Some stocks are like a college all-star athlete, a high draft choice, who never quite plays up to his or her potential in the pros. They’re a pretty good player, maybe even above-average, and you’re glad to have them on your team, but you always wonder…
With that in mind, re-introducing ASEA Brown Boveri (NYSE: ABB), a $28 billion-revenue Swiss-Swedish industrial corporation headquartered in Zurich, Switzerland, with four main divisions offering electrification, industrial automation, motion and robotics products. This company is no spring chicken; predecessor companies date back to 1883.
Based on past market performance there’s no reason to own this company, but ABB is undergoing some positive changes and there just might be an opportunity here. First, let’s deal with some facts.
Market Performance: Dismal
As a long-term buy-and-hold investment, ABB has been dead money for a long time. Here it is against the SPDR S&P 500 ETF Trust SPY (NYSEARCA: SPY) for the last 10 years:
If someone told you there was a company focusing on ABB’s businesses, wouldn’t your first reaction be that it was “on trend” and the company and stock – given good products, a reasonable economic environment and competent management – should perform well?
SOURCE: ABB Ltd. February 28, 2019 Investor Presentation
That’s a simple but pretty compelling slide. Remember, Power Grids was soon to be sold and Robots and Motion would become separate divisions.
Although product mix differences make direct comparison inexact, here’s ABB compared to a few other industrials including some direct competitors over the past decade:
Other than Rockwell Automation (NYSE: ROK), which actually out-performed the SPY over the past decade, there were better places to park your money. It’s pretty obvious that management was not able to translate the company’s advantages – look at that slide again – into superior stock market performance.
Financial Performance: Improving Until COVID-19
On July 1, 2020, ABB announced that it had completed the divestiture of 80.1% of its Power Grids business to Hitachi (OTC Pink: OTCPK:HTHIY) for about $7.6 billion to $7.8 billion of net proceeds and would launch a share buyback program of roughly 10% of the company’s stock after 2Q 2020. For the time being ABB is retaining 19.9% in a JV with Hitachi.
How did the company perform prior to the sale? We’re going to look at the four years up to the point where Power Grids was restated as discontinued operations. All items discussed in the table below are highlighted in yellow for bad, green for good.
From 2010 to 2015, ABB’s revenues declined by an annual average of 3.38% per year. Gross profit declined at a 3.79% CAGR and the gross margin hovered around 28%. Operating expenses were a bright spot, actually declining about 1.08% per year on average. Combined, these lackluster results produced a dismal negative 9.09% CAGR in operating income. From 2010 to 2015, the operating margin drifted down from 10.3% to 8.6% and the net margin fell from 6.9% to 5.4%. Predictably, net income attributable to ABB’s long-suffering shareholders declined over the period at a 10.59% CAGR. Dividends? In dollars, they increased at an anemic 1.20% annual average – much less than even the rosiest views of inflation.
Something had to give.
In 2016 Swedish investment group Cevian, then a 6.2% ABB shareholder and according to Wikipedia the largest “activist” investment firm in Europe with ties to famous U.S. investor Carl Icahn, began agitating for the sale of the Power Grids business. The Financial Times quoted ABB CEO Ulrich Spiesshofer on the possible sale after a “year-long strategic review:”
I was amazed how naively some people thought about the business . . . It is a highly complex business that is deeply ingrained in ABB. You could not carve it out so easily.
About two years later, in December 2018, ABB announced the sale of Power Grids via the JV with Hitachi. As we’ve already learned, divesting Power Grids via the new JV would take a while. A few months later management laid out a series of goals as a “medium term financial framework” in the 2018 Annual Report. We’ll follow up on two of them; 3% to 6% annual revenue growth and operational EBITA margins of 13% to 16%.
The next table presents selected items from the company’s financial statements which have been restated to “remove” the relevant portions of the Power Grids business beginning in 2016.
With a nod to the limitations of the restatement, you can see what Cevian was suggesting. Without Power Grids, revenues increased at a 3.92% CAGR from 2016 – 2019 while cost of revenues only increased at a 3.11% CAGR – and the gross margin hovered around 30% – as a result gross profit increased at a strong – for an industrial – 5.74% annual average. While 2016 – 2019 average annual revenue growth hits the low side of the 3% to 6% management target, revenue growth slowed to just $316.0 million or about 1.1% between 2018 and 2019.
