Schneider Electric Skids As Investors Dim Lights On Electrification, Automation

 

I’ve made no secret of my bullishness on automation, digitalization, and electrification as major global secular trends over the next five to 10 years, nor my belief that Schneider Electric (OTCPK:SBGSF) is an excellent play on those trends. Since my last article, though, the shares are down about 20% (20% for the ADRs, closer to 12% for the locals), underperforming a weakening tape for industrials in general and automation/electrification plays in particular.

In that last article, I said that valuation was becoming more of an issue, but that investors could see another 20% rise before a pullback. While the shares didn’t quite make it to 20% (closer to 12%), it does seem as though the Street has moved on from the automation/electrification theme here of late. While that’s understandable, I suppose, as higher expectations have worked into the valuations over the last couple of years, I think this pullback is worth watching, as I don’t think the automation / electrification story is over quite yet.

 

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Schneider Electric Skids As Investors Dim Lights On Electrification, Automation

Recent Sluggishness In Schneider Electric's Share Price Worth Watching

 

First things first – I’m not an advocate of focusing on short-term stock performance. I am an advocate of opportunism, though, and sometimes short-term wobbles can create windows of opportunity. Such could be the case today with Schneider Electric (OTCPK:SBGSY) – the shares have been a little sluggish since my last update and on a year-to-date basis relative to the wider industrial space and peers like ABB (ABB), Eaton (ETN), and Siemens (OTCPK:SIEGY).

I remain a big believer in both the macro opportunities in front of Schneider (automation, digitalization, electrification, et al) and the company’s ability to leverage those opportunities into above-average revenue growth, margin improvement, and free cash flow. I can’t say that I find the shares a screaming bargain today, but the long-term prospective return is still reasonable and a reasonable return from a good company that I believe has more leverage to outperformance isn’t a bad thing.

 

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Recent Sluggishness In Schneider Electric's Share Price Worth Watching

Schneider Electric Remains A Well-Rounded Play On Secular Growth Themes With A Reasonable Valuation

 

I’ve been a fan of Schneider Electric (OTCPK:SBGSF) for some time and the shares have done quite well over the last five years as the Street has come around to this strong player in automation, electrification, industrial software, grid automation and data/IoT growth. I have had some qualms about valuation, though, and I’m not entirely surprised that the share have lagged a bit since my last update.

I’m quite bullish on the growth prospects in electrification, including opportunities to facilitate automation and commercial building modernization, as well as grid modernization, not to mention Schneider’s leverage to industrial automation, industrial software, and data center infrastructure. I don’t believe mid-single-digit growth (4% for revenue, <5% for FCF) is a particularly aggressive assumption, and while these shares aren’t a screaming value today, I think they’re a solid long-term GARP option in an industrial sector that doesn’t offer a lot of clear bargains.

 

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Schneider Electric Remains A Well-Rounded Play On Secular Growth Themes With A Reasonable Valuation

Schneider Electric Leveraged To Multiple Secular Growth Drivers

Reluctant as I was to get off the Schneider Electric (OTCPK:SBGSY) (SCHN.PA) a little while ago, I still have this crazy notion that valuation ought to matter. Since my last update, Schneider has modestly underperformed its industrial peer group, including Eaton (ETN), but the shares have still outperformed companies like ABB (ABB) and Rockwell (ROK), not to mention the S&P 500 as a whole.

I still love the secular growth stories at Schneider, and I still believe that management maybe still doesn’t get full credit for the improvements they’ve made – I say “maybe” because although the shares have done well, there still seems to be a stubborn “show me” attitude with more than a few analysts. In any case, I love Schneider’s leverage to automation (factory and elsewhere), greener buildings, data growth, and so on. A growth story in a growth market can still work, but I’d really prefer to buy in at a lower valuation than what’s available today.

 

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Schneider Electric Leveraged To Multiple Secular Growth Drivers

Schneider's Business Has Slowed, But It Still Holds A Great Hand

However you want to characterize what's going on today (panic, pullback, recession, et al), these are the times when investors can get better deals on good or great companies. I believe Schneider (OTCPK:SBGSY) [SCHN.PA] is definitely one of those, and while today's price isn't a slam-dunk discount, I think it's an attractive price for a very good company that is leveraged to some powerful long-term trends like power reliability, energy efficiency, and automation. If approximately 4% long-term growth is still a valid assumption, I believe it is, these shares offer high single-digit to low double-digit annualized return potential, which is quite good for a quality industrial.

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Schneider's Business Has Slowed, But It Still Holds A Great Hand

Schneider Electric Taking Improving Execution And Momentum Into 2020

Schneider Electric (OTCPK:SBGSY) (SU.PA) has been one of my favorite companies to follow for a while now, and better-than-peer results from the third quarter did that sentiment no harm. Although it has taken some time for it to all come together, Schneider has built a strong business that is outgrowing its end-markets in both electrical and automation – two end-markets that I expect to be outperformers over the long term. On top of that, management has made some credible progress towards margin leverage that bodes well for the future.

I like Schneider’s exposure to non-resi construction, utilities, and a range of automation markets, and I love the company’s recent track record of execution in its electrical and automation markets. What I can’t love anymore is the price/valuation trade off, as sentiment has shifted pretty significantly – aided, I’m sure, by institutions flocking towards those industrials still managing to show attractive growth in this growth-poor industrial landscape. The price isn’t so unreasonable on an EV/EBITDA basis considering the margin/return improvement trajectory, but I’d rather wait in the hopes that this name cools off and another window of opportunity opens.

