The Hindu Business Line : ABB : Long term buy

THE ABB stock could outperform the broad market in the medium-to-long term as the company is set for strong and steady growth over at least three years.

The stock trades at 20 times its expected 2004 sustainable earnings per share (EPS) and 15 times the expected EPS for 2005.

ABB has been on a steady growth path over the past two/three years.

The performance for the recent quarter has also been robust as expected. Despite the pressure of high input costs, ABB reported sustainable earnings growth of 67 per cent in the recent quarter.

The numbers suggest the following key trends:

The pace of order booking has been rising even on a sequential quarter basis. This suggests that the investment activity in the power sector has not slowed down as feared, after the new Government took charge. The growth in order booking exhibited a steady uptrend.

Order booking for the quarter was up 58 per cent compared to the corresponding previous quarter.

The order backlog, at Rs 1,394.9 crore in end-September 2004, was 22 per cent higher than as on September 2003. This ensures strong revenue growth in 2005.

Over the last few quarters, ABB's revenue booking outpaced order booking. In other words, the order book has been translating into revenues at a much faster pace indicating a reduction in the execution cycle time.

This could be due to the higher share of standard products and services in its product portfolio compared to turnkey projects.

The execution time for standard products is less than half that of turnkey projects, which usually take between one and three years to complete. ABB has focussed more on standard products by increasing its channel partners and setting up additional service centres.

These efforts have lead to a higher contribution from standard products to 32 per cent of the revenues against 28 per cent the previous year.

The effect of higher input costs is beginning to show on the operating margins. Cost of inputs such as copper and steel have risen sharply over the past one year.

Operating margins fell 80 basis points in the latest quarter compared to the corresponding previous period. For every Rs 100 worth of revenues, cost of raw materials have shot up to Rs 75 as against Rs 71.5.

The pressure on margins could mount in the next three-four quarters as steel prices are expected to remain firm.

Moreover, higher taxes too could contract the pace of earnings growth. The provision for taxation has increased sharply in the latest quarter.

Despite the margin squeeze, ABB can be expected to maintain a compounded earnings growth in excess of 35 per cent as revenue growth is expected to be robust in the next four-five quarters.

ABB recently forayed into the retail segment of distribution, which includes switches for the home segment. This could provide an additional revenue stream.

But, its contribution to the bottomline might be limited as it is an extremely competitive and price-sensitive market.

Clear revenue visibility over the next few quarters, immense business opportunity in the long term, strong cash generation and the high return generated per rupee invested in the business justify the higher valuation enjoyed by ABB vis-a-vis its peers.

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