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As governments and utility companies around the world are looking to increase efficiency, improve environmental standards and enhance reliability, ABB LTD (NYSE:ABB) is a global industrial electrical company that will benefit from this need.

ABB LTD is global leader in power and automation technologies. The company is committed to improving performance and lowering the environmental impact for their utility and industry customers. ABB LTD provides a broad range of products, systems, solutions and services that are designed to increase power grid reliability, boost industrial productivity and enhance energy efficiency. ABB LTD's earnings come from two main businesses. The two core business for ABB LTD are: the company's power businesses and the company's automation businesses.

The company's power businesses focus on power transmission, distribution and power-plant automation, and support electric, gas and water utilities, as well as industrial and commercial customers.

The company's automation businesses serve a full range of industries with measurement, control, protection and process optimization applications.

In the section below, we will analyze aspects of ABB's past performance. From this evaluation, we will be able to see ABB's profitability, debt and capital, and operating efficiency and free cash. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $2.561 billion
  • Net income 2011 = $3.168 billion
  • Net income 2012 = $2.704 billion
  • Net income 2013 TTM = $2.790 billion

Over the past couple of years, ABB's net profits have slightly increased. They have increased from $2.561 billion in 2010, to $2.790 billion in 2013 TTM. This represents a 13.37% increase.

  • Operating income 2010 = $3.818 billion
  • Operating income 2011 = $4.667 billion
  • Operating income 2012 = $4.021 billion
  • Operating income 2013 TTM = $4.212 billion

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Over the past three-and-a-half years, the company's operating income has increased from $3.818 billion to $4.212 billion in 2013 TTM. This represents an increase of 10.32%.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $2.561 billion
    • Net income 2011 = $3.168 billion
    • Net income 2012 = $2.704 billion
    • Net income 2013 TTM = $2.790 billion
  • Total asset growth

    • Total assets 2010 = $36.295 billion.
    • Total assets 2011 = $39.648 billion.
    • Total assets 2012 = $49.070 billion.
    • Total assets 2013 TTM = $45.513 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 7.06%.
    • Return on assets 2011 = 7.99%
    • Return on assets 2012 = 5.51%.
    • Return on assets 2013 TTM = 6.13%

Over the past three-and-a-half years, ABB's ROA has decreased from 7.06% in 2010 to 6.13% in 2013 TTM. This indicates that the company is generating less income on its assets than it did in 2011.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating income 2010 = $3.818 billion
  • Net income 2010 = $2.561 billion

2011

  • Operating income 2011 = $4.667 billion
  • Net income 2011 = $3.168 billion

2012

  • Operating income 2012 = $4.021 billion
  • Net income 2012 = $2.704 billion

2013 TTM

  • Operating income 2013 TTM = $4.212 billion
  • Net income 2013 TTM = $2.790 billion

Over the past three-and-a-half years, the operating income has been higher than the net income in all years. This indicates that ABB is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $36.295 billion.
    • Total assets 2011 = $39.648 billion.
    • Total assets 2012 = $49.070 billion.
    • Total assets 2013 TTM = $45.513 billion.
    • Equals an increase of $9.218 billion
  • Total liabilities

    • Total liabilities 2010 = $21.410 billion.
    • Total liabilities 2011 = $23.871 billion.
    • Total liabilities 2012 = $32.164 billion.
    • Total liabilities 2013 TTM = $29.220 billion.
    • Equals an increase of $7.810 billion

Over the past three-and-a-half years, ABB's total assets have increased by $9.218 billion, while the total liabilities have increased by $7.810 billion. This indicates that the company's assets have increased more than the liabilities, thus adding shareholder value.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $25.348 billion.
    • Current assets 2011 = $23.787 billion.
    • Current assets 2012 = $28.002 billion.
    • Current assets 2013 TTM = $25.069 billion.
  • Current liabilities

    • Current liabilities 2010 = $16.738 billion
    • Current liabilities 2011 = $16.561 billion
    • Current liabilities 2012 = $18.974 billion
    • Current liabilities 2013 TTM = $16.363 billion
  • Current ratio 2010 = 1.51
  • Current ratio 2011 = 1.41
  • Current ratio 2012 = 1.48
  • Current ratio 2013 TTM = 1.53

Over the past three-and-a-half years, ABB's current ratio has remained steady. It has ranged from 1.51 in 2010 to 1.53 in 2013 TTM. As the most recent current ratio is above 1, this indicates that ABB would be able to pay off its obligations if they came due at this point.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $9.529 billion / $31.589 billion = 30.17%.
  • Gross margin 2011 = $11.434 billion / $37.990 billion = 31.00%.
  • Gross margin 2012 = $11.378 billion / $39.336 billion = 28.93%.
  • Gross margin 2013 TTM = $11.722 billion / $40.706 billion = 28.80%.

