ABB - Easy toss in the too hard pile

One post a day did fail last week. I will lower the quality ambition further and just post some general notes on the companies I review. Starting off with:

ABB (ASEA Brown Boveri)

ABB is active in the power and automation market. It is very difficult to get a grip on what they do. Just look at the products and services offered in the main segments - they do a lot of stuff:

• Discreate Automation and Motion
• • $9,2B sales
  • Product and services includes variable‑speed drives, motion control solutions, motors, generators, power electronics systems, rectifiers, power quality and power protection products, mechanical power transmission of rotating equipment, traction converters, solar inverters, wind turbines converters, electric vehicle charging infrastructure, programmable logic controllers (PLCs), and industrial robots. 
• Low Voltage Products
• • $6,6B sales
  • The division offers a wide range of products and systems, with related services, that provide protection, control and measurement for electrical installations, enclosures, switchboards, electronics and electromechanical devices for industrial machines and plants. The main applications are in industry, building, infrastructure, rail and sustainable transportation, renewable energies and e‑mobility applications.
• Process Automation
• • $6,5B sales (large drop from 2014)
  • The Process Automation division is a leading provider of fully‑engineered solutions, products and services for process control, safety, instrumentation, plant electrification and energy management for the key process industry sectors of chemical, oil and gas, marine, mining, minerals, metals, cement, and pulp and paper. 
• Power Products
• • $10B sales
  • The Power Products division primarily serves electric, gas and water utilities as well as industrial and commercial customers, with a wide portfolio of products and services across a wide voltage range to facilitate power generation, transmission and distribution
  • Key technologies include high‑ and medium‑voltage switch‑ gear, circuit breakers for a range of current ratings and volt‑ age levels, power, distribution, traction and other special transformers, as well as products to help control and protect electrical networks  
• Power Systems
• • $6,8B sales
  • The Power Systems division delivers solutions through four businesses: Power Generation, Grid Systems, Substations and Network Management. The scope of work in a typical turnkey contract includes design, system engineering, supply, installa‑ tion, commissioning and testing of the system. 

Financial development:

Source: Borsdata.se

We have seen a margin compression which ABB is pushing hard to turn. My takeaways from trying to understand the underlying reasons for this:

• ABB has the last years taken out some 3-5% efficiency on cost of sales annually the last 5 years. 
• However, the competitive pressure has more than made up for these efficiency gains putting a pressure on margins (i.e. due to pricing). 
• Oil and gas decline is also putting pressure on margin both from a mix (O&G is high margin) and from a volume perspective

ABB has a clear intention to turn this going forward, objective until 2020:

• 10-15% annual operational EBIT improvement
• 3,5-6% annual revenue growth

ABB is today selling for a P/E of 21,1, if we assume

• 12,5% EPS growth until end 2020
• Ending P/E of 15
• We get an annual return of 10,8%
• Growth return of 6,8% + dividend yield of 4% 

.

Some of the measures ABB are taking to achieve this:

• Share buy-backs
• Working capital push to raise 2B dollar (presumably used for share buy-backs)
• Relentless execution on efficiency
• • Efficiency program of 1 BSEK gross savings on top on ordinary year on year improvements (at least 50% will hit net operating EBITDA). Staff and support function cost reduction of 30%
• Technology differentiation - out-innovate competition
• Project selectivity
• Manage risks in projects - some e.g. turn key projects can have large downside in unexpected costs
• Focus on projects where differentiated solutions yields high profitability 
• New organzation and incentive system

In summary - This is an easy toss into the too hard pile:

• In order to reach their objectives they need to out-execute competition in efficiency and delivery to improve margins. High competitive pressure on pricing has historically resulted in a Red Queen effect. 
• On easiness to implement it cannot be the easiest hurdle to clear e.g. a 30% cost reduction in support functions 
• ABB have grown a lot with acquisitions and hopefully they did not go out and promise these gains just from a best practice benchmark. 
• With their previously decentralized structure you probably have a lot of different processes and systems patched together with manual activities. In order to drive efficiency you then have a lot of system and process harmonization needed. Tends to get quite complex and time consuming when you get into the details
• With a P/E 21 large share of targeted improvements is priced in
• Clearly outside circle of competence. Do not like (or understand) the unfocused, wide and complex the product portfolio. 
• • Why will they become the best in the world in all these ares? What is stopping more focused competitors from running circles around them?
• Long term they state that their space will become a lot more software heavy (Intelligent solutions, AI and Learning Machines). Given performance within e.g. PLC they have a lot to prove in the software space. 

/ RQ