ABB: A Strong Performing Business With Potential AI Tailwinds (OTCMKTS:ABBNY)

Introduction

ABB (OTCPK:ABBNY) has had a strong share price return of 20% CAGR over the past 5 years. A continuation of this performance is unlikely to be sustainable, in my opinion. The share price has potentially reached the top without further P/E expansion. Using a discounted cash flow valuation, I believe ABB shares are currently fully valued, offering limited upside.

ABB has been firing on all cylinders; riding the trend of technological and operational advances in their respective fields.

Digging deeper into the business, it appears that Artificial Intelligence will be a key component in ABB’s future. In mid-2023, ABB announced its partnership with Microsoft (MSFT), which I will delve into in a moment.

Being an industrial supplier, ABB is a ‘picks and shovels’ type of play on the AI trend. Management recently noted in their annual presentation, “We already have over 100 AI-focused projects across the ABB Group”.

I like the idea of being the supplier of the ‘picks and shovels’ to ride the AI trend as diversification from the main AI players. The use of AI enables ABB to develop software and systems that enhance the capabilities of its products. Looking across the areas of operation, AI-enabled robotics, and autonomous control systems are the two business units that stand out as likely to be positively impacted by AI.

The collaboration with Microsoft is targeted at implementing generative AI capabilities in industrial applications to add value through insights from operational data. The early focus of this collaboration has been on incorporating Copilot into ABB’s ‘Ability Genix’ product. This product is designed to enable users who use the data to act faster with decisions in order to increase productivity and efficiency.

The collaboration between ABB and Microsoft also aims to provide advanced monitoring and optimization insights into industrial greenhouse gas emissions and energy usage. By analyzing data using generative AI, ABB’s customers can identify specific opportunities to reduce emissions, optimize energy consumption, and extend asset lifespan.

Revenue

In my opinion, ABB is conservatively managed; when they provide future guidance, they typically play it safe. Guidance for 2024 is 5-7% revenue growth across the business. Marginally lower than last year’s 9% performance. However, guidance is in line with the annualized revenue CAGR of 6.30% over the past 5 years. The order backlog of $21.6 billion for 2024 should enable management to comfortably meet guidance for the year.

The strong order backlog across the business is promising for 2024, showing resilience in weak sectors and strong growth in others. As ABB continues to innovate and expand its offerings, it is poised to capitalize on emerging opportunities such as AI. Robotics and discrete automation performed poorly in 2023 with revenues down 6% YoY. However, moving forward, I expect this business unit to show robust performance and potentially have the most to gain from AI integration.

Growth

The ongoing strategy for bolt-on acquisitions continued in 2023, with several businesses acquired to fuel growth across the business units. CEO Bjorn Rosengren noted key financial targets for 2024 have been raised with revenue growth to 5-7% and raised the operational EBITA margin target to 16-19%. Margin and earnings per share clearly demonstrated the growth performance of the business.

With all the recent hype around AI and Data Center growth; ABB is strategically positioned to seize the opportunity as a key supplier to this area of hyper-growth. The ongoing involvement in data centers positions them to grow this segment of the business through their various offerings.

Additionally, AI integration powered by Microsoft will be a key part of the story for ABB. A recent interview with ABB’s CEO reinforces this thinking:

“We are certain that generative artificial intelligence (AI) has tremendous potential for our business. We have already identified more than 100 AI-focused projects across our group. For example, our Robotics division produces AI-enabled robots with integrated vision, which can work safely and autonomously in warehouses. In our Process Automation business area, we continue to progress towards autonomous operations, for which AI is an important enabler. We also use AI for preventive maintenance and are working with our long-standing strategic partner Microsoft to unlock further customer value from operational data.”

Valuation

Using a discounted cash flow I will provide my analysis on valuation for ABB. The valuation is based on a blend of the normal, best, and worst case scenario for cash flow growth.

The following outlines my assumptions used within discounted cash flow.

In the worst case scenario, I have assumed 2% growth over 10 years with a 10% discount rate and terminal multiple of 10. This provides an intrinsic value of $22.96 USD in 2033.

The best case assumes a 15% growth over the next 5 years and 10% from year 5 to year 10, with a 10% discount rate and a terminal multiple of 23. The intrinsic value sits at $76.93 USD per share in 2033.

The normal scenario assumes 5% growth over the next 5 years and 10% growth over years 5 through year 10 with a 10% discount rate and a terminal multiple of 18. The terminal value in the normal scenario is $43.00 USD per share in 2033.

