As we head into the deep summer months, higher utility bills and blackouts will no doubt bring attention to the utility sector. Engineering and construction companies are experiencing not one, but two multi-year bull markets: global growth and the imminent need to replace infrastructure in developed countries such as the U.S. Since Barron's highlighted Foster Wheeler (FWLT), who constructs power plants, I want to bring attention to the power grid piece of the utility puzzle. My favorite name here is The ABB Group (NYSE:ABB).
When highlighting Jason Makansi's new book "Lights Out," Reuters' Timothy Gardner writes,
Deregulation, meant to increase competition, has busted that chain apart and left the wires and substations that deliver electricity as neglected." "Transmission only accounts for about 10 percent of the industry's assets, and for decades utilities and regulators have focused on more expensive parts of the system. Now, even electricity generated in ultramodern plants is dependent on the brittle transmission grid.
Based in Switzerland, ABB is one of the world's largest provider of power and automation technologies to utility and industry customers. Its two largest divisions are the Power Products and Power Systems divisions, which provide critical power grid components such as transmission and distribution lines and substations as well as the engineering services. While ABB's shares have quietly risen from around $5 a shares at the beginning of 2005 to $22.25 at the close on Friday (quietly because both its shares and its business is booming and we never hear about it), ABB is in the sweet spot in a world where both emerging and old cities are now dependent upon reliable electricity. Trading at 18x 2008 earnings, the valuation is inline with the S&P and cheap compared to other engineering firms such as Jacobs Engineering (NYSE:JEC), who trade around 22x 2008 earnings. I believe these forward valuations for ABB are much too low as ABB has won around $100 million in contracts each month in 2007 and over $600 million just in May.
What makes ABB's business more attractive than other engineering companies is the diversity of its business, both geographically and its product divisions. The revenue from Europe account for 46%; Americas account for 18%; Asia accounts for 25%; and the Middle East and Africa account for 9% and are growing fast. The amount of revenue from Asia shows ABB has a strong presence in the region where China and India will provide growth for years to come. The North American Electric Reliability Corporation finds that the U.S. power grid is constantly operating near critical capacity and only a heat wave or two away from collapse. While U.S. utilities such as PSEG (NYSE:PEG) have had a hard time raising utility rates to pay for upgrading the power grid, this problem affects the safety and security of the U.S. When the U.S. upgrade cycle does start, it will be a huge business boom for ABB since the U.S. has the largest power grid with every little component from coast to coast likely to be replaced.
Its business portfolio breaks down as follows: power products 30%, power systems 18%, automation products 28%, process automation 22%, and 5%. In addition to allowing delivery of power, ABB's expertise in power systems and automation plays into the flip side of the utility story: energy conservation. With limited energy sources, more advanced and efficient electrical equipment will allow cities and industries to consume less energy, as well as become more productive. Modern factories such as those used for semiconductor chip production or carbon-fiber production require precise electricity control. ABB has and continues to be a crucial factor that makes these industries possible. Finally, with factories popping up all over China so that everything can have the "Made in China" sticker on it, ABB's robotics and automation will allow these factories to catch up technologically and produce any thing from cars to computers.
With an increase in orders of 22% and backlog of 46% in 2006, ABB's services are in high demand. If you believe in the global growth story as strongly as I do, spend some time researching ABB and consider it for your portfolio.
Disclosure: Author has a long position in ABB
ABB 1-yr chart