Wall Street institutional investors are paid overreactors, but individual investors have the luxury of taking a more patient outlook in response to a disappointing quarter - that's the benefit of not being judged (and/or fired) after every quarter. That's especially relevant as a host of industrial companies post difficult first quarter earnings.
In the case of ABB (ABB), a few things are clear. First, China has really slowed down, and parts of Europe are feeling the pinch as well. Second, North America is especially strong. Third, the basic equation of helping companies operate more efficiently with respect to energy and labor is still plenty popular out there.
A Quarter That Gets Worse The Deeper You Dig
On the surface ABB's quarter didn't look so bad. Revenue growth of 8% sounds pretty good, and organic revenue growth of 6% may not be on par with General Electric (GE), but it stacks up fine with the likes of Siemens (SI), Eaton (ETN), Rockwell (ROK), and better than Schneider. Price erosion was troubling (down 3%), but volume did compensate.
Margins and profits is where things get a little hairy and definitely a little scary. Reported EBIT growth of almost 4% sounds okay, but the adjusted "clean" EBIT shows a much different picture - serious erosion that led to a 12% decline. Likewise, clean EBITDA dropped about 6%.
Margins got whacked in part because of a mix shift, but also because of declining business in areas like Italy and China - areas where ABB typically posts much higher margins.
Orders A Mixed Bag
ABB's order book also reflects the same sort of turbulent give-and-take. Reported growth of 2% and organic growth of zero are not encouraging, but strong growth in power products and discrete automation were.
ABB is clearly getting slugged by the economic slowdown in China, as orders were down 35%. That's at least directionally similar to what SKF and Schneider have talked about, and Siemens also reported poor order trends in China.
On a more positive note, the U.S. continues to post double-digit growth, orders in India were up 18%, Europe outside of Spain, Italy and Greece seems better, and orders to Brazil were up 26%. That latter number is a little odd given the iffy news from Caterpillar (CAT) and Eaton, though I'll be the first to acknowledge that power systems, factory automation, earth movers, and Class 8 trucks are not exactly overlapping markets.
Tough In The Short Term, Okay For The Long Haul
I'm still very much inclined to give ABB the benefit of the doubt. For starters, management said during the fourth quarter results presentation that this first quarter was going to be tough/challenging, and too bad for the sell-side analysts if they didn't quite listen. Moreover, while the China situation seems precarious, ABB management seems to be one of the more conservative commentators on whether things will get better throughout the year.
I would also point out that what ABB offers is a pretty compelling case for many customers. Emerging markets have to build out their utility and power distribution systems, the developed world needs to upgrade or replace a lot of theirs, and there is a large market for automation and process solutions in fields like energy today. And that is to say nothing of the general rising trend toward automation in countries like China where wage growth is becoming a real issue.
Probably No Big Deals This Year
Listening to management, it sounds like ABB is going to digest what they've already bought before delving into more deals. They shot down the rumor of acquiring Rockwell, and I would think future deals may center around smart grid, controls, and specialty products like high-power semiconductors.
The Bottom Line
As is probably clear, I'm a believer in the automation theme, as well as the thesis that utility companies still have capex spending left to do. While aggressive price competition could be a problem, ABB's relative efficiency should enable them to survive that sort of battle better than most.
I don't expect a fast pick up in business, but I do believe ABB can still post strong high single-digit free cash flow growth. That suggests a fair value in the high $20's, whereas today's price would seem to presuppose a middling mid single-digit growth rate that is scarcely better than those projected for the markets ABB serves.