JNM

The Long Case for ABB Ltd.

While I donʼt dispute your assessment of ABBʼs phenomenal market position with attractive exposure to the rapidly growing international markets, it seems that your valuation mark is a bit optimistic. To begin with, the consensus long-term growth rate of 20% is a bit toppy and sits at the top-end of managementʼs range of between 15% and 20%. A good chunk of ABBʼs easy growth has already been realized with comparisons growing tougher by the quarter. I have modeled 17.5% EPS CAGR on 11.0% REV CAGR through FY12E. Crediting ABB for its BRIC penetration, my DCF assumes TVG of 4%.. The balance sheet is roughly 80/20, equity dominated and bears a WACC of 11.6% based on current beta, UST rates, 12% dividend growth and 27% tax rate. I find it difficult to discount any companyʼs cash flows at just 8%. Under my assumptions, the DCF yields a value of just south of $30. If you look at PE/G, but substitute EV/EBITDA in the numerator, you will find ABB trades in-range with several of its peers (EMR, CBE, & SI). In pricing shares at 18x EPS, there does exist some modest upside, but incremental returns in ABB are more of an uphill battle from here on out. The stock is a story told now and management is CEO-less with a Board that is inclined to find a leader who will consummate a mongo M&A deal. Swallowing up Rockwell or comparable-sized firm will serve as a big distraction and will surely be dilutive for 12M if not longer based on deal terms usually in this space. Letʼs also not forget the BoE and ECBʼs hawkish tone in response to climbing inflation, which could mount headwinds for infrastructure players in quick time. To add to my current ABB position, I would require shares to revisit the mid-$20s, all else being equal.

Iʼm long ABB in several accounts.