and we achieved a 38% increase. There are a lot of questions on what happens in Southern Europe. And as you can see, we were up 3% in Southern Europe in the quarter, so still a stable situation also there.

Asia is sharply down. Again, due to the large project from India in the fourth quarter of 2011. So the positive sign is that China showed a growth of 10%, which is a sign -- a good sign from China of sustainabilities and when the relapse comes. We don't speculate right now, but it is a good performance in the quarter itself.

Turning to the next slide, Chart #13. We have the divisional overview for power. Joe already mentioned the stability of the margins we have in Power Products. We achieved about 15% and we stay with our near-term guidance for the coming quarters of 14.5% to 15%. The service sector also performed well and both power divisions continued to grow faster than the divisional averages, which also helps the margin. And on the reset for Power Systems, we have completed the first actions, and I will come back to that on the next chart, #14.

You have seen our announcement that we had a separate call on that back in December when we announced the charge we were taking and the reorientation of the PS business to focus on reducing low value-added contracting activities in a number of countries and to drive higher returns through higher ABB content and more selectivity in the bidding. We booked now a $250 million charge, which was exactly the number we announced before Christmas. And that charge includes also a few cost overruns on projects we have talked about in the previous quarters, including the offshore wind projects. And it also includes additional costs we have taken to complete projects in some countries, where we had high EPC content and we are now reducing the capacity as we will focus on projects with higher content from ABB and lower construction-type content.

We have also completed quite a few steps of the program, including changes to the tendering process, the risk reviews, resources in contract management and claims to make sure we have an organization in place to drive the division in the right direction towards the higher returns. The new targets, as we already announced for the EBITDA margin corridor, is now 9% to 12%, up from 7% to 11%. And we repeat that we are aiming to reach the lower end of this new range by the fourth quarter 2013 on a run-rate basis. On the growth side, we have reduced the targets to 7% to 11% on target basis from the 10% to 14%, reflecting the highest selectivity we have on projects.

Turning to automation. We have positive top line in both DM [ph] and LP despite difficult markets. The margin is slightly up in the quarter in DM [ph] from good cost control despite some negative mix changes between drives and robotics. LP is continuing to improve the margin from the lower numbers we had in the early part of the year. And the Thomas & Betts integrational changes are on targets. We are seeing initial effects on those synergies on the P&L side. And also here, services are -- continue to grow.

On the challenging side, we are looking to tap the market and portfolio's growth to secure profitable growth and get the return of the investments we have put into Baldor and Thomas & Betts, and to drive home the synergies in Thomas & Betts, and also optimize further on the automation side the product and system mix. We have done a lot of that already but we will continue to drive it to improve returns and margins.

On Thomas & Betts, we had a strong start on the standalone performance and the integration is on track. I already mentioned the $600 million revenues, the $100 million of operational EBITDA, also very strong cash flow from operations in the quarter. And on standalone basis, Thomas & Betts achieved percentage points higher margin in the fourth quarter of 2012 compared to a pro forma number in 2011. So integration is on track and it is already EPS accretive, excluding the onetime costs that we have for the acquisition. The special item for amortization are unchanged from our earlier guidance.

Turning to Slide #17, on the operational EBITDA bridge. You see on the left the 14.8% margin that we reported in the fourth quarter 2011. You can see that we have still product price pressure in mainly in the power business, but the rate is reducing. We are now on 2.6% of revenues, so we decelerate the rate. We had some negative impacts from project margins where we had positive effects in the fourth quarter 2011. We have reduced the rate of increase for sales and R&D significantly compared to earlier quarters and it's now down to $28 million. On the volume side, we had the $48 million positive effect, and that is also less than earlier quarters due to lower revenue increase. As you saw before, on organic basis, revenues are essentially flat. And then we have the important cost savings, which is in excess of $300 million and which then compensates well for the pricing deterioration and the other items. So on a comparable basis, we are on 14.7% operational EBITDA in the quarter, which is some improvement compared to the earlier quarters where we have had about 1 percentage points of deterioration from the quarters of '11 comparing to the quarters of '12. So we believe this also is a stabilization on the overall group. On the right side, you have then the contribution from Thomas & Betts, and as well as the PS reset of $254 million, bringing the operational reported EBITDA margin to 12.5%.

Turning to the cash, Chart #18, we had a great cash flow in the quarter, as I said before. We were up by $300 million on comparable basis from the divisions. This was mainly coming out of strong performance on inventory reductions, which always happens at the end of the year, but it was even better than earlier years. We have also reduced overheads and we achieved higher customer advances at the end of the year. The corporate cash flow, which has been negative in earlier quarters from accounting treatment of some of the balance sheet hedges we have, turned around because of the change of the exchange rates in the other directions, so that is now slightly positive in the fourth quarter but still negative for the full year. Networking capital ended at 13.8% of revenues, which is essentially the same level as at the end of 2011. Our efforts will continue to work on this and to aim to get more balanced cash flow over the year. We will always have a heavy cash flow in the fourth quarter but we are working hard on actions to try to have it more balanced over the year.

