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ABB Looks Undervalued, Despite Recent Gains

NEW YORK (TheStreet) -- As with the product pipeline for big pharma companies and the "billings" metric in big data, investors in big industrial companies, such as General Electric (GE) and Honeywell (HON), that are leveraged to economically sensitive markets such as automotive and energy, understand that order growth is the lifeblood of their operations.

So it came as no surprise when shares of ABB (ABB) fell 5% following a disappointing July quarter. I say "disappointing" here because although ABB's year-over-year revenue rose 6%, which beat Street estimates by a decent margin, not to mention the 2% organic growth, investors were nonetheless disappointed by the 11% decline in orders, which missed Wall Street's estimates by roughly 9%. And it didn't help that process automation orders plummeted 21%.

Given what was -- at the time -- broad sector weakness, analysts were understandably alarmed. Even so, I believe the fact that weak orders were not a unique concern to ABB was reason enough to remain optimistic that management would turn the operation around. Not to mention, management had just delivered a 5% increase in operating income, with better-than-expected results in operating margin.

Essentially, despite ABB's revenue beat and the relatively solid performance in operating margin compared with other industrial giants such as Dover (DOV) and GE, that there were concerns about ABB's future seemed overdone. Fast-forward three months later, and not only has ABB stock gained close to 20% since the second quarter, but management just delivered an exceptional third quarter that reverses all prior concerns of weak orders.

I'm not going to toot my own horn here (too much), but there were plenty of reasons to believe that this rough patch for ABB was temporary. Not the least of which is that management had said as much, suggesting that its timing was a bit off with respect to customer delays. And with orders growing sequentially in almost every product category, ABB benefited from all that pent-up demand, which management hinted at.

Third-quarter base orders were up 5% year over year, compared with the 11% decline in the July quarter. From the standpoint of both automation and power segments, Europe was by far the strongest region, led by a 17% jump in Germany, with both France and Sweden posing growth of 14%. In the Asia region, China and India posted decent results, which helped offset weakness in the Americas where the U.S. was flat and Canada declined 16%.

On a segmental basis, every segment posted strong revenue results on a constant currency basis, led by a 13% year-over-year jump in process automation. It's hard to be disappointed when revenue was up at least 9% or higher in every part of the business. Interestingly, however, these numbers could have been even better. Management talked of some large delays due to project selectivity in the Power Systems business that reduced total orders.

While that can be interpreted as a disappointment, I see it as a positive. It was these sorts of timing issues in the July quarter that produced this strong of a quarter. On a related note, management had previously discussed strategies to expand long-term margins in the Power Systems business. Being more "selective" was cited as one of those strategies.

So essentially, although a "delay" may seem outside of management's control, don't rule out the possibility improved profitability remains at the forefront of these decisions. The other encouraging aspect about this quarter, even amid the order delays, is that the order growth dispels any notion that ABB is losing share to Honeywell. For that matter, given the struggles that Siemens (SI) has experienced recently, a case can be made that ABB's strong growth in some key markets has come at Siemens's expense.

All told, with strong operational EBITDA and cash-flow growth, it was an exceptional quarter for one of the more underrated industrial companies in the sector. That the stock is now trading near their 52-week highs suggests that the Street has begun to pay attention. But even with ABB's recent gains, given the long-term potential in the automation and power markets, I believe investors that are looking for industrial exposure can still do well here.

At the time of publication, the author held no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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