Why ABB India investors are jittery on ABB-Hitachi deal
ABB India shares have fallen 6.7% since AAB AG’s decision to sell its global power grid business to Japan’s Hitachi for $11 billion
ABB India Ltd’s investors are jittery about the parent firm ABB AG’s decision to sell its global power grid business to Japan’s Hitachi for $11 billion. ABB India shares have fallen 6.7% since the news became public. Indian investors’ fears are not unfounded. After all, the power grid segment comprises 40% of the Indian arm’s annual revenue and 30% of Ebit (earnings before interest and taxes). Also, there is still scope for growth in the domestic power segment, where ABB had carved out a strong name for itself. And profit margins have been inching up over the last few quarters, even though they remain lower than some other segments.
But then, investors must know that revenue and profits from the India operations are a minuscule part of the global business. At the group level, the Hitachi-ABB deal may be more meaningful.Announcing the deal, ABB spelt out a road map that would chart a new course in industrial automation, electrification, robotics and automation. Analysts said that in mature markets, the power transmission and distribution (T&D) business has limited incremental growth opportunities both in terms of orders and profits. From a technology-driven solutions business earlier, it is now a converter of raw material into finished goods, where there’s hardly any upside in margins.
Besides, shareholders of the parent firm would see near-term gains as it intends to return 100% of the estimated net cash proceeds from the sale to shareholders through a share buyback or another similar mechanism.
Considering the contribution of the India power grid business to the group is small, it is uncertain if such gains would accrue to domestic shareholders. From the perspective of restructuring, the group’s new focus areas are in a nascent growth stage in India. So, it may be a while before revenue and profit reach meaningful scale. But, will these business segments be able to make up for the exit of the power grids segment from revenue and profits?
Fortunately, the new businesses have delivered better returns on capital employed, between 40-50%, compared to the T&D segment which hovers around 15%. But this does not ease concerns on volatility in profitability in these segments.
According to Emkay Global Financial Services: “given the sluggish pick up in domestic private sector capex, we should expect near-term volatility in revenues and profitability in ABB India, especially if growth fails to accelerate in the industrial segments in the next 12-18 months”.
ABB India’s share price of ₹1,336 discounts the FY20 estimated earnings by 35 times. Indeed, the restructuring is well-timed and hopes to take advantage of new growth areas. But, it may take investors a while to have faith in the earnings prospects of the firm, in the absence of a key business segment.
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