Next slide is on the debt situation, Chart #19. We ended the year with $1.6 billion of net debt, an improvement from $3.6 billion net debt at the end of the third quarter from the strong cash flow. We have a strong balance sheet, which will support all our planned organic growth actions, as well as further M&A. The cash is at $8.5 billion, which is higher than you have seen in earlier year ends and partly this is due to our actions last year to take advantage of the low interest rate environment and secure long-term funding at attractive rates, so we will have now, in the first half-year of 2013, quite some need to repay bond loans and also obviously pay the dividend and potentially reduce some commercial paper funding that we have.

The net debt-to-EBITDA stands at 0.3x, which is a comfortable rating to maintain our debt rating of A, which is a key pillar in our finance strategy. You can also see here that we have pension under funding at $1.8 billion at the end of the year, which is up from earlier numbers, but that is mainly due to accounting effects from very low discount rates at the end of last year. And the rates are already moving in the other direction so today, this is less than $1.8 billion but we are still looking at this very carefully to make sure we manage our pension funds to the best possibility in order to keep this underfunding as low as possible.

On Chart #20, you have the dividend history. We have succeeded to increase the dividend year-by-year except for 2008, according to our policy of the steadily raising sustainable annual dividend over time. The proposal from the board is now to raise the dividend to CHF 0.68 per share, so a 5% increase over 2011, equivalent to a 63% payout ratio and a 3% dividend deal based on the share price at the end of December, which is a good yield in comparison to our peers and also in the industry's environment. So we believe that this is the correct level of EBITDA in today's environment.

So with that, I hand back to Joe.

Joseph M. Hogan

And so moving to Chart 22. Thanks, Eric. If you take a look at where we stand versus our 2015 targets overall, from a growth perspective, we're on target so far. As you recall, our growth target is based on an assumption that global GDP bottoms out in '12 and '13 before heading back up to the 4% range in 2014, 2015. So we're still counting on that, we'll see that. That kind of economic growth would certainly be a tailwind for us and obviously other people in the segment to make this work.

We'll have to see how it develops in the meantime. On the margin side, we're on track there, as you can see. EPS growth is behind at the moment but we think we can come back as the global economy recovers in the next couple of years. Cash conversions in the green zone, and which is really good. As I mentioned before, the cash return on vested capital metric will be determined mainly by the timing of acquisitions, so we're clearly on track. There's nothing red here, more greens and yellows. And we'll give you periodic updates as we go through 2013 and how we feel about that.

So moving to Chart 23, this is just to give you an idea of what we see by region from an aggregate macroeconomic standpoint. Next year, we think we're going to see a slight upturn in United States both in power and automation, and that falls in line with some strength we saw in that geography this year.

In Europe, it's a mixed bag. In the northern part of Europe, we think we'll continue to see growth. The southern economies will continue to be a challenge but we're looking for more stability in Europe and we'll see that but overall we're calling the European side relatively flat.

We had a strong year in the Middle East and Africa and so we're calling it flat also but in general, we'll continue to see investment, we think, in power and automation in those economies too. And on the right, in Asia, leaning a little bit into China, from a standpoint of what we read and hopefully what we see here shortly, we think that China could be a little bit stronger in 2012 than it was in 2013. We're counting on that and so from an Asia standpoint, we think we'll see some positive growth next year.

Turning to Chart 24, just examples of growth and actions in 2013. From an emerging market standpoint, we want to build on our footprint. Area that we've made a significant investments with in the Middle East, China and Brazil. And we'll continue to move west in China, particularly with our low-voltage products business that we tend to lead with in that sense and then to follow with our other businesses. From a developed market standpoint, we want to capture large potentials in North America. We still have significant, what we call, revenue synergies that we have in, what we say, the Baldor acquisition and also the Thomas & Betts acquisition that we'll push hard to drive. We're going to be very selective overall in the power standpoint from a cost of growth standpoint reflecting Eric's comments particularly on the Power Systems business.

On automation, again, the synergies in Baldor and T&B and the end-to-end software solutions for resource efficiency, that's Ventyx and Mincom. We think we'll see some decent growth in those areas, too.

On the megatrend side, when we talk about megatrends, there's really 3 really critical key megatrends and that has to do with renewable energy and energy efficiency and productivity. Those are the big deals and we see that across almost every economy in the world.

And lastly, in technology, this is a technology-based business. We'll continue to invest in technology. We made some significant investments over the last couple of years. We'll look to really push hard on those and really grow our technology investments, really an inflation this year as we move into 2013.

