On the face of it, there's a lot for investors to like about ABB (NYSE: ABB). The company's eye-catching yield stands at 4.38% at the time of this writing, and will attract income-seeking investors. Moreover, there's a classic value investment case for the stock based on the idea that management can release value in its collection of businesses. Does it all add up to make the stock a buy?
The case for buying ABB stock
First, let's take a look at the company's performance by segment for the first nine months of 2018.
The company's robotics and motion segment is performing well -- comparable revenue up 7% in the first nine months -- and is pretty much in line with peer Rockwell Automation (NYSE: ROK) -- a company known for being a growth stock in the industrial automation sector.
Industrial automation can catch up to its peers
Meanwhile, the industrial automation segment's paltry 1% comparable revenue growth in the first nine months is considerably below the 10% underlying sales growth produced by Emerson Electric (NYSE: EMR) in its automation solutions segment for its recently reported full year. Emerson is also forecasting its automation solutions segment to grow underlying revenue at 5%-8% in its fiscal 2019.
As we shall see later, ABB's industrial automation segment isn't directly comparable to Rockwell's and Emerson Electric's (which partially explains the growth gap), but looking at this forecast, it's hard not to think that end-market conditions are favorable and that therefore ABB has a big opportunity to improve its performance.
Electrification products and power grids to add value
Though robotics and motion and industrial automation offer growth (theoretically at least) due to end markets, the electrification products segment is seen as a steady cash cow that has earnings growth opportunities from industry consolidation. For example, the deal to acquire GE Industrial Solutions (GEIS) offers a chance to boost revenue and increase GEIS margin to the levels achieved by Eaton and Schneider Electric.
Finally, hedge funds have long made the case that ABB's ailing power grids segment should be spun off or sold so that management can focus its efforts on the growth opportunities in the other three segments. Therefore, it's not surprising to see press speculation that ABB is receiving advice on just such an option.
To sum up, the bull case isn't based on the company that ABB is right now, but rather on what it could become if management executes better in industrial automation, increases margin in electrification products -- with existing business and GEIS -- and explores strategic options with power grids. Meanwhile, you'll get a 4.38% dividend yield while you wait for management to improve the company's prospects.
Power grids might not be separated
The bear case for ABB argues that the company is currently underperforming and there's no guarantee that any of the factors outlined above will come to fruition.
The speculation over a sale or spinoff of power grids doesn't mean anything will come of it. Furthermore, any such action would also represent something of an about-face by management since it conducted a strategic review of the segment in response to hedge fund criticisms. The review concluded that the better option would be to keep power grids and invest some more in the business in order to generate growth -- it doesn't appear to have worked.
Industrial automation and electrification products face headwinds
The idea that the industrial automation segment can be run better and ultimately catch up with Rockwell or Emerson Electric is somewhat flawed because, as CEO Ulrich Spiesshofer argued on the earnings call, "industrial automation has a very specific business model in ABB, which is also not really comparable to some of the competitors." In a nutshell, the segment partly acts "as a channel for the other parts" of ABB's business rather than solely generate stand-alone sales.
Also, the near-term outlook for industrial automation isn't very positive, with management expecting revenue to be "somewhat lower year on year" in the fourth quarter, according to CFO Timo Ihamuotila on the earnings call. In addition, Ihamuotila expects lower operating margin in the coming quarters.
Turning to electrification products, there are two causes for concern. First, Spiesshofer outlined that the segment was "more exposed" to the process automation industry (processing raw materials into products) than some of its competitors. Based on how Emerson (largely process automation) has been growing faster than Rockwell (discrete automation), that should be a good thing, but as Spiesshofer pointed out, the strong point of the industry has been in "North America in the unconventional onshore" oil industry, which is "not exactly ABB's sweet spot."
In other words, ABB's end-market exposure has been relatively weak in the current cycle -- at least compared to its peers'.
The second concern is that the GEIS acquisition may not turn out to be as earnings-enhancing as originally planned. Interestingly, management refused to give specific margin guidance on GEIS, and investors will have to watch closely to see if management maintains its guidance for 15%-19% margin in the overall segment by 2020.
Time to buy ABB?
Value investors looking for a collection of unloved stocks will no doubt be tempted to take a bite out of ABB stock, but for most other investors, it's probably just one to keep an eye on.
If management is committed to taking action over power grids and capitalizes on the opportunity at robotics and motion, then ABB may well turn into a buy, but with overall growth likely to slow in 2019 and ABB finding itself facing a combination of integration challenges (GEIS) and relatively poor end-market exposure in industrial automation and electrification products, there's also downside risk. ABB is worth avoiding.
10 stocks we like better than ABBWhen investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has quadrupled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and ABB wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of November 14, 2018