Despite the absence of capex cycle (in particular private capex), ABB, Siemens and Honeywell have delivered strong earnings growth, led by margin expansion.
The latest financial results of ABB, Siemens and Honeywell (not rated) reflect a slowdown in the opex spending-related businesses. Siemens’ order inflow declined 14% y-o-y in Q4FY19 (year ending September), while ABB’s order inflow growth decelerated to 5% y-o-y in Q3CY19 from 23% in the previous quarter.
We attribute this to the economic slowdown, which has impacted the key end-markets of auto, food and beverages. However, the medium-term opex-related opportunities appear promising, given the faster adoption of such products & services and cost savings led by preventive maintenance for end-market players.
Given the short cycle nature of such orders, inflows will bounce back sharply as the economy recovers, in our view. Beneficiaries of rising exports: Over the past five years or so, revenue growth has been supported by exports for multi-national engineering companies. ABB delivered a CAGR of 9.5% in exports (15% of CY18 revenue) versus 7.1% in overall revenue. Importantly, this is primarily led by external exports (20% CAGR) rather than to related party (4.4% CAGR). Siemens’ exports (21% of FY18 revenue) CAGR was at 7.7% over FY13-18 v/s 1.7% in overall revenue. Again, exports growth was primarily led by external sales (10.7% CAGR) rather than to related party (5.9% CAGR). Honeywell’s exports (46% of FY19 revenue) CAGR was the highest at 17.6% over FY15-19 versus 6.8% in revenue. With the new corporate tax rates in place, MNC engineering companies are well placed to benefit from the increasing competitiveness of their Indian entities.
Scope of margin expansion, operating leverage to play out: A comparison of the segmental margins for the Indian entities versus their global parents suggests ample room for margin expansion, despite taking into account the royalty/technical fees. Revenue growth, coupled with margin expansion, is likely to drive 20%+ earnings growth over the near-to-medium term. We upgrade ABB to ‘Buy’ with a TP of Rs 1,660. The pending demerger of the Power Grid business (likely by Jun’20) has led to valuation correction. We maintain our ‘Buy’ rating on Siemens as well with a TP of Rs 1,705. That said, we prefer ABB over Siemens.
Superior cash flow generation and strong balance sheet hard to ignore. Despite the absence of capex cycle (in particular private capex), ABB, Siemens and Honeywell have delivered strong earnings growth, led by margin expansion. We like the strong cash flow generation potential of these businesses, along with the superior strength of the balance sheets and strong cash balances (for any potential inorganic opportunity). These engineering companies enjoy high barrier to entry, better pricing power due to access to global technologies and thus command high valuation premium.