>ABB LIMITED (JAYPEE CAPITAL)

We initiate coverage on ABB with a ‘SELL’ recommendation and a target price of INR 588 per share implying a downside of 15% from current levels. We expect ABB to generate strong revenues from power business due to robust spending planned in power generation resulting in robust demand for power equipments. However, the slowdown in industrial capex due to high cost of borrowings and limited access to capital will drag the project business putting greater strain on the financials of ABB.

Power business going from strength to strength
With demand for power expected to grow at 8 to 10% annually, power supply will face greater strain. In order to meet the shortfall, heavy investments are planned in increasing the installed capacity of power generation. Higher plan outlay for power T&D has also been made in 11th plan as the need for more efficient T&D network is severely felt. More emphasis will be given to reduce the T&D loss (India – 27%, world average – 15%) by strengthening the grid and replacing the old T&D equipments with the new ones. Majority of these investments will be undertaken by state utilities and central government entities, providing further cushion in the present economic
environment.

Corporate capex yet to take off, project business to drag
Although the power segment is poised to grow at a fast rate, the industrial segment will see the continuation of slowdown in the current year. The key differentiator is the availability of funding. We do not expect any revival in industrial capex as the access to capital is still constrained. The capital that is raised at the currently prevailing high cost will be utilised only to secure funding for the ongoing projects. We believe the impact of increasing cost of capital on IRR will keep away private sector from investing in new projects as they become unviable.

Slowdown in order inflow, worsening credit cycle
CY08 saw significant slowdown in order inflow on account of economic slowdown which resulted in deferment / cancelation of industry capex. This lead to a drastic fall in order intake in four consecutive quarters beginning from INR 27bn in Q1CY08 to INR 13bn in Q4 CY08. We expect a subdued order intake in CY09 as well. ABB is also experiencing a severe expansion in the working capital cycle which has resulted in a heavy fall in cash levels from INR 6.4 bn in CY07 to INR 3.5 bn in CY08 and increased borrowings for short term working capital loans at high interest rates affecting the business profitability.

Ground realities do not reflect market buoyancy, valuations expensive, SELL with a price target of INR 588
In the previous down cycle that lasted between 1997 and 2000, the capital goods industry recorded negative earnings growth on account of slowdown in both power and industry capex. However, this time around, due to government’s increased thrust on infrastructure development, there is a strong visibility in the power T&D segment. This will ensure positive business environment for ABB’s power segment verticals. However, we believe the recovery in the industrial capex is unlikely for next two quarters which will keep the industry segment sub‐dued. This change in business mix has put pressure on the financials of ABB as a result of falling earnings, slowing order book, and expanding working capital cycle. We project a moderate growth of 8% in revenues and 3% in profits for ABB in CY09. We assign a P/E multiple of 18 times CY10E EPS of INR 32.7 to arrive at a target price of INR 588 per share implying a downside of 15% from current levels.

To see full report: ABB LTD.