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A Turnaround Story for Long-Term Investors

September 30, 2011 | About:
Chandan Dubey

Chandan Dubey

97 followers
My investing philosophy can be succinctly represented as follows:

  • Find companies with a record of good performance — this is shown through earnings, solid free cash flow, and strong management. Also, this is harder to do but get a feel of the company and see that the above prospects are not diminished going forward. Hold these companies for years.
  • Once you find such a company, buy shares consistently — reinvest dividends, do not panic, do not sell, draw out the noise in the street. Do this for the rest of your life.


Some of the companies that fit this bill are Johnson & Johnson (JNJ), Procter & Gamble (PNG), Exxon Mobil (XOM) and Coco-Cola (KO). Here I want to pitch another company which is a very successful turnaround story since the last decade. Let us look at the share price of the company first.

XinSLijuNOS-0Bo-b9AwvRelJFdmEtFEfHojJ24D

Bear with me for a moment (before I tell you the name of the company) and look at the following phenomenal improvement in the metric of this company during these years.

Growth2001200220032004200520062007200820092010
Book Value Per Share USD1.771.072.491.611.712.744.754.886.036.50
Revenue growth YoY3.3-232.7108.3201919-9-0.6
Profitability
Gross Margin (%)21.124.725.1242528.130.731.329.330.2
Operating Margin (%)1.62.54.55.57.51013.714.71312.1
Net Margin (%)-2.91-4.3-4.08-0.23.285.6912.98.939.128.11
ROIC (%)-5.7-7.5-7.7-0.49.216.432.7232015
Balance sheet
LT debt(% of balance sheet)15.618.220.719.917.612.66.966.253.1
Debt/Equity2.55.321.71.130.50.20.180.160.08




  1. The company has consistently improved the book value which has more than tripled in the last decade.
  2. The five-year average revenue growth stands at 7%.
  3. The gross margin, operating margin, net margin and ROIC have all improved (arguably the best time was 2007 when the shares were the most expensive).
  4. The company has consistently paid down debt and now the debt-to-equity stands at a measly 0.08. As a percentage of balance sheet, the LT debt is only 3.1%.


If I piqued your curiosity enough, the company is ABB Ltd. (ABB) and is based in Switzerland. It is an industrial powerhouse with market cap of $41 billion.

The history of ABB goes back to the late 19th century, and is a long and illustrious record of innovation and technological leadership in many industries. Having helped countries all over the world to build, develop and maintain their infrastructures, ABB has in recent years gone over from large-scale solutions to alternative energy and the advanced products and technologies in power and automation that constitute its Industrial IT offering.

ABB offers valuable solutions for industrial companies and utilities, as the world seeks more-efficient energy generation. ABB's efforts to slim down its cost structure and eliminate underperforming assets have helped position the company to generate strong profits as demand for power infrastructure strengthens.

Let us answer the following questions to make sure if ABB is a good long-term investment.

Question 1: Does the company have a moat? Will it be here in the next 100 years?

ABB, like GE and Siemens, has been around quite a long time. ABB is now around 120 years old. I am pretty sure they can survive another century. They have their paws everywhere. Let us look at some of the things they do.
  • ABB has won an order worth $71 million from Steel Authority of India Limited (SAIL) to supply a substation package for its Bhilai Steel Plant located in the central Indian state of Chhattisgarh (Sept. 22, 2011).
  • ABB, has won an order worth around $1 billion from the Dutch-German transmission grid operator TenneT to supply a power link connecting offshore North Sea wind farms to the German mainland grid (Aug. 2, 2011).
  • ABB has won orders worth $144 million from the Saudi Electricity Company (SEC), Saudi Arabia’s national power transmission and distribution operator, to construct new substations and upgrade existing ones to help address the growing demand for electricity in the region. The orders were booked in the second quarter (July 19, 2011).
  • ABB has won orders worth about $80 million from Itaipu Binacional, the operator of the Itaipu hydroelectric power plant, to build a new substation in Paraguay and expand an existing installation. The civil works will be carried out by CIE, a Paraguayan construction company (July 22, 2011).


Question 2: Will the company grow? Where do you think the growth will come from?

