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ABB's Q2 Earnings Beat Estimates but Fall Y/Y, Shares Down

ABB Ltd. ABB reported operational earnings per share of 30 cents, down 14.3% year over year, but beating the Zacks Consensus Estimate of 29 cents by 3.4%. Steady revenues and diligent cost-saving initiatives helped maintain earnings. However, this was more than offset by tough macroeconomic and geopolitical conditions which ultimately affected revenues.

Investors were disappointed with the year-over-year earnings contraction and ABB’s shares were down 3.7% at one point in pre-market trading.

Quarterly revenues were up 1% year over year and came in at $8,454 million. Individually, revenues witnessed growth in two of the four segments of the company, with growth in Electrification Products and Robotics and Motion, more than offsetting flat Power Grids growth and contraction in Industrial Automation revenues. However, revenues lagged the Zacks Consensus Estimate of $8,593 million.

Revenue in Segments

Electrification Products (up 2% year over year in comparable terms to $2,509 million): Orders were down 1% year over year to $2,512 million, as positive orders in Europe were more than offset by a decline in the Americas and AMEA.

Robotics and Motion (up 5% to $2,087 million): Sales grew steadily on strong demand trends in robotics and the light industry. Orders of this segment moved up 14% year over year to $2,219 million on a year-over-year basis, driven by continued strong demand patterns in robotics and light industry.

Industrial Automation (down 7% to $1,608 million): Revenues remained on a downtrend in this segment, particularly due to declines in discretionary spending in oil & gas, and related sectors. Orders reversed the recent negative trend, rising 8% year over year to $1,499 million, owing to selective capital expenditure investments in oil & gas and in mining. Lower capital spending in process industries and constrained discretionary spending in process industries continue to harm this segment.

Power Grids (flat at $2,647 million): Steady execution of a healthy order backlog and solid project execution kept revenues steady. However, orders declined 6% to $2,484 million mainly due to the timing of large contract awards.

Total orders were flat year over year at $8,349 million and increased 3% on a comparable basis, as the noteworthy increase in Robotics and Motion and Industrial Automation more than offset the decline in Electrification Products and Power Grids. A stronger U.S. dollar resulted in a negative currency translation impact of 3%. Base orders grew 3% on a year-over-year basis, while large orders grew 5%. The order backlog at quarter end amounted to $23.6 billion (down 1% year over year).

On a geographic basis, demand was positive in the European countries, with moderate overall growth and good timing of large capital investments. Orders displayed sound growth in the Americas as well, driven by increased demand for automation and energy efficient solutions. The U.S. grew 7% in total orders, offsetting decline in Canada. The Asia, Middle East and Africa (AMEA) witnessed mixed performance, with substantial order growth in India, Saudi Arabia and South Africa, which were offset by order declines in China.

Book-to-bill ratio at the end of the second quarter was 0.99, up from 0.96 in the comparable quarter a year ago.

Operational earnings before interest, taxes and amortization (“Operational EBITA”) in the quarter under review fell 5% year over year in comparable terms to $1,042 million. The figure was hurt by commodity price increases and overcapacity in some businesses.

Next Level Strategy: Stage 3

In third-quarter 2016, ABB had launched the third stage of the revamped version of its “Next Level Strategy” which focuses on three areas, namely profitable growth, relentless execution and business-led collaboration. This stage calls for restructuring the company’s divisions into four market-leading entrepreneurial businesses, unlocking its full digital potential, increasing momentum in operational excellence and enhancing the company’s brand.

ABB restructured its business into four segments: Electrification Products, Robotics and Motion, Industrial Automation and Power Grids, effective from Jan 1, 2017. This restructuring will help in increasing its focus on higher growth segments, strengthening its competitiveness and de-risking the portfolio. Further, in order to unlock its digital capabilities, ABB had announced a strategic partnership with Microsoft Corporation MSFT, to shore up its capabilities in the industrial internet market, by combining cloud technology with industrial digital technology. Together, the companies will develop next-generation digital solutions on an integrated open cloud platform.

During the reported quarter, ABB continued the implementation of this strategy by shifting its core operations to higher growth segments, boosting its competitiveness and de-risking the portfolio.

