Energy
ADR Watch: ABB Group
 By Vasu Vijayraghavan
RealMoney contributor
3/27/2008 2:58 PM EDT
URL: http://www.thestreet.com/p/rmoney/energy/10409583.html

During uncertain times in the financial markets, many people are looking for defensive plays. Swiss power infrastructure company ABB (ABB) could provide your portfolio some stability.

The company, which sports a market cap of $57 billion, provides support structure for electricity transmission and distribution in such key markets as China and India. The International Energy Agency says that electricity generation should grow at an average annual rate of 4.9% per year in those countries until at least 2030.

ABB, which has gradually climbed out of near-bankruptcy since 2002, has a particularly rosy future given the projections of the IEA for electricity generation growth until 2034 (according to IEA's Energy Outlook 2007).

World Electric Power Generation
2004 to 2030
Click here for larger image.
Source for 2004: Energy Information Administration's International Energy Annual 2004; projections: EIA, System for the Analysis of Global Energy Markets (2007).

ABB's stock has grown consistently for the last two years, as can be seen from the following graph, with one- and two-year returns of 43% and 45%, respectively.

ABB vs. Siemens
Click here for larger image.
Source: Yahoo! Finance
One of its main competitors in power transmission is German conglomerate Siemens (SI) , which is restructuring its divisions in an attempt to recover from bribery allegations and antitrust investigations that cost the company 843 million euros in 2007.

The company is also revising its 2008 earnings downward by 900 million euros. As a result, its one- and two-year stock returns have been particularly unappealing, at 7% and 15%, respectively, and although its earnings growth for 2007 was 17%, this was largely due to a capital gain of 5.4 billion euros on the sale of its automotive divisions.

ABB's relative valuations are also strong, at a PEG of 0.74, slightly higher than Siemens' 0.46.

ABB has also had its slew of problems, but compared to Siemens, its problems seem to be those of growth. Its CEO was forced to resign due to his purported conservatism in contemplating new acquisitions given that the company is flush with cash. And in a relatively recent development, ABB, along with eight other Swiss firms, is the object of an investigation alleging violation of Swiss embargo laws in dealing with Saddam Hussein's government.

These developments notwithstanding, the basic potential for this company can be shown from the following table, which provides some basic comparative metrics with the Siemens. Profit margins and new order growth are reported for ABB and Siemens' Power and Transmission Distribution (PTD) group, but the other statistics concern consolidated results between the two companies. All figures are from the 2007 20-F reports for the two companies.

ABB Siemens
EPS Growth 155% 17%
Profit Margins 13% 8.5%
R&D/Revenues 3% 4.7%
Cash/Current Assets 20% 8.4%
Debt/Capitalization 23% 53%
Return on Equity 32% 14%
New Order Growth 27% 23%

In fact, while the above figures look impressive -- especially the strong ROE, low debt to equity and strong earnings growth -- the earnings growth doesn't represent just a blip this year. While important projects, such as the order that would provide support to a 2,400-megawatt power superhighway from western China to the industrialized coastal areas, are important in explaining 2007 earnings, 2007 is not an exception.

Since climbing out of negative earnings territory in 2004, the company's earnings have grown by an average of 558% per year between 2003 and 2007. Moreover, as the following table shows, both new order growth and order backlog growth have been pretty uniform over the company's five divisions.

(Robotics represents an interesting if minor offshoot: It should be noted that the company is heavy into new R&D, having engaged in a five-year commitment with MIT, to the tune of $5 million to do research into nanofluids, power electronics and intelligent robotics.)

Segment % of total revenues New order growth Order backlog growth
Power products 31% 29% 43%
Power systems 18% 35% 45%
Automation products 27% 21% 43%
Process automation 20% 21% 49%
Robotics 4% 20% 20%

It's difficult to think of another company that reports such robust results in all its segments in such a uniform way. What's also impressive is that, on geographical terms, order grew strongly in Europe and Asia, by 29% and 41%, respectively.

This company occupies an important niche in a sector with bright prospects, and despite its troubles, I have no hesitation in asserting that ABB is a strong long.

At the time of publication, Vijayraghavan was long ABB Group.

Vasu Vijayraghavan was an academic finance professor at the University of Paris who has now turned to a new career as a financial consultant. As an academic, she wrote on corporate governance issues, especially in the European context, and she believes in a long-run and balance sheet approach to stock picking.

Currently, Vijayraghavan is working as a consultant for lawyers, doing business valuation. She is a Level II CFA candidate and enjoys writing long/short and earnings calls pieces for TheStreet.Com.

Vijayraghavan holds a Ph.D. from the University of Michigan and a B.A. from Harvard University.