And then on Page 25, we just had some examples of products that have come out of our investments recently. On the left-hand side is software per ships. On ships, about 60% of the operating costs now have to do -- and these are industrial ships, have to do with fuel usage. And so our software really is good at saving a significant amount of fuel in the sense of how the ship is run, how the load is actually oriented on top of the ship and actually the hull design and as it relates to weather. And so it's a whole control system that we offer from a solution standpoint with our customers we've been doing well with.

On power electronics, this -- the train that you see there, that is a transformer that's -- a solid-state transformer, so we take out all steel, all copper. And we use solid-state capability to run that. This is an experimental product for traction transformers. It's being done now. And what that offers is about 15% energy savings. But in the case of transportation, it reduces a significant amount of weight and also space. So you can design these cars differently from a power standpoint.

On smart buildings, this is our Busch Jaeger product for security and it's been doing extremely well for us and on the right-hand side is a wireless heart-communicated intelligent device. One of the biggest challenges in the marketplace with a product like this is if you have to have batteries, because it's remote and there's not a power piece to it, the batteries will go dead and it's hard to maintain them. What this does is it actually harvests excess heat. It turns it into electricity to make it completely standalone, self-sufficient and to eliminate that battery piece. And so just some small examples in the sense of what we've been investing in and we think will be able to drive future growth around.

So turning to Chart 26 and looking ahead, fundamental long-term drivers of our business such as growing electricity consumption, urbanization, industrialization of emerging markets, all of these continue to move forward. In the short term, there's a lot of questions around the pace of growth in the United States and in China and also in Europe. And we'll have to -- we're going to approach those markets cautiously from a cost standpoint and -- but again push hard in areas where we think we could see growth and drive it. And we've demonstrated over the past 3 years the ability to really compete successfully and we're very confident about our competitive capabilities in each one of these geographies. And that means we'll continue to be conservative on cost again and make sure that we are positioned to outperform in the economy and in the environment.

So with that, I'll turn it over to questions and answers, and Eric and I are in the room to help you with any questions you have. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] First question comes from Mr. Andreas Willi from JPMorgan.

Andreas P. Willi - JP Morgan Chase & Co, Research Division

My first question is, on restructuring, you normally take a sizable piece in Q4; this year that was mainly for the Power Systems work you're doing but you haven't taken a lot elsewhere. What should we expect as we go through '13 on fixed cost restructuring for the group? Second, you talked this morning on the press call about still quite good demand in mining, good demand in Australia. Maybe you could elaborate a little bit on your exposure there and how you see that develop given that some of the project orders now coming out of the big miners are coming down? And thirdly, on your return on capital targets, I mean, how important is it to reach that 20%-plus by 2015 for you versus what you try to do on the portfolio? Obviously, you're running at 12% now. You mentioned that you would like to continue to do M&A, which will probably mean you wouldn't get to the 20%, how important is that target?

Joseph M. Hogan

Andreas, I'll start with the demand in the mining sector first is, on that end, my comment this morning, what I meant by this is that we don't expect a whole lot of greenfield sites out there. We -- what we see from a mining standpoint, there are companies really wanting to get the most out of the assets that they have in the mines that they have. I think that the mode we're in because you see a lot of commodity prices moving sideways. I think coal, Andreas, is really a tough one right now. And so a lot of the mining equipment that goes into coal, we think will be suppressed. But the -- really, the hard, the ores and the hard rock kinds of things, we participate pretty significantly in whether it's fearless mildries [ph] or whether it's dries themselves and motors, the automation software that's associated with that, a whole solution set that go into those mines. So we -- I'm not -- we're not talking about significant growth in mining but we think that we'll continue to see investment in existing facilities that will help us during the year. From a standpoint of restructuring, Eric, will you help?

Eric Elzvik

Yes, I can take that. So the guidance remains unchanged. We are in 0.3% to 0.5% of revenues for restructuring long term. And obviously the number for 2012 included now Power Systems. We have no such projects in the pipeline but the long-term guidance was where the project remains 0.3% to 0.5%.

Joseph M. Hogan

And Andreas, the return on capital piece, we're at 12%, we would have been at 14% without Thomas & Betts, I think. Look, 20% is important, Andreas, to us. We think that investors -- this is a very big point for you guys and for us also. We need to get a good return on our capital. But obviously, if we think that there are opportunities out there strategically that make sense for us, that fit well with this business, we'll take advantage of it. And so I'll just say there's a balance here, Andreas. We put -- we make this a very serious metric for us. I think I learned this at GE-2 over the years, we'll watch it closely but if there is something that makes sense, we would certainly take advantage of that, too. So I think all I can tell you is we're serious about it, but we just have to wait and see what eventually takes place.

