ABB's Third Quarter Keeps The Uncertainty High

By Stephen D. Simpson, CFA | October 25, 2012 AAA

It seems like the analysis of ABB's (NYSE:ABB) third quarter has a lot to do with an analyst or investor's preconceived notions going into it. ABB fans and bulls found signs of increasing stability and deficits that were neither large nor likely to repeat. More skeptical analysts saw another miss, weakness in orders, and yet another less-than-perfect quarter. I am long these shares, and while I didn't see anything in the third quarter results that scared me, I can understand if other investors would want to wait before adding ABB to their portfolio.

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Third Quarter Results Miss Down the Line, but Not by Much
Good news has been relatively hard to find this quarter in the industrial sector, as companies such as Emerson (NYSE:EMR), General Electric (NYSE:GE) and Ingersoll-Rand (NYSE:IR) have all registered relatively iffy performances in Wall Street's eyes. ABB was no exception.

ABB reported revenue growth of a little over 4%, with organic revenue likewise up about 4% (actually an improvement over the second quarter's 3%). This was just barely below consensus, though. By division, Power Systems was quite strong (up 11% in local currencies), while Discrete Automation and Process Automation were both up in the low-to-mid single digits. Power Products revenue was flat, while Low Voltage saw a 2% decline.

While reported EBIT declined 4% and reported EBITDA fell 6%, adjusted EBITDA was down more on the order of 11%. Here too the miss was not that large relative to expectations, but it was a miss all the same.

SEE: Understanding The Income Statement

Orders Even More of a Jumble than Usual
On a straight reported basis, ABB saw orders decline 6% and miss expectations by a similar 6%. Power Systems saw a 27% drop in orders, while Power Products orders fell 6%, Process Automation fell 3% and Low Voltage fell 1%. Only Discrete Automation was positive, eeking out a 1% gain.

That's not quite the full story, though. ABB had a large $1 billion transmission and distribution order last year (a German offshore wind project), and base orders were basically flat (after growing 2% in Q1 and 1% in Q2). Better still, margins in the order book have been holding up pretty well.

Business in the U.S. continues to be strong, with double-digit order growth. Europe is a mixed bag - while the U.K. was strong and Southern Europe seems more stable, Germany and France aren't looking great. China is a mess, though, as it was "stable" overall, but with a lot of moving parts (power up, automation down).

Looking at process automation, ABB seems to be doing better than Emerson or Fanuc (OTC:FANUY) and holding its own with Honeywell (NYSE:HON). That said, the declines in the oil/gas sector may be a sign of trouble for others like Dover (NYSE:DOV) and Flowserve (NYSE:FLS) down the line. In power, utility and renewables aren't great today, but companies such as GE and Siemens (NYSE:SI) continue to maintain their confidence that 2013 and 2014 will be better.

SEE: How To Decode A Company's Earnings Reports

The Bottom Line
I can see why some investors won't like the iffy performance or weak order trends this quarter at ABB. What's more, with oil/gas and mining seemingly on their way down (and auto capex possibly peaking), other categories are going to need to pick up the slack in 2013 and 2014. At this point, though, I'm still confident that pickups in sectors such as utilities, construction and emerging market manufacturing will materialize. At the same time, I like the company's competitive position relative to the likes of Emerson, GE, Honeywell, Siemens and Rockwell (NYSE:ROK).

I expect ABB to deliver long-term revenue growth of 4% to 5%, with incremental improvements in free cash flow conversion lifting the free cash flow growth rate into the mid-to-high single digits. With those numbers, I believe ABB is one of the most attractively priced well-run industrials in the market today, which is why I bought shares a little while ago. Though ABB is clearly exposed to worse global macroeconomic performance in 2013, I believe this is a good company to own for the long term.

At the time of writing, Stephen D. Simpson owned shares of ABB since September of 2012.

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