Operating expenses are where the restatement may have run into classification issues as they increased at a 7.53% rate over the period. An adjustment for fair value write-downs shows that ABB was making progress toward its financial goals – until the impact of COVID – 19.
Few would argue with the 7.40% CAGR for R&D – that’s a good place to spend money, but the 6.32% CAGR for SG&A is questionable, although a lot of the increase is related to restructuring and divestiture costs. Also note that the rate of increase in SG&A moderated over time. For the 2018 – 2019 period, for example, SG&A increased only $152.0 million or about 2.9%. In addition, the 2019 $323.0 million explosion in other operating expense/(income) consisted largely of $421.0 million in fair value adjustments on assets and liabilities held for sale only partially offset by income items. If we replace 2019’s other operating expense/(income) with the $60.3 million average income of the previous three years, the operating expense CAGR for the 2016 – 2019 period drops to a more reasonable 5.52%, especially in relation to the faster growth in gross profit.
This adjustment also boosts 2019 operating income from $1.9 billion to about $2.3 billion and the associated 2016 – 2019 CAGR from an anemic 0.16% to a more robust 6.32%. Considering the unadjusted numbers, management would rather have its pre-Power Grids sale operating margin than the 6.9% reported in 2019. Our other operating expense/(income) adjustment sends the 2019 operating margin back up to 8.3% – still less than the 8.6% 2015 operating margin! As we noted before, however, there’s a lot of restructuring static in these numbers.
On the bottom line, ABB’s shareholders continued to suffer, as net income attributable to ABB declined over the period at an 8.83% CAGR. The majority of the decline in net income attributable to ABB occurred between 2018 and 2019, with a decline of $734 million or 33.8% from $2.2 billion to $1.5 billion. While the $421 million fair value write-down was a major contributor, ABB’s effective tax rate also contributed, soaring to 41.5% in 2019 from 25.7% in 2018. The effective tax rate increased due primarily to the impact of the sale of the solar inverters and Power Grids businesses. If we adjust for both the write-down and the tax rate (using the 2018 tax rate), net income attributable to ABB increases about $578 million to $2 billion. The net margin, a very weak 5.1% in 2019, increases to 7.2% on an adjusted basis – still low.
Dividends, denominated in dollars, continued to lag any reasonable estimate of long-term inflation, increasing at a 1.56% CAGR.
Had management hit any of its goals in 2019? There’s two hits and five misses in the table below – not counting the overall corporate misses. Management’s revenue growth target was 3% to 6% and the EBITA margin target was 13% to 16%.
As we noted previously, total ABB revenues grew only 1.1% between 2018 and 2019. The ABB total EBITA margin for 2019 was 11.1% – short of the goals set in 2018. In fairness to management, the Power Grids divestiture was not complete and the corporate restructuring was ongoing during 2019, but time had run out.
This Is Awkward: We Sold Power Grids, Launched a Massive Restructuring and the CEO Left
In April, 2019, CEO Spiesshofer “abruptly” resigned. Cevian had kept up the pressure, Power Grids was sold and a massive reorganization launched, but the stock had gone nowhere – and after six long years of weak performance under Spiesshofer, the board finally took action. According to an April 17, 2019 CNBC article:
Spiesshofer’s abrupt exit follows the launch of the biggest overhaul in ABB’s 31-year history to reposition the company more towards digital industries and agreeing to activist shareholder demands to sell its power grids business. But the latest revamp by the former management consultant failed to revitalize ABB’s stock, which has flatlined under his tenure while profits fell last year. Time ran out for Spiesshofer, who has led ABB since September 2013, following a conference call between board members on Tuesday evening.
Chairman Voser took the interim CEO spot while a search was conducted. What exactly was the restructuring? Part of it looks like a typical decentralization where former corporate business functions are stuffed into the operating divisions. Note the “empowerment” corporate-speak! Priceless…
SOURCE: ABB Ltd. February 28, 2019 Investor Presentation
Shareholders should applaud the expected savings of about $500 million per year with the new structure, but also acknowledge that there will probably be a human cost. Management is reticent about mass staff reductions, but it’s hard to see where else expense savings can be achieved and there is substantial anecdotal evidence of layoffs. The other major aspect of the restructuring was to drive “digitization” and Internet-of-Things connectivity throughout ABB and its product offerings through ABB Ability, a cloud-based platform built on Microsoft Azure, and a global partnership with Dassault Systèmes (OTC Pink: OTCPK:DASTY) to offer software combining ABB Ability and Dassault’s 3DEXPERIENCE modeling and simulation platform. Branding and advertising now emphasizes the company’s digital future. On the web, ABB’s tag line is “ABB. Leading digital technologies for industry.”