Andreas P. Willi - JP Morgan Chase & Co, Research Division

On the restructuring, just because you did specifically something in Power Systems but for the other divisions, you did very little in '12. So just in terms of delivering fiscal savings in '13, you haven't done a whole lot of restructuring in '12 outside the specific PS program.

Joseph M. Hogan

When I think about that, Andreas, and Eric can chime in here, too. I mean, Power Products, we made some significant investments this year in restructuring parts of that business. We are not as overt and communicating exactly what that is at times because of obviously union situations in things the we do, but we've been fairly aggressive in that sense. And if you look at Eric's old business, we had a motors repositioning this year in the...

Eric Elzvik

Yes, we closed a factory in Spain which is public information. So, yes, we are taking quite a few steps and behind that restructuring number are, of course, PS reset and quite a few smaller projects.

Joseph M. Hogan

But I think, Andreas, I've been here 5 years now, I think that numbers that we normally give you, the percentages Eric's giving you in that $200 million, $250 million range for restructuring, is not necessarily a bad number to keep around. Sometimes, it would be less, sometimes, it would be more but, historically, that's proven to be, I think, pretty accurate.

Operator

Next question comes from Mr. Ben Uglow from Morgan Stanley.

Ben Uglow - Morgan Stanley, Research Division

I have a couple of questions. First of all, could you talk a little bit just in very broad terms about the amount of time it should take for the improved pricing on your orders in Power Products to begin to come through the P&L? The reason why I asked is, obviously, we've been seeing some improved trend on your orders. I think last quarter, it was roughly 3.5% down versus roughly 6% down in the P&L. But in theory, sooner or later, there should be some accounting positive in your P&L from the convergence between order pricing and revenue pricing. I wanted to know how we should think about that. And the related question to that is fairly obviously, when I look at your Power Product, I guess, its new margin guidance or reiteration of old margin guidance for this year, about 14.5% to 15%, are you factoring in the current improvements that you're seeing in order pricing? So how do you square those 2 effects? The final question is just on discrete automation. And there definitely is seasonality in the fourth quarter. Could you just give us a sense of whether we see some improvement, we go back toward the last year's levels during the first half of this year?

Joseph M. Hogan

I'll let Eric handle DM. I can talk about PP. When you ask that question, Ben, you have to remember the 3 big BUs inside Power Products have different time differentials in the sense of long and short cycle and mid-cycle. And so when you look at our medium voltage business, that's more medium cycle, sometimes even short cycle. So when that happens, those things kind of go through pretty quickly. Like you saw with medium voltage in China last year when we told you we had a down -- downturn and how it affected our margin. So -- and medium voltage has been pretty consistent over the years in that sense, it doesn't take long there. But we have been very selective in medium voltage all along in the sense of industrial customers trying to push that side, it has less price sensitivity than utilities. So we play that pretty well, Ben, not just recently but really over the whole cycle. So that leaves you with transformers and high-voltage products. In the high-voltage products, these things take at times 12 months, 18 months, depending on how the order flows through. It takes a while to get through. On transformers, on distribution transformers, there are shorter cycle times, you can see faster, but on large power transformers, it's still 12 to 18 months. [indiscernible] Most of what we talk about on this mix equation, big mix within a BU has to do with transformers. And if you see large power transformers getting a little better, it takes a while for it to really hit our P&L.

Ben Uglow - Morgan Stanley, Research Division

So basically, if we saw the uptick, let's say in the last 6 months, we won't be feeling the full benefit of that possibly until 2014? Is that the right way to think about that?

Joseph M. Hogan

That's the right way to think about it.

Eric Elzvik

And the long range, end of the scope which is quite a bit...

Joseph M. Hogan

And on the DM side?

Eric Elzvik

Yes, so that's on the seasonality on DM, we achieved an unchanged margin in the last quarter. Last order has traditionally been lower in DM. The first quarter last year was a very strong quarter so we expect to have improvements on the margin, but not all the way back to the margin levels of the first quarter of last year.

Ben Uglow - Morgan Stanley, Research Division

Okay. And just as a follow-up, Eric, obviously I know you know that business very well. Is there any change you see in terms of competitive dynamic or is it just really kind of volume effect waiting for volume to pick back up?

Eric Elzvik

It is waiting for volume to come back up. The revenues are typically a bit lower in the first quarter which, of course, puts some pressure on the margin, on the leverage. And it's also a bit of mix in it. Okay? Between the different business units, between the regions which has been putting some pressure on the margin lately. We have a very good mix in the first quarter of 2011 -- 2012, excuse me.

Operator

Next question comes from Mr. Mark Troman from Bank of America Merrill Lynch.

