ABB India`s valuation is racing ahead of its earnings growth forecasts

ABB India Ltd’s shares have risen about 22% since end-February. It seems investors’ fear of a drop in revenue and profit, following the sale of parent ABB’s global power grid business to Japan’s Hitachi Ltd, have been allayed. Remember the shares had fallen about 13% when the blockbuster $11 billion deal was announced in December.

So, what has changed since February? One positive is that the Swiss-Swedish parent’s plan to sell the business through a demerger is now being seen as a transparent mechanism.

This eliminates the fear of undervaluation of the India business, since the subsequent listing of the demerged entity will have a market-determined valuation. A demerger also avoids high tax outflows, which would have occurred in the case of a direct slump sale.

A report by JM Financial Services Ltd cites the examples of Crompton Greaves (split into CG Power and Crompton Consumer) and Areva T&D (split into Alstom T&D and Schneider Electric) as precedents.

In short, the demerger would give investors an opportunity to stay invested with either or both entities post the demerger.

That apart, ABB India’s sharper focus on new areas, such as robotics and motion, digitilization and automation, will steer the company towards short-cycle orders. Such orders have lower risk from project delays and cost overruns.

To be sure, revenue may dip in the near term, as nearly two-fifths of total revenues accrue from the power grid business that will be demerged.

However, the remaining products and services business, where globally ABB has an edge over competition, is expected to deliver higher profit margins. Analysts, therefore, have forecast improved return ratios over the next two years.

Be that as it may, investor euphoria seems overdone given the earnings growth rate forecast of 20-22% over the next two years.

The company is confident of orders linked to efficiency improvement from existing units of cement, steel and other core sectors. There are also expectations of orders from urbanization and transportation segments within the public sector space and process industries in the private sector.

However, globally and on the home turf, there are signs of an economic slowdown, which could impact order flows adversely.

As of December, ABB India’s order book of ₹4,227 crore (excluding power) was less than one year’s revenue of about 7,000 crore, which raises pertinent questions on future growth.

All eyes will now be on the March quarter (first quarter of calendar year 2019; the company follows a January-December fiscal year) performance. Any shortcomings will puncture the rally in ABB India’s stock price and valuations.

Best Share Market News, Click Here To Get More News - Stock Market tips, for 2 Days Free Trial give a missed call @9644405057 and Get Share Market Services.