In August 2019, the board appointed Bjorn Rosengren as the new CEO. Rosengren, an industrial business veteran, was widely credited with a turnaround at Swedish mining equipment company Sandvik (OTC Pink: OTCPK:SDVKF). Industry Week described his tenure at Sandvik as follows:
During Rosengren’s tenure, Sandvik shares gained more than 70%. The CEO has been “instrumental” for the company’s improvement in recent years, DNB analyst Olof Larshammar said in a note. Although helped by better markets, the company improved under his watch as Rosengren unpicked an overly centralized corporate structure, implemented extensive performance reviews and benchmarked units against one another, Larshammar added.
Investors apparently approved of the new CEO as ABB stock rallied following the announcement of Rosengren’s appointment. Not all, however, is roses and unicorns. On June 10, during a strategy presentation for investors Rosengren announced that he was committed to a “prioritization of stability and profitability before growth.” Many investors would differ; the company has been starved for growth. He also mentioned a new operating model featuring 18 sub-divisions below the main four divisions called the “ABB Way.” There have been other “Ways” before, most notably Jack Welch’s “GE Way.” Coincidentally, ABB bought GE Industrial Solutions (GEIS), GE’s global electrification solutions business, on June 30, 2018.
1Q 2020: The Wrath of COVID-19
For ABB, like many companies suffering from the impact of COVID-19, it was a foregone conclusion that 1Q 2020 and 2Q 2020 would be bad. 1Q 2020 earnings were hard hit; net income was down $184 million or 32.6% compared to the prior year quarter. The Wrath of COVID-19, however, did not impact the stock price. First quarter 2020 earnings were announced April 28, but the slow upward momentum ABB had built from its March low was not materially interrupted.
This was a bit of a surprise as already low expectations for 2Q 2020 and the rest of the year were confirmed by management. Here’s what CEO Rosengren had to say in the ABB 1Q 2010 Press Release:
The COVID-19 pandemic impacted our first quarter results, lowering revenues and operating margins in all our businesses, although order growth held up well. We are doing our utmost to ensure the health and safety of our employees while maintaining business continuity, serving our customers and continuing to invest in R&D for the long-term.
He went on to set expectations for 2Q 2020:
In the second quarter, we expect ABB’s operations to be significantly challenged by a sharp drop in demand due to lockdowns in many parts of the world. Nevertheless, we will accelerate our efforts to manage our costs and safeguard liquidity, while moving ahead with decentralizing the group and our target to complete the divestment of Power Grids at the end of the second quarter.
Management was not providing 2020 guidance, other than to generally lower expectations for the entire year, but specifically noted that “Robotics & Discrete Automation [was] expected to decline by more than 30 percent year-on-year.” With that gloomy background, we’ll quickly review 1Q 2020’s financial results. In the table below, we’re using results as reported in dollars unadjusted for currency fluctuations and not using ABB’s custom “comparable” results which consider changes in the company’s portfolio of businesses.
We could have easily highlighted the whole income statement in yellow, but let’s try to parse the numbers. Total revenue was down $631 million or 9.2% to $6.2 billion 1Q 2020 from $6.8 billion 1Q 2019. Of special note, on a quarter-over-quarter basis, revenues at Electrification, the largest division, and Robotics, the “sexiest” division, led the way down at 9.3% and 21.2%, respectively.
The decline in revenues was accompanied by a decline in margins; gross profit was down $299 million or 13.5% and the gross profit margin eroded 150 bps compared to the prior year quarter. Other operating expenses declined $82 million or 5.1%, a good showing but not enough to compensate for the decline in gross profit. As a result, operating income was down $217 million or 8.5% and the operating margin fell 260 bps quarter over quarter to a very weak 6%. Here’s a table illustrating the erosion of each division’s EBITA margin:
When we reach the bottom line, the result was a disappointing $184 million or 32.6% drop in net income, equivalent to a $159 million or 29.7% drop in net income attributable to ABB shareholders. Diluted EPS was down $0.07 or 28%.
In a final positive note for the quarter, however, CEO Rosengren noted during the ABB 1Q 2010 Conference Call that so far orders had held up well:
The book to bill ratio for the quarter was 1.18, which means that the orders are 18% higher than the revenues.