The company has been planning to achieve growth through following means:
  • Emerging markets — ABB is very active in India and China. In 2010 $12.8 billion revenue came from Asia, the Middle East and Africa. The total revenue for the year was around $31 billion.
  • Climate change and energy efficiency — for example, with recent launch of the solar inverter portfolio, ABB has entered into a $5 billion solar inverter market.
  • Infrastructure renewal and build — for example, ABB has won orders worth about $75 million from Swiss train manufacturer Stadler Rail to supply traction and on-board power equipment.
  • Strategic acquisitions — as an example, it just acquired the Baldor group from the U.S. in an all-cash transaction.


Question 3: What about the valuation? Is the company cheap? Can you compare it to a few of the industry competitors?

The discussion here will be in two sections. The first one will deal with historical valuation of ABB and the second one will be across the industry. For this, I chose Siemens, UTX and GE who are in similar industries.

Let us look at the historical valuation of ABB.

Price/Earnings2001200220032004200520062007200820092010TTM
ABB-85.535.872.525.722.625.320.911.015.220.213.6
S&P 50023.219.721.119.217.216.816.510.918.615.513.5
Price/Book
ABB5.23.43.54.15.86.26.13.13.23.42.6
S&P 5003.32.53.13.12.92.92.71.72.22.22.0
Price/Sales
ABB0.50.10.30.50.81.62.31.01.41.61.2
S&P 5001.51.31.61.61.51.61.50.91.21.31.2
Price/Cash Flow
ABB5.448.3-38.57.816.719.521.58.610.912.39.7
S&P 50012.49.911.911.610.811.111.66.89.19.38.6


From the table it is easy to see that ABB is at the cheapest point it can be in the last decade, both in absolute terms and compared to S&P500.

Let us look at how cheap ABB is compared to its competitors.

ABB GESIUTXIndustry AvgS&P 500ABB 5Y Avg*
Price/Earnings13.61211.31413.413.518.5
Price/Book2.61.322.91.92.04.4
Price/Sales1.21.10.81.21.21.21.6
Price/Cash Flow9.74.98.311.18.68.610.6
Dividend Yield %3.83.72.92.52.62.31.7
Forward Price/Earnings10.39.78.611.8
PEG2.20.81.41.2


Compared to the industry, the valuation does not seem as cheap. There are different winners according to each metric. And on absolute terms GE might come out as a safer bet (from this table). But ABB looks quite undervalued itself.

Question 4: I am a dividend investor. What is the situation with ABBs dividend?

I will let the following chart do the talking (Swiss francs/share, 1 CHF=$1.1). The payout ratio in 2010 was 40%.

BA16TCeSH-AeOjP_nUM7QclcP-P7Kfzcz8u92ZZc

Question 5: How about the management? What are the insider holdings? Are they buying shares? Are they overpaid? Since when is the CEO on the job?

Whoa … easy there! Let me answer one by one.
  • Last year, insiders were paid around $35 million. The company made a profit of $2.5 billion. When one compares this to GE, SI or UTX, none of them seem out of line.
  • The CEO, Joseph Hogan, has been on the job since September 2008. Mr. Hogan was the CEO and president of General Electric's (GE) Healthcare unit from 2000 to 2008. From 1985 to 2000, Mr. Hogan held various positions at General Electric.
  • The insiders are not really buying substantial amounts of shares, but the executive committee together with the board of directors hold 2.5 million shares. This is not necessarily a strike against ABB though. GE has a 0.06% insider holding, while SI has 0% and UTX has 0.1%. For a company of this size, the insider holding generally is quite low. One of the insiders, Bernard Jucker, bought shares in February 2011 at around 22.48 CHF/share for a value of 240,000 CHF.


Question 7: Are there significant risks associated with the company?

Any investment has some risk associated with it. ABB is no different. But it has a very diversified portfolio and does business almost everywhere in the world. With such a strong balance sheet at the moment, I am not worried about the short-term risks. The company is well-positioned to execute its emerging market, renewable energy and acquisition based strategy.

Question 6: Do you have anything else to say?

  • Why yes! I am long ABB, have $400 worth of position which is now down 10%.
  • The data here has been taken from Morningstar, the company website and the company's financial reports.


Happy investing!

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.2/5 (40 votes)

Comments

cdubey
Cdubey premium member - 3 years ago
I feel that I should also make a note that I would consider buying ABB if it falls below $16.55/share.
Cornelius Chan
Cornelius Chan - 2 years ago
You were very sharp to purchase shares at ABB's depressed prices when it dropped last summer. I was unprepared during that last dip to invest in stocks - unfortunately.

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