Higher orders and margin boost needed to sustain ABB's valuations

While there should be satisfactory double-digit growth in capital goods revenues in the first quarter of the ongoing financial year (Q1FY25), order flow has been impacted by the elections. But strong order books from FY24 will ensure that revenue growth continues.

Margins may improve somewhat based on raw material price moderations and better operating leverage. Analysts are optimistic about pickups in order flow in Q2FY25. Seasonality should result in a pickup on air conditioning, and other cooling solutions. Exports may remain weak due to the soft global macro environment. Overall, the impact on PAT should be strongly positive. The defence sector should continue to see strong growth.  

Given big order books, many capital goods companies have visibility for revenues through FY25 and beyond. The order pipeline is strong across power, metro, renewables, railways, transmission & distribution (T&D), data centres and automation. Monitorables include possible upticks in private capex and better export demand. Any rise in commodity prices and possible shortages in skilled labour could hurt margins. Even though government ordering slowed in Q1FY25, Larsen & Toubro announced orders worth Rs 18,300 crore, BHEL Rs 4,300 crore, among others with growth coming from T&D, data centres and electronics. Enquiries could convert into orders from Q2FY25. Global weakness triggered by inflation, geopolitical worries, and economic slowdown has hit export growth and this weakness will continue for some quarters.

ABB could be a key player given the improved market for short-cycle orders from the private sector and T&D, railways, data centres, and PLIs. However, valuations for ABB are very high, which has led to profit-booking. While ABB's earnings have been upgraded by at least 40 per cent in the last 12 months, the stock was up by over 90 per cent, which fully discounts upgrades. The forward price to earnings (P/E) ratio is running at over 70 times for FY26 estimates – this is well above historical average P/E ratios.  

While analysts remain very positive about earnings quality and growth estimates, the stock’s run-up has discounted the consensus. There’s scope for better margins in the electrification segment (around 40 per cent of revenues), but margins are likely to be flatter in industrial revenue (around 60 per cent of sales), given competitive intensity, especially in motors.

Monitorables which could deliver positive surprises for ABB include stronger-than-expected quarterly order run rates, or really strong margin gains in electrification, or unexpected margin gains in industrial revenue. Order inflows are expected to be around Rs 4,000-4,800 crore per quarter and this consensus would need to be beaten (or the upper range hit) for upgrades. This implies stronger order flow from mobility and process automation.

After a recent business consolidation, ABB has a new strategic focus and capacity expansion to cater to global exports driven by its parent. It also enjoys better local demand, and better semi-urban reach in India, due to better penetration of Tier II-III cities.

ABB has sustained its leadership in some core areas with a better product mix, giving it better pricing ability and cost control. Faster localisation of technology-led products and solutions could push up margins as revenue streams broaden. A strong balance sheet and good cash flow could help it generate better return rations than competitors and its services business also generated a 14 per cent operating profit margin in 2023. A recent mandate from the parent for low-voltage manufacturing should improve its export opportunities. The only cause for concern for investors is expensive valuations.