1 Schneider Electric: Bird’s eye view of the business
Current price: $69.45
Buy below: $39
Schneider Electric, before 2000, was active in Electrical distribution and industry automation. After 2000, it started focusing on energy management and now serves customers around the world and has €22.4 billion in sales.
In simple terms, Schneider makes the delivery and usage of energy more efficient. It has solution for utility companies, industry, IT, infrastructure companies and building automation. It is easier to give some examples of projects which Schneider has completed to explain the end market better.
- ExxonMobil (NYSE:XOM) wanted to create a 1070 km pipeline to deliver the oil extracted from the south of Chad to maritime terminal of Kirbi in Cameroon. The pipeline required construction of 10 compression substations and Schneider supplied the entire electrical package. It also manages the electrical part of the substations and is responsible for fixing and upgrading them.
- NPDL is a joint venture created by Tata Power and Government of Delhi and delivers electricity to nearly 1 million customers with daily supply average of 17 BWH. NPDL wanted to localize faults and remotely operate switches to shorten the duration of network outages. Interestingly, they wanted to achieve this by solutions which were adapted for the existing network. The lack of skilled field staff to operate the remote terminal units also added to the complexity of the problem. Schneider did a bang-up job in this scenario. ABB was insisting on CDMA wireless technology with nearly 20 times operating expense compared to the GPRS installed by Schneider. Schneider also managed to reduce the downtime for the outages to only four hours against two days for Siemens.
- Samyoung, a beverage manufacturer from Korea, wanted to increase productivity and did not want to trade off the cleanliness of its manufacturing units. They wanted to keep a similar number of personnel and still have highest level of microbial safety. Being a natural company, it only used natural ingredients with no added preservatives. The shelf life and the safety of the beverage depends highly on the quality and cleanliness of the manufacturing process. These critical aspects of the problem necessitated a solution with efficient and stable hardware and process automation software that will monitor and control the continuous mix of fresh ingredients as well as proper sterilization of the aseptic equipments. Schneider installed two production lines with the same number of staff and same equipment. The plant is now twice as efficient and cost effective.
1.1 Capital Spending
The company has been able to transform its portfolio by keeping the capex nearly the same as a percentage of revenue during 2002 to 2011. The capex at Schneider has been around 4% of revenue since 2002. This when compared to Siemens (SIE) and ABB (NYSE:ABB) is still quite high. Siemens’ capex runs around 2.8% and ABB’s around 2.6%.
During the same time, i.e. 2000 to 2011, Schneider was able to diversify its global presence and increase the percentage of its revenue from emerging markets. The data can be seen from the picture below.
Given the growth in emerging markets, Schneider is positioned to grow revenues at a fast pace.
The revenue growth has been a compounded 10.6% in the last nine years. Last year, the growth was 14%. I do not expect the growth rate to be this high but the significant exposure of Schneider to emerging markets means that a growth rate in the high single digits can be expected in the times to come.
2 Financial Analysis2.1 Debt
The company continues to take additional debt, year after year. The debt as a percent of equity is 0.43. This is a bit lower than 0.55 for Siemens (SIE) and higher than 0.41 for ABB Ltd. (NYSE:ABB).
The group uses fixed rate debt and at Dec. 31, 2011, 81% of the Group’s debt was fixed rate. A 1% change in interest rates will have an additional burden of €12 million on the Group’s income.
I am quite comfortable with the balance sheet of Schneider. It seems that the debt is not too large and the interest expense is €331 million (2011). With €2.8 billion in operating income, the interest expense is well covered. The company also has €2.7 billion in cash as opposed to €6.9 billion in LT debt. If we look at the debt maturity, the company will have to roll over most of its due debt for the next few years, if it plans to pay its dividends.
The Group currently holds an A- credit rating from Standard & Poor’s and an A3 credit rating from Moody’s.
2.2 Shares Outstanding
The company has granted 40 million options to its employees and officers since 2000. The management has instituted plans to increase the employee shareholding in the company. Currently, employees hold 4.6% of the shares outstanding. The rest of the dilution, i.e. 45 million shares, is because the company keep buying and selling its Treasury shares as well as some extra shares to fund its operations. I don’t believe the company really needs it, but I am not sure why it keeps selling small amount of shares each year. In any case, the number is around 2% each year in total: 1% for share-based remunerations and 1% for funding operations.
The company has a dividend policy in place: It aims to pay 50% of its net income in dividend. Given the cyclicality of the operations, I do not expect the dividend to be increasing year after year in an almost linear fashion. A look at the dividends paid during the last few years confirms my theory.
|EPS (in €)||3.35||3.5||1.71||3.27||3.35|
|Dividend (in €)||1.65||1.725||1.025||1.6||1.7|
With increasing sales and incomes, I expect the dividend to increase at a satisfactory rate.
3 Risks3.1 Regulations The company operates in a partially regulated industry. Its products are sold in markets where the products subject to standards, both national and international. Furthermore, the company may face liability if one of its installed components causes damage to its customers.
3.2 Cyclical market The company operates in a cyclical industry. In a downturn, the operations of the company will suffer. The EPS will be down and the dividend will subsequently be also down.
3.3 Growth by acquisitions The company has a strategy of growing by acquisitions. In these cases, the company is at an increasing risk of destroying shareholder value and overpaying for acquisitions.
4 ManagementLet us look at the free cash flow and return on invested capital for Schneider.
Although the return on invested capital is not great, it is not bad either. The figure has been largely around 10.
Schneider and AXA have a cross shareholding agreement. AXA has to maintain a minimum of 1% shareholding in Schneider and Schneider has to maintain at least 0.4% of the AXA capital. Four members of the Supervisory committee have connections with AXA (they are either on the board of AXA or in the management). Furthermore, the previous CEO of Hewlett-Packard (NYSE:HPQ), Leo Apotheker is vice chairman of the supervisory board.
Given that AXA is an insurance company and Schneider is a respectable business, I do not know what is going on here. This does make me a bit cautious.
The CEO Jean-Pascal Tricoire has been with Schneider (or subsidiaries) since 1988. He has risen through the ranks and was made CEO in 2006. There is a very positive article about him and Schneider here.
Since Tricoire took over in May 2006, sales at the French conglomerate have risen 90% and earnings have more than doubled, to $2.5 billion in 2011.I did not find anything wrong with the compensation practices. At least the end results were reasonable. For example: The CEO was paid nearly €2 million in cash and €2 million in stock options.
Given the figures, FCF does not seems like a good way to measure the value of the company. Current market cap of €29.6 billion puts the FCF multiple at 20, which is quite expensive.
I would rather do a sales analysis of the company with conservative P/E ratio estimate. We make a conservative estimate of the value of the company, five years in the future.
Currently, the company has €23 billion in sales. At a conservative 6% compounded growth in revenue, after five years, we expect a revenue of €30 billion in 2016. A net margin of 8% will yield profits of €2.4 billion. At 12 P/E, the market will be willing to pay €28.8 billion for the company.
A compounded 2% share dilution will result in a share count of 600 million and a value of €48 per share. If we ask for a 10% capital gains then we should pay €30 a share.
6 ConclusionI like the company and its business. It is well managed and has a large exposure to the emerging markets. It has a good dividend policy of paying 50% of its net income and seems a reasonable candidate for buying shares.
The only problem is the price. The company is too expensive at the moment. I will feel comfortable buying below €30 a share (current price €54). Last year, the lowest the company was selling for was €37. It is unlikely to reach my buy price of €30 unless something severe happens with the world economy, France or to the company itself.
I need to be patient.