Removal of demerger overhang a positive; RoE expected to rise to 16.2% by CY22e; ‘Buy’ retained with TP of Rs 1,460.
As the record date for the demerger of the Power Grid business was set as Dec 23, 2019, the stock now trades without the value of the same. For 9MCY19, the Power Grid business reported PAT of Rs 1.4 bn (-23% y-o-y). This is 38% of the reported PAT for company. Our prior SOTP-based valuation ascribed Rs 276/sh to the Power Grid business at Sep’21e PE multiple of 25x.
A pure play on products and services rather than direct play on capex: Post the demerger of Power Grid business, ABB India’s business is largely products & services oriented with projects forming 7-8% of revenue. This makes it a pure play on the digitalisation and automation theme. Today, ABB is a beneficiary of consumption revival as well, especially in the end markets of auto, food and beverages. After coming in at 13% over CY15-18, residual business revenue CAGR is estimated at 14% over CY18-21.
Order inflows may be volatile due to short cycle nature of business: Given the high component of products & services, the residual business will be short cycle in nature. Thus, order inflows may be volatile over the near term, especially given the ups and downs of the economic cycle. For example, order inflows increased at just 5% y-o-y in Q3CY19 v/s 23% y-o-y in the preceding quarter. While the sharp slowdown in order inflow momentum may be attributed to the slowdown, we believe that order inflows will bounce back sharply as the economy recovers.
Expect strong earnings momentum to continue: Over FY13-18, ABB delivered an adj. PAT CAGR of ~22%. In 9MCY19, it delivered reported PAT growth of 22% y-o-y. However, in the continued business, the growth rate stands at 89.2%. We forecast residual business CAGR of 29.5% over CY19-21. Tax rate should aid growth next year.
Return ratios to improve: RoEs have improved from 11.8% in CY16 to ~14% in CY19e. We expect RoEs to improve further to 16.2% by CY22e. ABB’s RoEs are depressed due to high cash balance. The improvement in the business model is better captured in ROIC calculations. We expect ROIC to improve from 21.3% in CY18 to 30%+ by CY21.
Maintain Buy: We assign TP of Rs 1,460 to the stock based on target PE multiple of 45x on CY21e EPS of `32.4. Our target multiple remains unchanged for the continued business. Maintain Buy. At an aggregate level, we expect ABB would trade at a premium to Siemens.