Mark Troman - BofA Merrill Lynch, Research Division

A quick question, Joe, on investments. If you repeat the sort of cash flow performance this year, as you might expect, you're going to be maybe not that free, but reasonably close, reasonably ungeared. How are you thinking about M&A? Are there more opportunities out there or less? Are you happy with the pricing? Are you happy with the pipeline? Can you give us a little bit of detail of what, where that M&A or pipeline expires, a little bit more color on that, please, question one. Question two, I guess just back to pricing and [indiscernible] there's always questions about pricing, but could you just give us a read of what you really see going on in the field, Joe? Because, obviously we're starting to see as has been highlighted, some moderating pressure, some leveling. What's really going on in the regions like competitively? And do you expect this trend to continue when you see sequential trends? And finally, just on China, maybe a little bit more color on what you see, obviously we're seeing PMIs rise, beginning to rise there. There were some signs of hiccup. You're obviously expecting a little bit of growth this year on your Chart 23. Maybe just a little bit more color how you see China developing for you and how quickly that can pick up.

Joseph M. Hogan

Yes. First of all, on the M&A piece, Mark, I'd say do I -- when you say about the pricing, the pricing is always variable by segment. So if we want to do something in deep sea oil and gas that we thought that the portfolio, some of those multiples I consider astronomical. So you kind of shy away from them. But if you look at the core parts of our business in automation and different areas, they're usually between that 9.5% EBITDA range, 13% EBITDA range, which when you look at those things are reasonable, in that sense, depending on cash flow and position and those kind of things. Do we have -- but you said, what's our pipeline like? Our pipeline, I can tell you in our pipeline right now, we don't have any $5 billion deals that are -- but we always have a pipeline of a series of deals anywhere between $100 million and $1 billion. I mean, it's really, that's always there. We obviously don't always execute on those things. I'm still shy right now because we executed on Thomas & Betts, and that takes a lot of organizational capacity to make sure that we deliver on those integrations. But we'll do, Mark, I think you've seen us now, for the last 4 years, 5 years, when we say disciplined M&A, we really mean it. It's disciplined from a price standpoint. It's disciplined by not having too much in the sense of too much to integrate with and not being able to follow up on it. And it's also disciplined in the sense of making sure that we balance our cash properly, too. So I hope -- I can't really say much more, but I hope you gain confidence over the years that we -- and we won't -- and we're not going to go anything outside that would be strategically obvious of the power platform and automation platform that we have. On pricing, in this field, Eric, you can jump in on this, too, but it's -- I would say when you see us -- remember, we're very selective at times and so what you might see is this -- it looks like we're giving you obviously lower pricing declines quarter-to-quarter over time. Don't always think that, that's just strictly market-driven. That's often our selectivity in the marketplace that really drives that and our breadth of product and scope of businesses across geographies I think affords a broader look to be able to make those decisions at times than maybe some of our competitors have. Mark, honestly, with 3% GDP growth out there, it's still tough. I mean, you can't look at -- there's just a significant amount of capacity constraint out there that would allow these prices to go up. So it's really based on selectivity and then the overall restraint that our competition shows in the sense of how they want to compete on pricing or work at price, too. But don't look at it so much as a capacity constriction that would force a discipline in the market place. I think it's more about our discipline in the sense about how we go about this. Eric, what would you say?

Eric Elzvik

Yes, I think that's right, and there is also quite a few different pockets that are also focused with price increases in some areas of the automation portfolio, so it is not everywhere price pressure, but I think with the low growth we have, we will still have some price pressure. And we also have, of course, quite a lot of products where we simplify and we make them more competitive where then the price points go down for an equivalent product, and that also comes into this calculation. So I think there are many different impacts that come to this line.

Joseph M. Hogan

And, Mark, on China, I think we all have -- I think everybody that sits in my chair or Eric's chair, has to be careful in China. Because I think we just got back from the World Economic Forum, too, you can talk yourself up into a frenzy on China, but we see the PMI numbers, too. But the industrial production numbers haven't followed. And we're going to have to wait and see, when that thing crosses the 50% line in a meaningful way, what that means. But I think the logic that many of us use is that with the political pressures that were in China last year, the focus on that governing transition, is I think many of us feel that China should be better in 2013 than it was in 2012. And we're going to watch industries like nuclear and transportation and renewables, those are areas that we thought we were behind last year. And we're going to watch those closely this year if see an uptick on those markets. If we do, then we should, at least in our markets, we should see a better China.

Operator

Next question comes from Mrs. Daniela Costa from Goldman Sachs.

Daniela Costa - Goldman Sachs Group Inc., Research Division

Just one question regarding the movements we have seen in the Japanese yuan (sic) [yen], wondering if, how do the Japanese players typically compete in automation in particular? Do they normally compete on pricing or not so much? Have you seen or expect any changes in competitive dynamics on the back of that?

