ABB's Q3 Earnings Beat Estimates, Macro Issues Remain

ABB Ltd. (NYSE:ABB) reported operational earnings per share of 32 cents, down 1% year over year. Steady revenues and diligent cost-saving initiatives helped maintain earnings; however, it was more than offset by tough macroeconomic and geopolitical conditions which ultimately affected revenues. However, earnings beat the Zacks Consensus Estimate of 28 cents.

Quarterly revenues were down 3% year over year, and came in at $8,255 million, lagging the Zacks Consensus Estimate of $8,364 million. All round weakness and declines in such segments as mining and oil and gas proved to be headwinds, more than offsetting steady execution of a healthy order backlog in the Power Grids space. Individually, revenues took a beating in all the four segments of the company, thus dragging the overall top line.

Revenue by Segments

Discrete Automation & Motion (down 1% to $2,203 million): Sales remained steady on strong order execution; however orders of this segment declined 5% to $2,123 million on a year-over-year basis. Declining capital expenditures in process industries, including oil and gas, hurt the order performance of this segment.

Electrification Products (down 2% to $2,308 million): Unfavorable demand pattern and lower orders in key end markets affected revenues. Orders were down 6% year over year to $2,223 million on account of persistent poor performance in the Americas and AMEA region.

Process Automation (down 8% to $1,523 million): Revenues were down in this segment, particularly due to declines in discretionary spending in oil & gas and related sectors. Orders plunged 22% to $1,193 million, owing to lower capital spending in process industries and constrained discretionary spending in process industries.

Power Grids (down 6% to $2,636 million): Currency fluctuations and adverse timing of orders dragged the revenues. Orders were down 22% to $2,391 million mainly due to the timing of large order awards and sluggishness in markets like the U.S., Saudi Arabia and Brazil.

Total orders fell 14% year over year to $7,533 million and were down 13% on a comparable basis. Base orders shrunk 3% on a year-over-year basis, while the number of large orders was lower across all divisions. Timing of large order awards and lower short-cycle volumes were responsible for the fall.

On a geographic basis, European countries, namely Germany, Italy, Sweden and Switzerland witnessed order growth, slightly offset by order declines in the U.K. and Norway due to the Brexit referendum. Orders declined in the U.S. largely due to significant investment delays triggered by the U.S. election and sluggish industrial demand. The Asia, Middle East and Africa witnessed a mixed performance with order improvements in India, which somewhat offset order declines in China and the UAE.

Book-to-bill ratio at the end of the third quarter was 0.91, down from 1.03 in the comparable quarter a year ago.

Operational earnings before interest, taxes and amortization (“EBITA”) in the quarter under view slid 3% year over year to $1,046 million.

Next Level Strategy: Stage 3

At the end of the quarter, ABB launched the third stage of the revamped version of its “Next Level Strategy” which focuses on three areas, namely profitable growth, relentless execution and business-led collaboration. This stage calls for restructuring ABB’s divisions into four market-leading entrepreneurial businesses, unlocking ABB’s full digital potential, increasing momentum in operational excellence and boosting the company’s brand.

ABB will restructure its business into four segments: Electrification Products, Robotics and Motion, Industrial Automation and Power Grids, and the same will be effective from Jan 1, 2017. Further, in order to unlock its digital capabilities, ABB announced a strategic partnership with Microsoft Corporation (NASDAQ:MSFT) , to shore up its capabilities in the industrial internet market, by combining cloud technology with industrial digital technology. Together, the companies will develop next-generation digital solutions on an integrated open cloud platform.

Moreover, ABB is optimistic about its White-Collar Productivity savings program, which has surpassed expectations since its launch. Consequently, the company has raised the cost-reduction target under the program by 30% to $1.3 billion. Another transition that the company is launching is to adopt a single corporate brand, by consolidating all its brands across the world under one umbrella.

ABB LTD-ADR Price, Consensus and EPS Surprise

Liquidity & Cash Flows

ABB’s cash and cash equivalents as of Sep 30, 2016 were $3,538 million compared with $3,970 million as of Sep 30, 2015. Total long-term debt fell to $6,319 million at the quarter end, from $5,985 million as of Dec 31, 2015.

ABB’s cash flow from operating activities came in at $1,081 million for the third quarter compared with $1,173 million in third-quarter 2015. The decline was primarily attributable to lower net income.

Divestitures and Partnerships

During the quarter, ABB decided to sell its global high-voltage cable system business to NKT Cables in a deal worth $934 million. The high-voltage cables unit is part of ABB’s $11.6 billion Power Grids business. High voltage cables are the key components in sustainable energy networks.

ABB and NKT Cables have also signed an agreement for a long-term strategic partnership, under which they will work together on future projects, in areas like sub-sea interconnections and direct current transmission links.

ABB considered the offloaded unit as a niche business, which had been improving in recent times. However, ABB is facing what will likely be the end to Europe's offshore wind-power boom years, as the industry grapples with shrinking investments and uncertainty over future subsidies.

At the heart of it, the cables deal is part of ABB’s active portfolio management and will make the core power grids business simpler, stronger, and more focused.

Alongside, ABB also announced two important partnerships. It inked a partnership deal with engineering and construction firm, Fluor Corporation (NYSE:FLR) . The deal was signed to cater to the growing needs of power grids worldwide for safe, dependable and state-of-the-art electrical substations. Through the strategic partnership, ABB and Fluor will execute large turnkey engineering, procurement, construction (“EPC”) electrical substation projects.

Further, ABB formed an agreement to partner with Aibel to deliver offshore wind integration solutions. Per the contract, Aibel will be responsible for turnkey EPC services for the design, construction, installation and commissioning of the offshore platforms, while ABB will focus on high-voltage direct current technology.

Per ABB, the two new alliances, in addition to greater focus on higher-margin consultancy services and software, will help elevate the Power Grids unit’s margin target to 10-14% (up from a previous target of 8-12%).

Share Repurchase

During the quarter, ABB declared the completion of the $4-billion share buyback program introduced in Sep 2014. Under the program, the company repurchased approximately 171.3 million shares for about $3.5 billion.

Consequently, ABB announced a new share buyback program of up to $3 billion from 2017 through 2019.

To Conclude

ABB’s third-quarter earnings suffered from the uncertainties plaguing the process industries, from which the company derives a significant portion of its profits. Lower capital spending for ABB’s key upstream energy end-markets is likely to hurt its financials, at least in the near term. The energy markets are not expected to stabilize before 2017, thus dampening ABB’s short-term prospects. Additionally, softness in industrial production and the projected slowdown, particularly in the emerging markets, are adding to the company’s woes.

Despite the negatives, we believe that the company’s long-term growth prospects are stable. The company’s three major customers in utilities, industry, and transport & infrastructure are likely to drive growth. Apart from this, positive development in electricity value chain, rapid progress of Internet of things, services and people and a surge in energy-efficient transport and infrastructure bode well.

Stocks to Consider

Another company in the same space as ABB is AO Smith Corp. (NYSE:AOS) , carrying a Zacks Rank #2 (Buy). This commercial and residential water heating equipment manufacturer has a robust earnings beat history, with an average positive earnings surprise of 5.4% over the trailing four quarters, beating estimates all through.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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