The economic slowdown has not spared the capital goods companies, and those with higher dependence on industrial capital expenditure have been impacted more.

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ABB is no exception and has faced the heat of the slowdown. The company generates about 40 per cent of its revenues from sale of products and solutions to various industries, with the balance accounted by the power segment.

The company has reported a significant decline of 33.4 per cent in net profit during the first quarter ended March 2009, while its revenues fell by 9.2 per cent.

Among the few positives is the receipt of a large order from Power Grid, which has helped push up its order book. While the stock has rallied significantly in the recent past, many analysts are expecting a decline in earnings in 2009 factoring in concerns over revenue visibility due to slower growth in order book and pressure on operating margins.

Low visibility
The most critical issue for the company has been the growth in its order book and receipt of new orders. The growth in ABB’s new order inflow was continuously falling since March 2008 quarter.

Though the March 2009 quarter looks better on a sequential basis (over December 2008) given that order intake is up by 83 per cent to Rs 2,303 crore mainly on account of the order receipt from Power Grid for transmission projects, it is still lower as compared to the corresponding March 2008 quarter. Nonetheless, it may be, too, early to conclude a trend reversal.

Says Satyam Agarwal, analyst, Motilal Oswal Securities, “The improvement in the order intake is a positive sign, but we will have to wait and see if this is sustainable.”

“The market sentiment has considerably improved as visible with the growth in orders received compared to December 2008 quarter. However, due to the slowdown the impact is still being felt and this will take some time to ease out,” remarked Biplab Majumder, vice chairman and managing director, ABB at the time of its March results last month.

Analysts though are conservative regarding the company’s outlook for the next 2-3 quarters partly due to the fact that ABB derives about 40 per cent of its revenues from sale of process automation products and systems to user industries like oil & gas, metals, minerals, chemicals, pharmaceuticals, paper and telecommunication, which are not expanding. Revenues of this division were also down 10 per cent to Rs 620 crore during March 2009 quarter.

Power interruptions
Even as the impact of slowdown is relatively lower in the case of the power business, analysts indicate that projects in the power space are also experiencing delays, including private sectors projects.

The company’s power system business, which provides turnkey systems for transmission, distribution and electrification projects, has reported a 13 per cent year-on-year decline in March 2009 quarter revenues and a 41 per cent decline in profits.

Besides the project delays, the performance was also impacted on account of company’s decision of exiting rural electrification projects, where the working capital cycle is relatively longer. So, while the growth from power segment is better, revenues could remain subdued for next few quarters.

Margin pressure
The impact of slowdown has been high in the industrial automation segment, which has been the company’s most profitable business.

The division’s profit margins have fallen by 414 basis points over December 2008 quarter and by 175 basis points over March 2009 quarter, to about 10 per cent. The decline in the company’s overall margins is partly due to foreign exchange losses. But, due to the increasing share of low margin power business, analysts expect the margins to decline further by about 100-150 basis points in CY09 and CY10.

This is also consequent to pricing pressures in the power and automation segments led by increasing competition from rivals like Areva T&D and Siemens.

Adds Agarwal, “The operating profit margins will depend on the order intake, since most of the capacities are now under-utilised. Once the company has enough order flows, the margins will improve due to the economies of scale.”

Including the recent expansion for various components and automation products, ABB has also increased its power transformer manufacturing capacities from 12,000 MVA to 17,000 MVA. With this and a weak demand environment, the company is now cautious about its incremental capacity expansion.
 

Outlook
In this background, analysts expect revenues to remain largely flat and profits to decline for the year ending December 2009. Any recovery is likely only in 2010 with revenues and net profits seen growing by around 15-18 per cent.

Meanwhile, with the 33 per cent rise in the stock price over the last one week, valuations aren’t cheap. At Rs 617, the stock is trading at 20.6 and 18.4 times its 2009 and 2010 estimated earnings, respectively.

Historically, ABB’s stock has traded at a premium to the market as well as most other power equipment companies. But, analysts say, since growth rates are unexciting as compared to those during CY2000-2008 (average growth in net profit was 38.6 per cent), competition is high and margins under pressure, and also, that the return on equity is seen declining to 20-22 per cent in 2009 from 29.4 per cent in CY08, the current valuations are not justifiable.

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