Joseph M. Hogan

Daniela, on the Japanese side, you have to look at what Japanese competitor. I mean if you take someone like Gil Kagawa [ph], they're always competing on price. When things get outside of Japan, they can be pretty aggressive. They kind of target projects that they want and they could be pretty aggressive. But you take someone like Stanic [ph] in robotics, they're very disciplined on price, very. And I mean, these guys carry 30% operating margins in their business. They're a very good competitor in that sense. so you really have to look at it by competitor or whatever. But I wouldn't -- and I think I know where your question is coming from in the sense of the Japanese yen, that's -- recent weakness. I mean, it's weaker than it was before, but it's still in its historical lows. And so I'm not looking that as a competitive advantage or disadvantage as we roll into 2013, would you agree, Eric?

Eric Elzvik

Yes. I think that's right. That's absolutely right.

Operator

Next question comes from Mr. Jeff Sprague from Vertical Capital Research.

Jeffrey T. Sprague - Vertical Research Partners, LLC

Just a few things. I wonder if you could elaborate a little bit more on what you're seeing in process, in particular, perhaps the pipeline and downstream U.S. oil and gas and how that looks over the next 12 to 18 months?

Joseph M. Hogan

Okay. Jeff, I think everybody's excited about Thai oil and what that means. I mean, when you -- I think I've read recently it's almost $60 billion to $100 billion of investment in refineries and capacity announced in the Gulf Coast. I would say, Jeff, that doesn't mean anything to us in the next 12 to 18 months because there's a lot of engineering and planning that'll go in place before you see those assets go. But I think, Jeff, I was looking at the World Economic Forum, BP put out this information to show you what's really changed in their 2030 estimates in the sense of where oil and gas is coming from. And when you see the incredible difference between what was expected to come out of the Middle East and what now will come out of North America is truly amazing. And so I think, America's going to be long oil right now. It's going to change the dynamics of that economy. I think you're going to see a significant amount of industrial investment around that but we still don't have a good handle around what that's going to mean for us in the midterm. I would guess as we get into the second quarter of this year, we'll be able to give you a more definitive answer.

Jeffrey T. Sprague - Vertical Research Partners, LLC

I want to come back to the ROIC question. If we put deals aside, there's maybe 3 levers, maybe there's other, but I kind of I think it's 3 levers, right. To organically grow the company, you improve the margins or you're more aggressively return capital on what's an underlevered balance sheet, right, a generous dividend but an underlevered balance sheet. How do you see playing those levers? I mean, obviously, it's not all or nothing on any of those, but what do you see as the primary driver of getting to 20% if, in kind of non-M&A environment?

Joseph M. Hogan

Yes. First of all, Jeff, we're not Apple, okay? I don't know what they're going to do with all their cash. My God! But I think our lever right now, our biggest lever, I feel, is on the margin side. I mean, what we did in Power Systems I think was meaningful. I mean, we basically -- we've chopped out $4 billion of revenue growth that we had in our strategic plan out to 2015. And we substituted that with margin basically by raising our bottom end from 7% to 9%. And so that should be a big help to us. Secondly, Jeff, I think what's really interesting, we've been talking about this a lot recently, if you go back to 2008 and you look at the margins that Power Products had, up in the 19% range for operating EBITDA, what's happened is we have bled a lot of margin after the super cycle really came off in 2008 out of Power Products. And we finally feel like we stabilized in that 14.5% and 15% range. What the investors haven't really felt was the incremental margins that we were generating in our automation products and our low-voltage products because it was really being consumed by the decrease in Power Products. By holding Power Products stable and then moving Power Systems up and then driving the margins forward in our low-voltage business and Discrete Automation and Motion business it -- and also in Process Automation to a certain extent, that's where we think we can really see the margin going forward and you could feel it. That also implied a certain amount of organic growth with it, too. And, Jeff, the last piece on the capital return, I mean, I really mean what I said on that question before is that you and I have lived that before, that 20% number is very important. And we take it seriously here and we will work hard to get there.

Eric Elzvik

And also in the areas where we have made investments, like in Discrete Automation with the big Baldor investment, which then obviously took down the average return quite significantly. We are now building that back up relatively quickly from synergies, cost savings and a lot of things on the same asset base, so I think our position in this from the large deals will also come quite some improvements on this area.

Operator

Next question comes from Mr. Fredric Stahl from UBS.

Fredric Stahl - UBS Investment Bank, Research Division

I was wondering if we could -- yes, maybe on that last point on the synergies, if you can remind me at least what those are for Baldor and PNB in particular? And then more housekeeping, if you could talk a bit on how you see R&D for 2013 and the net interest cost line, that would be great.

