At a 52-week high, ABB (NYSE:ABB) has nevertheless remained a relative underperformer next to peers like Siemens (OTCPK:SIEGY), Rockwell (NYSE:ROK), and Schneider (OTCPK:SBGSF), as investors fret over ABB’s heavy exposure to end-markets like power gen, oil/gas, and mining and some of the gaps in its business coverage relative to its peers. Management has recently shown that it is willing to get back to M&A, though, and there is some relative undervaluation that may appeal to investors.
Beating A Lower Bar
ABB posted a decent first quarter, though I believe expectations were low going into the report. Organic revenue growth of 3% was a nice improvement over the recent trend of down-to-flat, with three of the four units posting organic growth (Industrial Automation, formerly Process Automation, was the exception). Margins improved a bit, as three of the four segments showed margin improvement with Robotics and Motion the exception due to an adverse mix.
Orders were soft (down 3% organic), but base orders were okay (up 2%) with three of the segments showing growth. Power Grids was the exception, with a difficult year-ago comp weighing on the results.
In terms of nuance and context, management seemed to be incrementally more positive and more sure that operating conditions are improving across its businesses. The oil/gas and mining markets remain pressured, which is an issue given their significant weight in ABB’s business mix, but there are areas of growth and improvement that do offset this to some extent.
B&R Fills Some Gaps
Investors have been waiting for ABB to make a meaningful move on the M&A front, with long-running speculation that ABB would make a move for Rockwell. ABB instead went for privately-held Austrian company Bernecker & Rainer (“B&R”), a company about one-tenth the size of Rockwell.
While B&R is small, it does fill some gaps in ABB’s line up and makes it a stronger player in the automation space. B&R is a distant, but growing and share-taking, #5 player in the PLC market and that builds up an area of weakness that contrasts with ABB’s leadership in distributed control systems (or DCS). Programmable logic controllers are basically industrial computers that control machines on the shop floor. While DCS are used in “process automation” settings, PLCs are used in discrete automation environments like assembly lines. B&R is also strong in industrial PCs, human-machine interfaces, and servomotion, and has some presence in software (including automation and visualization).
Regrettably, ABB did not disclose the price paid, but the hints that management gave suggest a price around $2 billion – making it a pricey deal, but one that can still be a positive contributor down the road. B&R has been a strong innovator and has grown more than twice as fast as the underlying market over the past couple of decades. While B&R doesn’t vault ABB into a leadership position in markets like PLCs, it fills a noticeable gap and gives ABB the opportunity to expand upon B&R’s business through cross-selling (cross-selling B&R controls to ABB customers, as well as ABB electrification and automation products to B&R customers).
B&R does give ABB a little more exposure to attractive markets like food/beverage, but the magnitude is not meaningful. Expense synergies are possible, but likely not especially material. The biggest value, in my mind, is that gap-filling and giving ABB a fuller suite of products to sell to automation customers.
The M&A Story Isn’t Over
The deal for B&R does not meaningfully constrain ABB’s M&A options, as the company has a clean balance sheet and solid cash flow. What’s more, there are still holes to fill. I continue to believe that ABB may be interested in software, with companies like Dassault (OTCPK:DASTY), Autodesk (NASDAQ:ADSK), and PTC (NASDAQ:PTC) being potential targets. I also expect the company to look for deals in sensors, controls, valves, and actuation, and I would like to see ABB focus on those capabilities in attractive markets (like food/beverage, pharma, et al).
ABB is rumored to be in the bidding for GE‘s (NYSE:GE) Industrial Solutions business. Adding more scale in areas like low-voltage and switchgear makes some sense, but I don’t think the market will be overjoyed to see ABB win the bidding here – even though this is a business that can generate mid-to-high teens margins and grow in conjunction with increasing factory automation.
I’m also curious now what may happen with Rockwell. B&R’s market position(s) wouldn’t preclude a deal for Rockwell, but I expect ABB management to move on to filling other holes now. With ABB out of the running, Emerson (NYSE:EMR) and Honeywell (NYSE:HON) would look like the more logical potential acquirers, with Schneider and maybe GE also long-shot possibilities. Flipping the script, I think Rockwell may itself now be looking for deals to broaden its own offerings; Rockwell’s focus has served it well over the years, but there are some gaps that management may want to address.
I’m not making major changes to my model at this point, as B&R’s contributions are modest and don’t fundamentally alter the company’s prospects. This is a leveragable deal that could improve ABB’s long-term position in automation, but I don’t want to put the cart too far ahead of the horse at this point. With that, my basic outlook for low single-digit revenue growth and mid-single-digit FCF growth remains intact, supporting a fair value in the mid-$20’s.
As I said, there is still work ahead of ABB. B&R needs to be integrated well and despite the recent collaboration with IBM (NYSE:IBM), ABB still needs to bulk up its digital/software offerings. I’d also note that future restructuring could still be in play – the company recently shuffled its operations again, but I think there’s an argument to make that robotics should be part of automation and the turbocharger and marine propulsion businesses should not be in the automation group.
The Bottom Line
There are reasons that ABB has lagged rivals like Siemens, Schneider, and Rockwell, and it isn’t solely a function of the company’s market exposure(s). I believe management has done more to address its problems than the valuation reflections, but the company’s markets are too competitive to allow for any let up. I expect improving conditions in markets like the U.S., Western Europe, and China to support better results, and I expect more M&A, but investors should note that although ABB does appear undervalued, management still has work to do to convince the Street that it is moving toward true industry leadership.
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.
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