Sector Update | 6 December 2019
Digitalization/Automation + Exports + margin expansion:
Strong tailwinds outweigh near term blip in order inflow
Order inflows/revenue growth to rebound sharply as economy recovers
Products & services business has
grown at 11% CAGR over FY15-
19 at an aggregate basis (INRb)
Aggregate exports have risen at
CAGR of 10% over FY15-18
Aggregate exports as % of sales
has been on rise
Attractive digitalization/automation opportunity:
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% YoY in 4QFY19
(year ending September), while ABB’s order inflow growth decelerated to 5%
YoY in 3QCY19 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).
(b) Siemens’ exports (21% of
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).
(c) Honeywell’s exports (46% of FY19
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.
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.
Upgrading ABB to Buy; maintaining Buy on Siemens:
We upgrade ABB to Buy
with a TP of INR1,660. The pending demerger of the Power Grid business (likely
by Jun’20) has led to valuation correction. We maintain our
Siemens as well with a TP of INR1,705. That said, we prefer ABB over Siemens.
Honeywell is not rated.
Nilesh Bhaiya – Research Analyst
(Nilesh.Bhaiya@MotilalOswal.com); +91 22 6129 1556
Pratik Singh – Research Analyst
(Pratik.Singh@MotilalOswal.com) +91 22 6129 1543
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