Over the past three-and-a-half years, ABB's gross margin has decreased. The ratio has decreased from 30.17% in 2010 to 28.80% in 2013 TTM. As the margin has decreased, this indicates that ABB overall has decreased its efficiency.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $31.589 billion .
    • Revenue 2011 = $37.990 billion.
    • Revenue 2012 = $39.336 billion.
    • Revenue 2013 TTM = $40.706 billion.
    • Equals an increase of 28.86%.
  • Total Asset growth

    • Total assets 2010 = $36.295 billion.
    • Total assets 2011 = $39.648 billion.
    • Total assets 2012 = $49.070 billion.
    • Total assets 2013 TTM = $45.513 billion.
    • Equals an increase of 25.40%.

Over the past three-and-a-half years, the revenue growth has increased by 28.86% while the assets have increased by 25.40%. This is an indication that the company from a percentage point of view has been generating more revenue with fewer assets or effectively becoming more efficient at creating revenues.

Based on the information above, we can see that ABB LTD has produced good results over the past three-and-a-half years. Revenues have increased by 28.86% but the gross margin has increased to 28.80% from 30.17%. This mix has resulted in earnings essentially remaining flat as indicated from the chart below. ABB LTD's assets have increased more than liabilities thus increasing shareholder value while the company's ROA has decreased from 7.06% to 6.13%. Based on the results above, we can see that the company has produced good results over the past three-and-a-half years but has only produced a slight increase in earnings.

ABB Net Income TTM Chart
(Click to enlarge)

ABB Net Income TTM data by YCharts

Global Growth

Over the past few years, Asia and Europe have been a laggard on the company's orders. In 2012, Asia had a decline of 13% which was lead by India where orders declined by 41%. The next laggard was Europe where overall orders declined by 6%. The decline was lead by Germany where orders declined by 31%.

On the positive side, leading the way in 2012 were the Americas and MEA (Middle East and Africa). Orders in the MEA increased by 28% while orders in the Americas increased by 32%.

Looking forward, the company envisions volatility to continue in the short-term, but long-term dynamics should produce positive results. The company envisions strong growth for Asia and North America in the near future, while ABB anticipates continued volatility in Europe, Middle East and Africa.


(Click to enlarge)

The North American Driver

Currently, the North American Utility Sector is going through massive changes. As environmental regulations are increasing and utility companies are looking to enhance efficiency, this will be a key driver for ABB's power businesses in North America. Estimates are that the U.S. Utility Sector alone is expected to spend $100 billion per year until 2020 on CAPEX spending. Examples of this include Consolidated Edison (NYSE:ED) that is expecting to spend $2.0 billion a year in CAPEX, to upgrade and replace the equipment of its electric, gas, and steam networks. Southern Company (NYSE:SO) is planning to spend approximately $3.6 billion over the next two years on environment CAPEX, while Duke Energy (NYSE:DUK), spent almost $5.9 billion on capital projects in the 12 months through the end of the first quarter 2013. This massive spending in North America will be a key driver of ABB's power businesses in North America over the next 7 to 10 years.

Analysts' Estimates

Analysts at MSN Money are estimating an EPS for FY 2013 at $1.42 while the EPS is expected to improve into FY 2014 with an increase to $1.66.

Bloomberg Businessweek supports this idea, as it expects the company's revenues to be around $41.4 billion for FY 2013 and increase to $43.2 billion for FY 2014.

Dividend

As ABB is committed to paying a sustainable and steadily increasing cash dividend over time, the chart below indicates the company is doing as it states.

ABB Dividend Chart
(Click to enlarge)

ABB Dividend data by YCharts

Currently, with a dividend ratio of 64.27% and the EPS for FY 2013 expected to be $1.42, the company should be able to maintain its history of dividend hikes. In 2014, as the EPS is expected to be $1.66, the future for the dividend growth looks to be strong and the company should be able to increase the dividend faster than inflation or the 10-year bond which is currently 2.77%.

ABB Payout Ratio TTM Chart
(Click to enlarge)

ABB Payout Ratio TTM data by YCharts

Price Targets

  • Finviz has a price target for Consolidated Edison at $24.37.
  • Nasdaq has a price target for ABB at $25.24 for FY 2013.

The above analysis reveals that ABB is facing some short-term challenges, but is setting itself up for success in the long-term. From a global point of view, ABB is expecting growth driven by Utility CAPEX spending in the Americas and Asia while ABB expects growth in Europe and MEA to remain stagnant over the next few years. Revenue projections are estimated around $41.4 billion for FY 2013 and increase to $43.2 billion for FY 2014. As this is the case, analysts are estimating that ABB's EPS for FY 2013 will be $1.42 while the EPS are expected to improve to $1.66 in FY 2014. Based on this information, ABB should be able to maintain its history of dividend increases. Over the next few years as North America and Asia look to be the drivers for growth in the company, dips in stock price from here would be an excellent opportunity to begin to accumulate shares in ABB LTD and wait for the main driver which would be a European recovery.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: ABB LTD: A 3.13% Dividend With Growth In The Future