Applying probability to each scenario, the following table summarizes the data to demonstrate a discounted cash flow valuation for ABB of $43.77 USD per share. Indicating a current overvaluation of approximately 8%.

Relative Valuation

As far as valuation goes, ABB is in line with its peers. The secular trends of electrification and automation continue to push share prices in this sector to new highs. Cash flow is strong, with ABB currently leading the pack with $5.8 billion in cash on the balance sheet. Furthermore, debt standing just shy of $9 billion is very reasonable; typical of a diligent management team watching the top and bottom lines.

Looking at the forward multiples, we can see that ABB is valued at a P/S ratio of 2.55, the lowest among its competition. With a forward P/B of 6.53 ABB is pushing the upper end relative to its peers. However, the cyclical nature of this sector has driven the valuations of the peer group ever higher.

To tie the above information together and provide another reference point I will use Seeking Alpha’s Quant rating. ABB is currently rated a Buy, with a notable A+ for profitability. Supporting data from the latest financial year puts Return on Capital Employed (ROCE) at 21.1%, a sector-leading performance. However, valuation and growth both receive a low rating from the Quant with a D and C+ grade, respectively. The Quant rating aligns with my analysis for valuation.

Competitors

Competition is fierce in this industry. ABB and its competitors continuously face challenges to gain market share. Healthy competition from companies such as Rockwell Automation (ROK), Eaton (ETN), Schneider Electric (OTCPK:SBGSF), and Emerson Electric (EMR); some of the largest players in this industry. With most having an extensive history of technological advances capturing market share by segment or geography. All of ABB’s competitors operate internationally and operate to varying degrees in the same sectors.

Share price performance for ABB has been strong in comparison to peers. However, Eaton has led the way in this regard with a 5-year share price growth of 291%.

Shareholder Returns

ABB’s share price has grown 100% over the past 10 years, and shareholders have been rewarded through buybacks and dividends. Additionally, a new $1 billion share repurchase was recently announced, continuing management’s commitment to shareholder returns.

The dividend is well covered at an expected 48% forward payout ratio, aligned with Management’s progressive dividend policy. Share repurchases are another method management has chosen to distribute excess cash flow to shareholders. Over the past 10 years, management has returned over $29 billion to shareholders through dividends and share repurchases.

Additionally, ABB has previously noted its intent to separate ABB Mobility into a separate listed company. In February 2024, outgoing CEO Bjorn Rosengren (retirement in July 2024) noted on the conference call “I would be surprised if we would make the IPO during this year. I think it’s some headwind there in the markets. I think the financial market is not so good at this time, but also some headwinds in the market, especially in Europe.”

This postpones any sudden potential windfall ABB and shareholders may have been seeking in the short term.

Risks

China is a key market for ABB and over recent years, it has been a significant driver of growth across the business, but the outlook has deteriorated. China is forecast to be a headwind given the current macro conditions.

Leverage is a relatively small risk for ABB, with its outstanding $9 billion of debt.

Being a truly international business and ABB being a Swedish-Swiss company operating in Swiss Francs, the business and its shares are exposed to currency risk.

Sector Tailwinds: There’s no denying this sector has performed well over recent years, and this could continue to fuel growth for ABB beyond the conservative forecasts provided by management.

Resources – In particular, the lack of qualified and available human resources continues to be a challenge for ABB in the current low unemployment economy.

Conclusion

Solid, dependable, and safe are three words I would use to describe ABB, but at the current share price and with the forecast revenue growth of 5-7% annually, there’s not much room for further share price growth without P/E expansion, which is very much a possibility given sector growth.

The dividend yield, although small at 2%, is a moderate 51% trailing payout ratio, which I expect continued growth, as per management’s capital allocation strategy. Additionally, the newly announced $1 billion available for share repurchases will bolster shareholder returns.

There’s not much to dislike about ABB. They are clearly a well-run, albeit conservative company. They operate in a growing sector with strong tailwinds. AI could become a key component of future growth; I believe the partnership with Microsoft is very positive. How AI will grow the business for ABB is still to be determined. In my view, AI will provide iterative improvements in ABB’s existing business, but I remain unconvinced of any blockbuster advancements as a result of AI integration. I will continue monitoring the progress of the AI initiatives and its various applications within ABB’s business as the year progresses.

A key takeaway for ABB investors is to be cognizant of the current valuation when making new investments in this company. Existing shareholders should be pleased with the recent share price performance. The business continues to improve and secular trends show no signs of abating. I like ABB as a business and I intend to keep track of their progress. The current valuation, however, is less appealing. I rate the shares a Hold.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.