Why you should accumulate ABB stock

The engineering and capital goods industry has been among the key sectors impacted by the pandemic-induced slowdown in capex activities . On the positive side , there is now greater focus on automation and digitisation, alongside plant upkeep (during/after shut-down).

ABB India that derives a major portion of its revenues from the automation and digitisation segment is set to gain from the opportunities present in the medium to long term.

Though the company’s performance was impacted in the recent March and June quarters, its sound financials and cash reserves should hold it in good stead. The company bagged orders worth ₹3,153 crore, cumulatively in 1HCY20 (company follows January-December financial year). Though this is 16 per cent lower than the order inflows seen during the same period last year, it is still a healthy performance considering the pandemic-induced lockdown and the impact on economic activity.

At the end of the recent June quarter, the company had an order backlog of ₹4,671 crore, which provides a good revenue visibility. The company had clocked revenues worth ₹8,210 crore in CY19.

At the current market price, the stock trades at 40 times its CY22 earnings, which is at a 11 per cent discount to its three-year historical average PE (two-year forward PE).

While near-term risks on margins and cash collections remain, the stock is well-placed to gain from a significant pick-up in investment cycle over the next two years. Investors with moderate to high risk appetite can consider accumulating this stock in dips, for the long run.

Diversified portfolio

After the recent hive off of its power grid and solar inverter businesses, ABB India is now a pureplay products (75 per cent) and value-add services based company (15 per cent), relying heavily on short-cycle orders. Its product portfolio broadly encompasses switchgears of all types (31 per cent of CY19’s revenues), Electronic control and supply units for variable speed drives & other applications (24 per cent), motors and other machines (19 per cent). About 18 per cent of the company’s revenues in CY19 came from exports.

The stock is a good play on the country’s industrial automation and ‘Make in India’ theme. The company stands to benefit from the impetus given to railways electrification, construction of MRTS and Metros, Smart Cities Mission, and infrastructure opportunities in the gas and water sector. The management believes that increasing digitisation across industries such as pharma, food and beverages (F&B), data centres, cement, metals and mining, marine, and oil and gas, coupled with deeper penetration of its electrification products (in tier 2-3 cities) would be key drivers for growth in the coming years. The diversified set of industries it serves has aided the company tp tide over the pandemic crisis better.

Through its electrification and motions segments the company is now focusing greatly on building automation systems, which along with offering comfort and control on operations, aids clients in achieving energy efficiency as well. Delhi airport and many new hotel chains are currently running on ABB building automation systems.

Its other major orders include, equipment supply for Titagarh Wagons, SCADA (Supervisory Control And Data Acquisition) orders for an energy major, technological support for the Kolkata Metro, and Nepal’s biggest hydro project and data centres.

Near-term concerns

In CY19, the company recorded a 50 basis points improvement in the operating margins (ex- power grid business) to 7.3 per cent, led largely by sale of solar inverter business (which had wafer thin margins) and localisation initiatives that helped lower material costs.

But in the recent June quarter, volume shortfall and negative operating leverage eroded profits. The operating margins dropped to 2.4 per cent. But continuing cost-saving initiatives and favorable raw material costs offered some cushion. ABB India’s plants were in operation for only about 45 days in the quarter.

In both the March and June 2020 quarters the company reported significant decline in revenues (down by 17.7 and 42.9 per cent, respectively) and net profits (down by 25.8 and 76 per cent, respectively) due to the complete shut-down of operations during the lockdown.

Also, the lockdown severely impacted cash collections– loss in cash collection was about ₹1,800 crore in the March quarter . In June quarter, with further drop in revenue, the company posted a negative operating cash flow of ₹5,200 crore.

While the cash reserves of ₹1,500 core (as of June-end 2020) could help cushion the near-term stress on working capital, low yield on such reserves can impact the overall RoE– down to 9 per cent in CY19 from 13 per cent in CY18.

However, with the nation entering the unlocking phase, the situation is expected to return to normalcy in the coming quarters.