ABB Balancing The Reality Of Familiar Problems And New Leadership Opportunities

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About: ABB Ltd (ABB), Includes: ETN, HON, SBGSY, YASKY
by: Stephen Simpson, CFA
Summary

ABB's first-quarter results were better than expected, but it was a low-quality beat and margin erosion and relative competitive weakness remain serious challenges.

The resignation of ABB's CEO is likely a welcome development to most long-term shareholders, and his tenure wasn't brilliant, but ABB's board is also an issue.

A good CEO hire could offer a stronger case for the bulls, but there's a lot to fix and real improvement will take years.

ABB still looks undervalued on the basis of what it could be, but that spread between "could" and "is" also creates ongoing risks for a value trap.

ABB (ABB) continues to be a relatively underwhelming, if not disappointing, player in the multi-industrial space, as the company largely missed out on the recent up-cycle due to various execution issues. While process automation and electrification are still performing relatively well, a global slowdown in discrete manufacturing and automation is creating some near-term challenges, and there is a lot left to do in M&A integration and margin improvement.

The announcement of the departure of the CEO could improve the tone somewhat, but this change is not coming from a place of strength and it is going to take time for the next CEO to make meaningful positive impacts – assuming the board lets that happen. While I do still see avenues for ABB to do better, the upside I see is certainly “at risk” and I don’t regard this as a core holding at this point.

Q1 Numbers Offer A Little (But Only A Little) Good News

ABB posted 4% revenue growth in the first quarter, which is likely to be a little on the low side of average this quarter, but it was slightly better than expected and that’s a step in the right direction at least. Industrial Automation was the weakest contributor, with flat results on weaker demand in autos and discrete manufacturing, while Electrical Products rose 5% and Robotics and Motion rose 7%.

Gross margin improved close to a point, but EBITA rose just 2% on a 50bp decline in margin. Margin erosion continues to be a troubling trend here, with Robotics and Motion doing the best at “just” 20bp of margin erosion (segment EBITA down less than 1%). EP EBITA was flat, but margins continue to fall on the very weak (single-digit) margins of the GEIS business, while Industrial Automation saw a double-digit decline in segment profits and a greater than one-point reduction in margin. While total EBITA was about 2% better than expected, that was solely a product of lower corporate-level spending. Lower corporate-level expenses are better than the alternative, but it still makes this a lower-quality beat.

There aren’t an abundance of comparables out there for ABB yet. Schneider (OTCPK:SBGSY) outperformed overall (organic revenue up 6%) and in both the Electrical (up 7%) and Industrial Automation (up 2%) segments. Yaskawa’s (OTCPK:YASKY) Robotics business was stronger (up 8%), while the Motion Control business was down 6% (Yaskawa’s servomotors compete with AC/DC motors and both compete in inverters). Honeywell’s (HON) process automation business continues to do well, and likewise the company continues to benefit from its leverage to logistics automation and industrial software – areas where ABB was slow to enter.

The Outlook Is Okay, Or At Least Okayish

Management basically reiterated guidance and called out an expectation for continued growth in the U.S. and China, while acknowledging mixed macro indicators in Europe.

Orders were up 3% on an adjusted organic basis, with 6% growth in base orders. U.S. base orders were up 4% and China base orders were up 1%, and I think it’s worthwhile to call out the ongoing shrinking momentum in the China business. Process end-markets like mining and pulp/paper remain healthy, and ABB is seeing strong demand in transport markets like rail and marine, as well as in non-office construction markets like hospitals and reports. Data center infrastructure spending remains strong (good news for Schneider), but auto and discrete manufacturing are slowing, and I’m still worried about the impact of a more broad-based manufacturing slowdown as 2019 progresses.

One of the ongoing issues with ABB is the question of just how the company is holding up in terms of market share. ABB’s process automation performance hasn’t really kept pace with Honeywell and Emerson (EMR) to the extent shareholders should expect (mix has something to do with that), while Schneider has looked stronger in electrification, and companies like Rockwell (ROK) and Siemens (OTCPK:SIEGY) have looked stronger at times in discrete automation. Add in a weak margin structure (particularly in EP relative to Legrand, Eaton (ETN), and Schneider), and there’s a lot of work left to do.

New Management Is A Long-Term Opportunity

I can’t say that I’m sorry to see former CEO Speisshofer step down – while the announcement was spun as a mutual decision, I suspect the reality was more along the lines of “you can step down with some dignity, or we can throw you out.”

Speisshofer’s tenure was mixed at best – the B+R deal was a good one, and I think the GEIS deal could still work, but ABB’s margin progression over the last five years has been weak and the company appears to have been outmaneuvered by rivals like Schneider, Siemens, Honeywell, and Rockwell (dramatically, in some cases, like Honeywell’s entry into logistics automation). I am reluctant to pin this all on Speisshofer, though – ABB’s board is more active than most in the day-to-day operational decisions and I believe that means some of the blame goes to them as well.

ABB has the opportunity to hire a leader with a better long-term vision for the company and more skill/credibility in operational excellence, but questions remain as to whether the company can attract the best candidate(s) and whether the board will let the person do their job without interference (and that concern may well keep the top candidates away from the job).

Whoever is hired, it will take time (literally years) to get ABB on better footing. There are some low-hanging fruits here, including restructuring its ongoing businesses and improving the pathetic margins of the GEIS operation, and there are good operating assets (the cash-cow drives business and the very competitive robotics business). Still, ABB didn’t get into this mess overnight and there’s a lot to fix before the company is back in peak fighting trim.

The Outlook

I haven’t really changed much in my model, though I do have some growing concerns about the margin progression over the short term, particularly if end-markets slow more than management expects. If ABB can manage long-term revenue growth around 4%, long-term FCF growth in the high single digits and adjusted operating margins in the low double-digits, a fair value range of around $21 to $24 is still valid, and still offers some upside from here.

The Bottom Line

I’d feel incrementally better about ABB if there was also a bigger board shake-up in the works; as I said, I think the board has contributed more to ABB’s underperformance than it is normally given “credit” for, and I think that could be a concern for high-quality CEO candidates. I still believe that ABB has a collection of assets and businesses worth more than the share price reflects, but a new CEO will only add more uncertainty to the near-term operations and I can’t argue that you should own this stock over better-performing names in automation or multi-industrials in general.

Disclosure: I am/we are long ABB. 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.