As more industrial companies report, what had originally looked like a pretty good quarter is looking increasingly mixed. While companies with exposure to aerospace, automotive, and energy markets are generally doing pretty well (including Honeywell (NYSE:HON), General Electric (NYSE:GE), and Dover (NYSE:DOV)), businesses leveraged to industrial and utility markets are seeing shakier results.
In the case of ABB (NYSE:ABB), the problem isn't so much about the quarter that is in the books, but rather the company's double-digit decline in orders. Although it seems that management believes this is mostly a timing issue, weakness in the peer group and declines in markets like mining and robotics could be more problematic. I'm still fundamentally bullish on ABB shares, and it's a rare undervalued industrial stock, but it may take a couple of quarters for the Street to feel comfortable with the story again.
Q2 Good Or Bad, Depending On Where You Look
ABB had a good news/bad news report for the second quarter, with most of the bad news weighted towards where analysts and investors put the most emphasis (orders and margins).
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Revenue rose 6% as reported, or 2% on an organic basis, which was good for a very small beat relative to the average estimate. Growth was led by the power businesses (Products up 6%, Systems up 5%, Low Voltage flat), while automation was mixed as discrete fell 1% and process rose 4%.
Operating income rose a little less than 5% on an adjusted basis, with operating margins holding more or less steady. Operational EBITDA, the preferred profitability metric for this company, rose 6% and just slightly exceed expectations as margins barely improved (15.2% versus 15.1%) from last year. Profitability in the power businesses improved significantly, while automation profits declined.
Orders Will Overshadow Results
If that were all to say about ABB, I think you could make the case that ABB is doing pretty well in a market where competitors like Honeywell, Emerson (NYSE:EMR), Siemens (NYSE:SI), and Alstom are struggling to show much growth in these markets. Unfortunately, the news on orders will definitely overshadow second quarter results.
Orders fell 11% on an organic basis, missing the average estimate by around 9%. Even if you want to use various Jedi mind tricks to adjust the numbers, the best case scenario is still a 5% miss and one of the weakest book-to-bill figures for the typically strong second quarter in some time. There was weakness across the board, with the 21% drop in process automation orders particularly noteworthy.
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ABB management tried to pin the shortfall on global economic uncertainty leading clients to delay large orders, and that's certainly corroborated by a 45% decline in large orders. Moreover, management had previously announced it would be more selective in the Power Systems business so as to drive better long-term margins.
All of that is fine to a point, and it's true that companies ranging from Alstom to Siemens to GE have either seen weaker orders or at least mentioned significant order uncertainty in the relevant comparable businesses. But with industries like mining seeing significant cutbacks in capex and Japanese robotics rivals likely getting a boost from the yen, I have my concerns. That's particularly true given that the prior quarter saw orders miss (by about 5%) and the company's well-regarded CEO resigned for “personal reasons” earlier in the year.
The Bottom Line
With a decent gain in these shares, it's tempting to just punt and move on to greener pastures. Were it not for the fact that I think the automation and power markets are two of the best long-term markets in the industrial sector, I probably would. But given ABB's leadership position across these markets, I think the company can work through these macroeconomic issues and return to growth.
I continue to look for ABB to post long-term revenue growth of just under 5%, and basically consistent with comparables like Honeywell and Emerson. I'm also looking for nearly 10% free cash flow growth on improving margins and cash flow efficiency (which is likewise consistent with Honeywell). That works out to a fair value of about $25 today, making ABB one of the relatively rare under-valued stocks in the industrial space. Given the relatively restrained reaction to the big order miss, I'd say the Street is still basically on board with ABB, but investors considering the shares today need to appreciate that this may be more of a 2014/2015 story than a 2013 performer.
Disclosure – At the time of writing, the author owned shares of ABB.