Operational Improvements Will Support Structurally Higher Profitability at ABB; FVE Slightly Raised

We raise our fair value estimate to CHF 36.5 from CHF 35.0 per share for wide-moat ABB ABBN, underpinned by its shift toward a decentralized business model that will support structurally higher profitability and better reflects its underlying competitive advantages. The appointment of CEO Bjorn Rosengren, a turnaround specialist, has coincided with an increase in profitability through improved cost measures and active portfolio management. Shares are trading at a slight discount to our revised fair value estimate, but we require a greater margin of safety, especially since both Siemens and Schneider enjoy a superior outlook.

Nevertheless, ABB’s products will benefit from secular themes such as the energy transition, increasing automation, and the reshoring of manufacturing production. We estimate annualized revenue growth of 4.5% between 2024 and 2027. While its products are rich in software content, ABB does not have its own in-house design and simulation software that has likely contributed to lower growth rates than its peer group. We expect ABB will comfortably exceed its 16% EBITA margin target in 2023, assuming a 160 basis point improvement versus 2022 to 16.9%, due to its strong pricing power and improved operational performance within each of its 20 decentralized businesses. However, given the magnitude of some of the price increases in certain operating segments, we don’t anticipate any meaningful margin expansion during our forecast period beyond fiscal 2023.

ABB has been the most generous in terms of capital return compared with its peers, opting to return capital to shareholders rather than making acquisitions. The easing of supply chain constraints and execution of its order backlog will allow the reversal buildup of inventories, supporting improved free cash flow conversion. We model $1 billion of share repurchases during 2023 but given ABB’s strong balance sheet see further upside through additional capital return.