Despite healthy sales, Q1CY16 profitability was weak led by sharp rise in other expenses; some of the expenses may recur in the near term. Order inflow growth remains elusive in Q1 although a major respite is likely to come soon from a large HVDC order. ABB has undertaken several internal improvements and is well-placed to capture the recovery in the capex cycle. However, all the potential positives and much more are factored in the CMP. Maintain SELL. TP R900 (from R800).
Q1CY16 profitability below estimate led by sharp rise in other expenses: Q1CY16 revenues of R20 bn (up 10% y-o-y; ) were 7% ahead of estimates largely led by higher short cycle sales. Despite higher revenue growth, Ebitda margin declined ~45 bps y-o-y to 7.5% led by higher other expenses on (i) higher warranty provisioning, (ii) forex MTM loss, (iii) shared service centre expenses, (iv) higher expenses on training efforts to handle the growth initiatives better, and (v) additional expenses on go-to-market efforts in order to secure sufficient incremental orders to build a strong backlog. Other income was higher due to certain one-off items such as income-tax refund and interest on deposit made related to a litigation that was resolved in favour of ABB. Accordingly, PAT stood at R710m, 14% below estimate.
Q1 inflow weak; large HVDC and solar inverter orders will help report strong growth in CY2016: Order inflow for the quarter was weak at Rs 18.3 bn, below the quarterly average of close to Rs 20 bn. The company highlighted orders in renewable energy, infrastructure and railway sectors along with base orders from industry and utilities contributing to the growth. Also, exports saw double-digit y-o-y order growth. ABB was not able to book a large HVDC order where it was favourably placed and this would get booked in coming quarters, in our view. We estimate the total HVDC order size at ~Rs 60 bn, ABB Sweden portion at R45 bn (~75% share), with ABB India getting ~Rs 11 bn (~25% share). This together with higher solar inverter orders should help ABB report good order inflow growth in CY2016.
Revise estimates and target price; retain SELL: We revise our estimates to Rs 18.4, Rs 27.6 and Rs 36.9 from Rs 21.2, Rs 28.4 and Rs 36.8 for CY2016-18e on execution and margin-led changes. We roll over to March 2018e and revise TP to Rs 900 based on target P/E multiple of 30X.
Good revenue growth but margins miss estimates, order inflow stays weak
Good growth in revenue: Segmental analysis reveals strong execution in Discrete Automation & Motion and Electrification Products, partially negated by upper single digit revenue decline in Process Automation and Power Grids segments.
Sharp rise in other expense mars profitability: Despite the revenue growth and higher short-cycle sales, Ebitda stood at R1.49 bn. Ebitda margin at 7.5% was down ~45 bps y-o-y. Segmental analysis reveals broadly stable or improving y-o-y Ebit margin trajectory. Electrification Products and Discrete Automation & Motion segment margins improved due to higher localisation.
What upset the apple cart in the quarter is the sharp increase in unallocated expenditure by 94% y-o-y and 41% q-o-q to R552m. Overall other expenses were up 30% y-o-y led by:
Higher warranty provisioning: The company introduced a few new products and new technologies, which require higher warranty provisions in the initial phases till they get stabilised. As the adoption of these new offerings improves, margins would improve as well.
Forex loss: Financials were impacted by an MTM forex impact of R80m due to depreciation of INR vs CHF and SEK, the key import currencies for ABB India.
Shared service centre expenses: The Indian entity contributed to a global effort to set up a shared services centre in Bangalore for the whole group, as a part of its ‘Next-Level Strategy’.
The company intensified training efforts to handle the growth initiatives better.
Order inflow remained weak: Order inflow for the quarter was at R18.3 bn.
Order backlog as of Q1CY16 stood at R78 bn, down 2% y-o-y and provides low near-term growth visibility.