Moreover, ABB is optimistic about the White-Collar Productivity savings program, which has surpassed expectations since its launch. The company is on track to achieve the cost-reduction target under the program of $1.3 billion within the decided timeframe. Also, ABB now expects to incur about $200 million lower combined restructuring program and implementation costs than initially expected. The company is currently implementing its regular cost-savings programs to achieve savings equivalent to 3–5% of cost of sales each year.

ABB Ltd Price, Consensus and EPS Surprise

Liquidity & Cash Flows

ABB’s cash and cash equivalents as of Jun 30, 2017 were $5,018 million compared with $3,644 million as of Dec 31, 2016. Total long-term debt rose to $6,909 million at the quarter end from $5,800 million as of Dec 31, 2016.

ABB’s cash flow from operating activities came in at just $467 million for the second quarter compared with $1,082 million in second-quarter 2016. The decline reflected the delay of short-term incentive payments, timing of tax payments and delays in payment from the Middle Eastern customers.

Divestitures and Partnerships

During third-quarter 2016, ABB decided to sell its global high-voltage cable system business to NKT Cables in a deal worth $934 million. ABB and NKT Cables also signed an agreement for a long-term strategic partnership, under which they will work together on future projects, in areas like sub-sea interconnections and direct current transmission links.

ABB considered the offloaded unit as a niche business, which had been improving in recent times. However, the company is facing what will likely be the end to Europe's offshore wind-power boom years, as the industry grapples with shrinking investments and uncertainty over future subsidies. At the heart of it, the cables deal is part of ABB’s active portfolio management and will make the core power grids business simpler, stronger, and more focused.

Alongside, ABB also announced two important partnerships. The company signed a partnership deal with engineering and construction firm, Fluor Corporation FLR. Through the strategic partnership, ABB and Fluor will execute large turnkey engineering, procurement, construction (“EPC”) electrical substation projects. Further, ABB formed an agreement to partner with Aibel to deliver offshore wind integration solutions.

Per ABB, the two new alliances, in addition to greater focus on higher-margin consultancy services and software, will help elevate the Power Grids unit’s margin target to 10–14% (up from a previous target of 8–12%).

On Jul 6, ABB closed its acquisition of B&R — an independent provider dealing in product- and software-based, open-architecture solutions for machine and factory automation globally. This buyout will bridge the gap in machine and factory automation which ABB has been facing, and will create an exclusive, comprehensive automation portfolio for clients across the world. ABB expects this acquisition to be accretive to earnings in the first year.

Further, on Jul 3, ABB announced that it has agreed to acquire data transmission business of the KEYMILE Group. This buyout will enable the company to expand its communication networks business footprint in the industrial, transportation and infrastructure domains. It will add reliable communications technology offerings to ABB’s diverse portfolio, helping it fortify its foothold in digital electrical grids.

These buyouts will help accelerate ABB’s operational momentum.

Share Repurchase

At the end of third-quarter 2016, ABB declared the completion of the $4-billion share buyback program introduced in Sep 2014. Under the program, the company repurchased approximately 171.3 million shares for about $3.5 billion. Consequently, ABB had announced a new share buyback program of up to $3 billion from 2017 through 2019, highlighting consistent strength in cash generation and financial position. The company also cancelled 46.6 million shares this month, which will be reflected in the third quarter.

To Conclude

ABB is facing a mixed macroeconomic and geopolitical climate, as the U.S. and China remain buoyant amid modest global growth and heightened uncertainties. Lower capital spending for the company’s key upstream energy end-markets and foreign exchange volatility will likely continue to hurt its financials. The company is vulnerable to increased uncertainty, stemming from the Brexit decision, as well as geopolitical tensions elsewhere in the world, which are overshadowing global markets.

Despite the negatives, we believe that the company’s long-term prospects are stable. The company’s three major customers in utilities, industry, and transport & infrastructure are likely to drive growth. Apart from this, positive development in electricity value chain, rapid progress of Internet of things, services and people and a surge in energy-efficient transport and infrastructure bode well.

Zacks Rank & Stocks to Consider

ABB currently carries a Zacks Rank #3 (Hold). A better-ranked company in the same space as ABB is Eaton Corporation, PLC ETN, carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Eaton has an impressive earnings history, with a positive average surprise of 3.3% for the four trailing quarters, driven by three beats.

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