Joseph M. Hogan

Our R&D in 2013, we've had a pretty big run-up in the last 2 years in R&D. And if you take out our acquisitions, Frederic, I don't see that growing any more than 2% or 3% this year, I think that's our goal. So you won't see some of the double-digit increases you saw last year but we certainly are -- good investments in commercial resources to make sure that what we do have that we can commercialize properly. Okay? On the synergies standpoint, I'll make sure that Eric gives you the right answer here along with your net question here.

Eric Elzvik

On Baldor the math is easy, it's $100 million of cost synergies and $100 million of revenue synergies, of profit improvements. In the case of Thomas & Betts, it's some $80 million of cost synergies and revenue synergies of $120 million exactly, $120 million. We calculated in the same way after 3 years in the Thomas & Betts case.

Joseph M. Hogan

And then we had -- the net question you had, Frederic, was a...

Fredric Stahl - UBS Investment Bank, Research Division

Yes, net finance, net finance line, net interest cost?

Joseph M. Hogan

Net interest cost, hang on.

Eric Elzvik

For the -- I missed that because I was already looking for the synergy. Could you repeat it, sorry.

Fredric Stahl - UBS Investment Bank, Research Division

Yes, just for the group, the group P&L, if you have a view what the net interest line looks like in 2013?

Eric Elzvik

We believe it would be around $240 million for 2013.

Operator

Next question comes from Olivier Esnou from Exane BNP Paribas.

Olivier Esnou - Exane BNP Paribas, Research Division

Yes, a few questions please. Maybe you have given it, but I was wondering if you could give the power project price pressure on incoming orders versus what's being traded in the P&L? And second question, if I look at the bridge now, we have a savings exceeding price pressure, that's quite nice. Is that a valid framework for every quarter for the rest of the year? And maybe the third question, I heard during the presentation that you want to continue to solely focus the automation portfolio, maybe a bit of the systems type of works you do. I just want to understand, is that gradual exercise or is there also a possibility there's a formal reset happening in that division like in Power System? How is that going to happen?

Joseph M. Hogan

I'll take the last question first and leave the other ones to Eric. On the automation side, in systems, it's going to happen relatively quickly. Now some of these systems that we get sometimes can take up 4 years for them to work through like these offshore jobs and whatever. So it's hard to see that initially on the balance sheet but I mean when you look at what Breece [ph] and the team are doing there is we have really raised our expectations in the sense of margin in net income expectations across each one of the 4 BUs business units that was in there. And so for some of these, you'll see -- well, you can see it rather quickly, but some like in grid systems, that have this long cycle time, it will take a while for us to really be able to see.

Olivier Esnou - Exane BNP Paribas, Research Division

It doesn't involve a big charge coming up in one specific quarter?

Joseph M. Hogan

No. I think we took our charge.

Eric Elzvik

Yes, we have taken the charge from PS.

Olivier Esnou - Exane BNP Paribas, Research Division

No, no the full automation, there's nothing like that coming up?

Eric Elzvik

No, they don't see anything like that, no. Okay, let me take the other 2 questions. On the PP pricing in the last quarter of 2012, we saw on the order side some 2% to 3% price deterioration. So that is reducing the run rate compared to earlier quarters, as we already said on the call. Then your second question on the dynamic pricing and costs, I think you are correct to assume that there is a connection between the price deterioration and the cost savings in a sense, but part of that is a price that goes down when we simplify products. We sell the same features for lower price and that's, of course, connected to a lower-cost base. So there is connection between these 2.

Operator

Next question comes from Mr. James Moore from Redburn Partners.

James Moore - Redburn Partners LLP, Research Division

I've got 3. On pricing, very encouraging to see the improvements in the year-on-year rate. I just wonder if you could say how that moved by region and by business unit? I'm just trying to get a feel for what was the move and what the range is and the best to worse. I mean, you often tell us how complicated to get to that net number is, given all the many moving parts? So I wonder if you can just give us a bit of a deeper dive into that to understand how it moved better? And secondly, if you look at the source of pricing pressure in PP over the last 5 years, what would you say the balance was of where the price pressure came from Asian competition between the Chinese and the Koreans? I'm really asking given the move in the Korean won and do you see that won move is giving you a bit of optimism for the outlook for pricing? And then thirdly, I've seen that the increase in sales and R&D investment has slowed, probably slowed faster than I might have expected. And when you talk about that 2% to 3% for this year, is that assuming a degree of revenue growth so that you're going to get some leverage out of sales and R&D this year whereas last year, you had negative leverage, is that how you see that?

