Sustaining digitalisation orders crucial for ABB to boost its profitability

For investors of engineering goods and services major, ABB India (ABB), its December quarter (fourth quarter or Q4 - the company follows calendar year, or CY, reporting) results was crucial to determine how the numbers would shape up after divestment from power grid operations.

To their comfort, the continuing operations - comprising robotics, electrification products, and industrial automation - posted 15 per cent year-on-year (YoY) revenue growth in Q4. Even net profit, which rose by 58 per cent YoY to Rs 129 crore in Q4, met the Street’s estimates.

However, what needs to be seen in the next few quarters is how well ABB improves its profitability. Being a relatively secure long-term business on the cusp of recovery, profitability of the power grid business gradually improved over the recent quarters and recorded an earnings before interest and tax (Ebit) margin of 12.4 per cent in the third quarter.

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With this segment gone, Q4’s Ebit margin took a hit – down to 11.3 per cent, against 13.7 per cent last year. A part of this however, is due to the rise in other expenses on account of the discontinued operations.

Analysts at SBICap Securities say while digitalisation is a key enabler, growth and margins remain to be accessed over time. The reason why it may take a while for margins to improve is because barring the electrification products division, the other continuing operations are relatively newer businesses for ABB.

For now, these continuing businesses are getting orders from food and beverages, metals, cement, and automobiles industries, where order inflows (up 17 per cent in Q4) are gaining traction due to operating expenses deployed by end-use customers. Categorised as short-cycle orders, they tend to be relatively smaller in value and their margin profile, hence, is unpredictable.

While on a YoY basis, the continuing operations posted a neat operating margin expansion, from 8.5 per cent last year to 11 per cent in Q4, its sustainability in the medium-term is important. Also, in the context of foreign firms such as Siemens and Toshiba vying the same pie of digitalisation orders, competition, too, may limit the scope for margin growth.

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For ABB, its strategy to delineate its business from capital expansion-led growth to operating expansion-led growth may be rewarding in the long run. But in the meanwhile, investors should have mellowed expectations from the company. Trading at 38x CY20 estimated earnings, ABB India stock is quite richly valued, leaving little room for error.