I’ve made no secret of my bullishness on automation, digitalization, and electrification as major global secular trends over the next five to 10 years, nor my belief that Schneider Electric (OTCPK:SBGSF) is an excellent play on those trends. Since my last article, though, the shares are down about 20% (20% for the ADRs, closer to 12% for the locals), underperforming a weakening tape for industrials in general and automation/electrification plays in particular.
In that last article, I said that valuation was becoming more of an issue, but that investors could see another 20% rise before a pullback. While the shares didn’t quite make it to 20% (closer to 12%), it does seem as though the Street has moved on from the automation/electrification theme here of late. While that’s understandable, I suppose, as higher expectations have worked into the valuations over the last couple of years, I think this pullback is worth watching, as I don’t think the automation / electrification story is over quite yet.
There’s obviously a lot going in the world these days and understandable reasons for global markets to be trading lower, but Schneider is at least doing its part with another beat-and-raise report.
Revenue rose 7% in organic terms in the fourth quarter of 2021, beating expectations by 2%. If I have to quibble or complain, I guess that is lower than the 8% average growth rate for the multi-industrial group, but not that much lower, and management pointed to about 500bp of growth lost due to supply chain and logistics issues. Energy Management grew 7% in the quarter, while Industrial Automation grew a little over 6% - both more or less around 2% better than expected.
As Schneider only reports detailed financials on a semi-annual basis, all margin and earnings discussions are now in the context of the second half numbers, where revenue grew 8% in organic terms. Adjusted EBITA rose 12%, beating by more than 2%, with margin flat year over year and up 20bp hoh to 17.3 (beating by 20bp). Energy Management profits rose 10%, beating by 2%, with margin flat at 20.2%, while Industrial Automation profits rose 14%, roughly in line, with margin down 10bp to 18.7%. Operating income rose 18%, with margin up 90bp yoy and down 40bp hoh to 14.8%.
Relative to my full-year expectations, Schneider did better on revenue and better on margins, but was about 5% short on free cash flow – largely due to working capital moves tied to inventory builds in the face of growing sourcing challenges.
For the fourth quarter, product revenue was up 9%, with double-digit growth in automation, systems revenue was up 6%, and software and services revenue was up just 2%, as AVEVA (OTCPK:AVVYY) had a tough year-over-year comp.
For 2022, management guided to 7% to 9% revenue growth, above expectations, with healthy underlying GDP growth boosted by ongoing interest in digitalization and electrification.
On balance, I don’t think this was a bad set of results for Schneider, but there are a few areas to watch.
Looking at two-year stacks in electrification (that is, comparing growth rates to Q4’19 levels), Schneider comes up a little short of Siemens (OTCPK:SIEGY) and ABB (ABB), though stronger than Eaton (ETN) and Hubbell (HUBB), raising the question of whether the share growth here is petering out. I think it’s early to make that call, particularly with strong trends in data centers and given Schneider’s leverage to markets like healthcare and hotels that have seen some dramatic changes to capital budgeting priorities since 2019.
Looking at automation, Siemens has been outperforming here too, though Schneider’s performance is on par with ABB and Rockwell (ROK), and ahead of Emerson (EMR), which has been hit by its greater leverage to process in general and U.S. onshore shale in particular.
As far as strong markets go, strength in data centers should be no surprise given other updates from peers in electrification and automation, and I expected significant ongoing investment growth in data centers. Likewise, strength in automation demand in end-markets like electronics, material handling, and packaging is entirely consistent with what I’m seeing elsewhere, as is the “gradual” recovery in process automation.
Schneider has pretty good leverage to electronics, life sciences, and warehouse end-markets, and I expect those to remain quite strong in 2022 and likely into 2023. Hospitals should start improving, and I think Schneider is also leveraged to a positive residential construction cycle that I think has longer/stronger legs than the Street seems to think.
When I last wrote about Schneider, I talked about the risk of rising expectations and how the company pretty much had to guide for 6%-plus revenue growth at the late fall capital markets day “or else”. Management did raise guidance, to a stronger-than-expected 5%-8% growth range out to ’24, while also guiding to ongoing 50bp annual improvements in EBITA and lower future restructuring costs.
I still believe Schneider is leveraged to very significant multiyear growth drivers centered around automation, digitalization, and electrification. Achieving global climate targets is going to require a significant shift toward electrification, and Schneider is well placed at all levels, including microgrid, renewables, and storage on the supply side, a full range of transmission, grid automation/hardening, and electrical equipment on the delivery side, and a range of controls on the user side.
As these trends play out, Schneider will benefit from utilities and industrial customers building out microgrids (typically using renewable power sources) and greater adoption of automated monitoring and control hardware and software to optimize that energy use. Beyond industrial use, we’re also going to see more electrification in buildings and residences, with the electrification of European heating likely to get a lot more attention in the near future.
Automation and digitalization, too, are still significant long-term trends as companies look to manage around labor challenges and optimize both productivity and flexibility. Moreover, because automation demands electrical upgrades, there’s a virtuous cycle here for suppliers like ABB, Schneider, and Siemens who can meet the more sophisticated demands across electrification products, automation, and software with integrated offerings.
I was more bullish than the Street in 2021, but I’ve still raised my expectations relative to my last article. Most of this is just pulling forward some of my modeling assumptions; while my 2022 and 2023 revenue numbers are about 3% to 4% higher, I’m still looking for 5% long-term revenue growth. My near-term margin assumptions are lower due to the supply chain pressures across the sector, but I do still expect long-term FCF margins in mid-teens, with EBITDA margin improving from 18% in FY’19 to 20% in FY’21 to over 21% in FY 23. Long-term, I expect around 6% annualized FCF growth relative to pre-pandemic levels.
Between discounted cash flow and margin/return-driven EV/EBITDA, I believe Schneider could be 10% to 20% undervalued in the short term and is priced for long-term total annualized returns in the high single-digits – a pretty good prospective return for a higher-quality industrial with good leverage to acyclical growth drivers and margin improvement.
Still, it does look like sentiment has soured more for the automation and electrification names than for other industrials, and at least in the short term, fighting the tape can be an exercise in frustration and paper losses. I do still believe in the long-term story here, though, and while there are other names well worth considering (including Siemens), I think this is a pullback to consider for longer-term GARP investors.
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Disclosure: I/we have a beneficial long position in the shares of ABB either through stock ownership, options, or other derivatives. 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.