Margin cheer for ABB India

Revenue growth, localisation, service income are key positives

The quarter ended December has been tough for the capital goods sector as companies grapple with margin pressures, given a challenging environment. However, ABB India has defied this trend in its December quarter (the company follows a January to December accounting year), for which it was handsomely rewarded by the Street. Its stock jumped 14 per cent on Thursday.

Revenue growth of over eight per cent year-on-year (y-o-y) in its December quarter (Rs 2,425 crore) was in line with Bloomberg consensus estimates. But, operating profit of Rs 269 crore (up 40 per cent y-o-y) versus expectations of Rs 204 crore, and an operating margin of 11 per cent (up 250 basis points y-o-y) surprised the Street. Margins across most divisions increased during the quarter ended December.

Gross operating margins (revenues minus raw material costs) swelled from 42 per cent a year ago to over 46 per cent in the quarter ended December. While favourable raw material costs helped to some extent, localisation efforts paid off for ABB. Analysts say that over the years ABB has brought down the import component in order to improve its operational efficiencies and pricing. In 2014, the import component for the company is estimated at 40 per cent of total raw material costs. Also, increased revenue from the service segment (where margins are higher compared to the product segment) helped. With companies delaying their capital-expenditure spends and focusing on optimising existing capacities (incurring higher maintenance cost), ABB has garnered better service incomes (Rs 1,000 crore in 2015). The superior performance of the service segment is likely to continue in 2016.

Overall, ABB ended the December quarter posting a net profit of Rs 129 crore (up 54 per cent y-o-y), which was ahead of estimates of Rs 107.6 crore, even as Other Income fell by a fourth to Rs 11 crore and the tax rate inched up to 38 per cent.

For 2016, the company is cautiously optimistic due to the forthcoming pressure in the power systems division, where revenues in the December quarter (Rs 524 crore; a fifth of total revenue) declined 16 per cent y-o-y due to subdued demand. The order book of around Rs 8,000 crore, which the company expects to comfortably monetise, however, gives hope. Strong traction in railways and renewable energy sectors (about 14 per cent of revenues) is also a key positive.

But, valuations at 44 times estimated 2016 earnings are rich, despite strong earnings potential. Twenty-two of 32 analysts polled on Bloomberg recommend selling the stock, mainly for this reason.