The company booked $7.3 billion in new orders 1Q 2020 down just 4% from the prior year quarter. Although orders can be cancelled, the order backlog was $13.7 billion, down just 1% from the prior year quarter.
Sum of the Parts Valuation: 15.8% Discount
ABB’s financial presentation practically begs for a sum-of-the-part analysis, but an investor has to ask why? It would be easy to suggest likely acquirers for each ABB division, but it’s hard to imagine management and the board slicing the company up like a salami in what would in reality become a liquidation. I’m going to take a back-of-the-envelope approach simply to establish a very rough fair value benchmark. In the table below the two main assumptions are 1) the “normalization” of divisional EBITA by using an average of three year’s divisional EBITA and 2) divisional EBITA multiples based on an average of four competitors grossed up 20% for an acquisition premium.
With a current market price of $24.49 as of July 10, ABB is trading at a small 15.8% discount to our very rough current sum-of-the-parts value. Here’s a simple way to bracket the per share values:
It’s important to recognize that this analysis is “static” and not an estimate of the future value of ABB. The “complete” divestiture of Power Grids was just announced July 1. With a new CEO, tighter focus on four divisions, ongoing cost-cutting and digitization and a COVID-19 slowdown to battle through, the “new” ABB needs time to emerge.
Summary: Merits and Considerations
Just like that college star who never quite lives up to his or her potential in the pros, ABB has been a chronic underperformer. Let’s summarize the company’s merits first:
- Four main divisions producing high quality, high-tech industrial products for sale world-wide; three ranking #2 and one #1 in their respective markets.
- Many of ABB’s products support sustainability; smart buildings, EV infrastructure, efficient electric motors and robots to supplement an aging workforce.
- An ongoing restructuring designed to 1) cut $500 million per year in costs, 2) connect the company and its customers and products through digitization and the Internet-of-Things and 3) build entrepreneurial focus, creativity and responsiveness through decentralizing the divisions.
- A new CEO with a successful past record of re-energizing industrial companies – and their stock prices.
- A planned $7.6 billion to 7.8 billion share buyback program of roughly 10 percent of the company’s stock after 2Q 2020.
- The stock has been climbing from March lows, investors are apparently discounting the forecast of a few bad quarters and a dismal 2020.
- Dividends are a plus; per the website, ABB’s “dividend policy is to pay a rising sustainable dividend.”
There are, however, some considerations:
- The company has been a chronic underperformer; revenue and earnings growth has been minimal for years and the stock’s performance has been justifiably weak.
- ABB is still fat; revenue per employee is 24% lower than Siemens (OTC Pink: OTCPK:SIEGY) and 55% lower than Schneider Electric (OTC Pink: OTCPK:SBGSY).
- The company’s improvement efforts ran straight into the Wrath of COVID-19 which stifled demand and sent revenues and operating margins plummeting to recession levels.
- The Robot division depends heavily on the challenged auto industry; will other end users, or maybe EV companies, pick up the slack?
- Is ABB running in place? The analyst consensus is for EPS of $0.65 for 2020 and $1.02 for 2021 for the slimmed-down post-Power Grids company. It remains to be seen how investors will view earnings after the planned stock buyback.
- Dividends will be under pressure in 2020. The company paid out $0.79 per share in 2019, but consensus 2020 earnings are expected to be $0.65. Power Grids net proceeds could bridge 2020, but …
Recommendation: Interim and Long-Term
For perspective, I am a value-oriented investor generally operating with a three- to five-year holding period. As of July 10, 2020, I was up 21.32% on my ABB position, bought in two tranches on February 21, 2019 and March 7, 2019.
On an interim basis, I view the stock as a BUY now with a possible $30 – $35 per share exit in mind. My main concerns are 1) the COVID-19 situation worsens – and ABB is very much a global company and, 2) that 2Q 2020 will be worse than expected for ABB and many other companies leading to a re-appraisal of the entire market. Personally, for my own purposes and depending on future developments, if I see $30 per share in a few weeks, I’ll take it and wait for a re-entry point. I also have an investment in a competitor in mind that I will discuss in a future article.
Longer term, I am optimistic about ABB’s products, new management and restructuring. If you have a longer investment horizon, you could BUY an initial position now, watch for financial and operational improvement in the company, and plan to average down if you see a break to around $20 per share. Over a three- to five-year period I think ABB will finally reward its long-suffering shareholders.
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.