Expensive valuations

While ABB has reported an improvement in its financial performance for the June quarter, the macro environment remains weak. Also, the recovery in margins will take some more time, believe analysts.

In this backdrop and given expensive valuations, most analysts have a sell rating on the stock, which after rising 1.8 per cent on Wednesday fell 1.9 per cent to close at Rs 789.40 the following day. "We believe the stock is expensive given the current valuations of 56.1 times and 48.5 times on calendar year (CY) 2012 and CY13 estimated earning, respectively," says Amit Mahawar of Edelweiss Securities, in a recent note on the company.

In fact, after the results, some analysts have cut their earnings estimates and price targets. "Due to a cut in our earnings estimates, we lowered our target price on ABB to Rs 470 from Rs 495. We maintain our view the stock is already priced for strong margin recovery where in effect it is getting delayed from several quarters (ABB has missed expectations for 10 quarters in a row now). In addition, even on our optimistic estimates, the stock remains highly expensive," says Rahul Garg of HSBC Securities and Capital Markets.

Pressure on margins
Margins have been the biggest disappointment for analysts. During the June quarter, although reported ebitda margins improved 60 basis points (bps) year-on-year to 5.6 per cent, the adjusted Ebitda (forex related transactions) margins were down 110 bps at 4.7 per cent. The pressure came from the process automation and low voltage products segments, which account for about 24 per cent of revenues.

These segments largely cater to the industrial sector, which has seen a slowdown, increase in competition and overcapacity (issues which are likely to remain in the immediate future). Analysts were betting on an improvement in margins; these have dipped from 9.4 per cent in CY09 to 2.5 per cent in CY10 and later recovered to 4.9 per cent in CY11.

Hereon, analysts were expecting margins to rise to eight-nine per cent over the next two years, which they now believe may take some more time to achieve. This is also a reason why they have cut their strong earnings growth expectations for ABB.

Visibility low, but stable
Additionally, in the current subdued macro environment, ABB wants to be choosy about projects and clients, which mean growth in new orders needs to be watched along with the demand (especially in the industrial segment).

So far, thanks to a healthy 14 per cent year-on-year increase in order inflows at Rs 2,045 crore during the June quarter, the order book position (pending orders) is now comfortable at Rs 9,175 crore — this works out to 1.2 times its trailing 12 months sales, the same as in the last six quarters. Consequently, ABB's revenue growth is estimated at 10-12 per cent annually over the next two years, as against 17 per cent in CY2011. Even after assuming robust growth in profits (largely due to a low base), ABB is expected to post an EPS of Rs 18-19 for CY2013, which translates into a high PE of over 43 times.