Joseph M. Hogan

James, I'll start with your last question. We would -- given on what we end up with volume this year, we would hope to -- that's a good way to back in, we told you we think we're going to be 2% to 3% up in R&D this year kind of inflation adjusted. It's our hope that revenues grow faster than that and certainly we're going to drive some productivity to do that so -- and it did come in line quickly in the fourth quarter. I mean, we've been taking actions really since the second quarter, but there's some things that you really had to follow through on, particularly in PP and other investments we were making to make sure we're positioned properly, so I hope that helps. On the, it's an interesting question in PP. Remember, the Koreans have been -- outside of China, the Koreans were the big price players that were meaningful in that marketplace. We would, obviously, North America, it was primarily around large power transformers, we felt that. The dumping legislation that was implemented there with the Koreans really effectively helped to mute that issue. And, frankly, it has helped us in that sense. But at the same time, we saw the Koreans actually raise their prices in the Middle East there and at the same time, on large power transformers. So I think there's a realization within that business, within that company about what was being done and what was being addressed in some way. I don't think that the won change, right now, James, is really going to make a significant difference versus how, the difference in the Korean side. And then on China, what we see in China mainly has to do with China and somewhat India. And look, the Chinese are -- we're in China, we work with the same variables, we -- there's only a certain part of the power market that we're allowed to have in that sense and we compete pretty well in those higher voltage areas. I hope that helps. The last one is on the pricing moved by region in business, that's a tough one, James. I think that's probably one step too far for us, okay. If it's Power Products, I'd give you really the same answer that I believe I gave Mark, but this is -- James, honestly, this is an incredibly difficult business when you start going by product, by region, it is just alone when you think of Power Products in itself, it has 20 different products. I can think of better PGs and those that all interfaced in a different way by geography. I think, James, your best thing is to take it to the bank that will do 14.5% to 15% in Power Products in 2013. And we're going to have to manage all those variables to get that done.

James Moore - Redburn Partners LLP, Research Division

Very helpful. Can I just get back to China? And we all know the history of how some share loss happened because of the bilocal that was more in AC. Heard a lot of noise about increased investment in DC. Do you think the mix of Chinese investments in T&D grid is going to shift to DC and you can take a better share of that because of your positioning in AC/DC, or is that too optimistic?

Joseph M. Hogan

Well, I mean, there are some big jobs that are being considered in China that are really high-voltage DC jobs. We don't necessarily wear that stance right now in their 12-, 5-year plan but we've been working with State Grid on those things. James, I don't see a big change in what I would say is the -- would be the mix of what I'd say high-voltage DC things versus AC. What we'll watch closely in China, if you look at their fifth 12-year plan, they're talking about more distributed kind of energy and what that might mean and more renewables around that piece. And that might be -- that might facilitate these kinds of investments you're talking about because you want to move those renewables probably from remote places to get them to there. But we haven't seen the plans for those yet or it hasn't been presented to us.

Operator

The last question for today comes from Martin Wilkie from Deutsche Bank.

Martin Wilkie - Deutsche Bank AG, Research Division

This is Martin from Deutsche Bank. Yes, a couple of questions. Firstly, on your Power Systems, you reiterated that you want to be at a run rate and new margin target towards at the end of next year. But we back out the charges in Q4, it looks like you're pretty much close to that range anyway. Is that the wrong way to look at it or is there something else happening in the first half of next year that means you shouldn't be at that new level? That was the first question. And the second question was just on cash. You mentioned your press release about delivering higher cash to shareholders, I just want to clarify, given the priorities you list in your slide pack. I think it's Slide 19. I mean is a buyback or a return of capital something potentially on the agenda or is that something that you're not considering for 2013?

Joseph M. Hogan

Look, on the fourth quarter piece, I think you're right. I think if you back out the charge, you're going to be about 8.4% for Power Systems. What you have to be careful, Martin, in that analysis is that the way these systems businesses kind of come in by quarter. Sometimes based on mix, you can have some lower mix systems stuff come through. In the fourth quarter, we had some really higher pieces and that helped us. Again, I think as you guys try do your spreadsheets and models or whatever, we feel strong. You can model PS at 9% next year. At the end of the year, okay, is where we're going to gradually get to. We think the first quarter is going to be a challenge and based on what we have in the backlog right now. Eric, would you have...

Eric Elzvik

Yes, I think it's a mix issue but also keep in mind that we have those large orders, which we have talked with the PS set [ph], which are going to go through the books at a very low or even no-margin on some of the big orders, so that's been pushed down the margin in the coming quarters. So that is why we say that we'll reach the lower end of the range by the fourth quarter, so that's essentially where we are.

Joseph M. Hogan

And, Martin, on the return on cash piece, remember, what we were emphasizing is the ROTC at 20%. It's very important to us. We're not in any big discussion right now on share buyback or special dividends or anything like that. We'll just have to wait and see how the economy progresses, how our cash flow is as we go into 2013 and we'll certainly keep you appraised of what we're thinking and what we're doing.

I think that's the last question. Again, we appreciate your questions and interest. And we'll be back at the end of the first quarter to let you know how well we're starting off the year. Thanks again, and we'll talk to you next time.

Operator

Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines. Goodbye.

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