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Is ABB a Buy?

Lee Samaha, The Motley Fool

Following a series of earnings reports from the electrical equipment supplier's peers, it's time to reassess whether ABB (NYSE: ABB) stock is a buy. The company will attract value investors due to its near-4% dividend yield and the turnaround prospects following a change of management amid major restructuring activity, but is it all enough to warrant buying the stock?

ABB faces significant changes

Frankly, I think the answer is no, and here are the reasons why.

The first relates to the risk inherent in the changes that ABB is undertaking. When investors think about a company, they commonly assess three related factors. The first is its strategic end markets -- is the company in growth markets or not? The second is operational considerations -- how does the company compete within an industry? The third is its administrative function -- how is the company managed in order to maximize shareholder return?

Usually, when investors are looking at a restructuring business, they are focusing on one of these factors, but the problem with ABB is that all three of these aspects of the company need assessing.

Industrial automation in the food and beverage industry.

Image source: Getty Images.

Strategic end markets

There's little doubt that ABB operates in some attractive markets. The divestiture of 80.1% of its underperforming power grids business to Hitachi for $11 billion will see the company refocused on industrial automation, electrification products (electrical products from the substation to the consumer), motion (motors for automation), and robotics and discrete automation.

In general, the idea of investing in automation is a good one and plays on the increasing use of automated manufacturing as well as growth in the Industrial Internet of Things (IIoT) alongside exciting technologies such as "digital twins."

In fact, as part of its changes, ABB is committed to focusing on digital solutions and has entered a global partnership with Dassault Systemes (NASDAQOTH: DASTY) to offer digital twin-related software solutions.

That's good news for the long term, but before ABB gets there, it's going to have to get through a tricky period of possible weakness in end demand. For example, key automation rivals such as Rockwell Automation (NYSE: ROK) and Emerson Electric (NYSE: EMR) both lowered full-year sales and earnings guidance in their recent earnings presentations. Moreover, as industrial production growth slows in 2019, there's likely to be more pressure on companies to moderate spending on discrete automation. ABB could face challenges at a time when it needs to restructure.

Operational performance

An indication of the deterioration in ABB's performance can be seen in the earnings before interest, tax, and amortization (EBITA) figures from the first quarter of 2018. On a segmental level, each of the previously repowered segments saw flat or declining EBITA and EBITA margin.

HSBC analyst Michael Hagmann asked about the subject on the earnings call, and interim CEO Peter Voser candidly defined the problem as one of "the operational sharpness, the productivity was not entirely to what we were planning when we went through all these stages."

ABB Segment

Operational EBITA Q1 2019

Operational EBITA Q1 2018

Operational EBITA Margin Q1 2019

Operational EBITA Margin Q1 2018

Electrification products

$377 million

$377 million

12.4%

15.2%

Industrial automation

$226 milliom

$262 million

13%

14.1%

Robotics and motion

$337 million

$338 million

15.1%

15.3%

Total

$766 million

$752 million

11.2%

11.7%

Data source: ABB presentations.

Voser's commentary is indicative of the challenge ahead. As you can see below, ABB's margin sits right at the bottom of its peer group.

ABB EBITDA Margin (TTM) Chart

ABB EBITDA Margin (TTM) data by YCharts.

Time to take the red pill

And say goodbye to the matrix. I'm referring to management's decision to ditch its long-established matrix structure in favor of a traditional organizational pyramid. In a so-called matrix structure, an individual or business unit can report to a number of different leaders rather than to one immediate superior. ABB believes the change will improve performance and lead to $500 million in efficiency gains.

That's the good news. However, as Voser pointed out on the earnings call, the company:

needs a different culture. That needs empowerment. That needs people to understand that when they take decisions, they're also accountable for it. That was never the structure which ABB had for the last, say, 15 or 20 years.

Such root-and-branch administrative changes are not going to come without upheaval and friction. Moreover, management already has its hands full. For example, ABB is already in the process of changing its business structure in shifting toward operating out of four business segments, digitalizing its business, and integrating the acquired General Electric Industrial Solutions business. Meanwhile, it doesn't yet have a permanent CEO in place.

Time to buy ABB stock?

A glass-half-full view highlights the potential for improvement. However, a more realistic approach sees ABB coming under pressure from weakness in its end markets precisely at a time when its operational structure needs improving and management is undergoing a major overhaul of how the company is run. And all of this is happening without a permanent CEO in place yet. What could possibly go wrong?

Cautious investors might want to wait until a new CEO is appointed before considering diving in, because ABB has a lot of heavy lifting to do in the coming years. Frankly, the stock continues to look like one worth avoiding for now.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Dassault Systemes. The Motley Fool has a disclosure policy.