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Schneider Electric Taking Improving Execution And Momentum Into 2020

Schneider Electric Standing Out In An Increasingly Challenging Market

A lot of investors still have a grudge against Schneider Electric (OTCPK:SBGSY) (SU.PA), due mostly I believe to a historical track record that left a lot to be desired, including an M&A policy that saw a lot of capital flowing out, reducing ROIC, and not always a lot of quality coming back in. Starting with the Invensys acquisition in 2014, though, and maybe even including Telvent in 2011, management has been making better choices and has crafted a company with a strong position in electrification and automation - two of the more attractive business areas for the industrial sector in the coming decade.

As things stand today, Schneider is one of the better-performing European multi-industrials, and I like not only the company's strong position in electrification (across residential, industrial, commercial, and data center markets) but also its improving software and control-heavy automation portfolio. With a roughly 30% year-to-date run, though, I can't be as bullish as before. I do still like this company and see it as a share-gainer in its markets for many years, but the prospective return isn't high enough.

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Schneider Electric Standing Out In An Increasingly Challenging Market

Schneider Electric Reassures On Margins, But Macro Remains A Risk

Schneider Electric (OTCPK:SBGSY) has continued to do reasonably well, slightly outperforming the broader industrial group since its first quarter earnings release and pulling ahead of the group on a trailing twelve-month basis. With the company’s Wednesday investor day in the books, the company took the opportunity to reiterate and further explain its margin improvement targets, as well as outline some key longer-term growth opportunities like data centers and smart factories.

I liked Schneider before, and I still like it now, though valuation is more “okay” than exciting. While success on its margin improvement efforts could drive another point on the forward EV/EBITDA ratio, the near-term trading is likely to be more concerned with the macro environment, as Schneider is vulnerable to a slowdown in Europe, decreased capex in China, and a slowing U.S. market.

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Schneider Electric Reassures On Margins, But Macro Remains A Risk

Eaton Keeping Its Ducks In A Row And Still Undervalued

In the context of my general view of "long-cycle good, short-cycle bad", Eaton's (ETN) performance was largely as I expected in the first quarter. The stock performance also continues to support my general idea that Eaton, along with Honeywell (HON) is a better-than-average choice right now, as the shares have outperformed its industrial peers since the fourth quarter report (though not keeping pace with Honeywell!).

I still have my worries about shorter-cycle industrial markets, but I think Eaton's broad exposure to a wide range of end markets across a wide range of geographies helps insulate it somewhat, and I think the company is well-placed to benefit from growth opportunities in areas like data centers, aerospace, and perhaps some renewed vigor in oil & gas. The shares aren't dramatically cheap but still offer relatively decent upside in a sector where a lot of names have gotten pricey and where expectations have gotten more and more demanding.

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Eaton Keeping Its Ducks In A Row And Still Undervalued

Rockwell Skids On A Weaker Auto End-Market

The last three months haven’t been particularly kind to Rockwell (ROK), as the share price of what is usually a darling among industrials has lagged the broader industrial sector, and automation peers like Yaskawa (OTCPK:YASKY), Fanuc (OTCPK:FANUY), Nidec (OTCPK:NJDCY), Emerson (EMR), Schneider (OTCPK:SBGSY), and even ABB (ABB). To be fair, it was the significant slide after second quarter earnings on Thursday that did the damage, though the shares had still been lagging most automation companies (except ABB) and were only slightly better than the average industrial before the report.

Like 3M (MMM), Sandvik (OTCPK:SDVKY), SKF (OTCPK:SKFRY), Illinois Tool Works (ITW), and the Japanese automation companies, weakness in autos is a major contributor to Rockwell’s present weakness, but I took management’s guidance and comments as reflective of some potential warnings about spreading weakness in other industrial end-markets – something that I’ve been expecting as this year rolls on. Rockwell shares are now in a tough situation valuation-wise; they’re not so clearly undervalued that I’m inclined to say “just buy and wait for the cycle to reverse), but the valuation is getting more reasonable and this is a stock to watch more carefully now.

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Rockwell Skids On A Weaker Auto End-Market

Strong Energy Management Providing A Spark For Schneider Electric

I’ve liked Schneider Electric (OTCPK:SBGSY) for a little while now, as I’ve thought the Street hasn’t fully appreciated what I think may be the best energy management/electrification business out there and an underrated automation business that is getting stronger in hybrid/process and is well-placed to benefit from expanding IoT adoption.

Although these shares have lagged peers/rivals like Rockwell (ROK) and Eaton (ETN) (another stock I’ve liked for a while) over the past year, as well as the broader industrial segment, the relative performance has been much stronger on a year-to-date basis and since my last update in mid-February. With the move in the share price, I think Schneider looks more fully and fairly valued now, but it’s still a name that I believe is worth holding and it’s definitely a name to look at again if there’s a market/sector sell-off.

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Strong Energy Management Providing A Spark For Schneider Electric

ABB Still Has A Lot To Do And A Lot To Prove

Owning ABB (ABB) has not been a particularly rewarding experience. While the company's decision to sell its Power Grids business to Hitachi is a sound one, and the company has attractive opportunities across its business units, a long history of underperformance relative to the opportunities available is not something investors should just ignore.

Valuation, and the idea that ABB can be/do better than this, remain the best arguments for sticking with the stock, but that's an increasingly unconvincing argument to me, and I can't really say that you should favor ABB over Eaton (ETN), Schneider (OTCPK:SBGSY), and Honeywell (HON), let alone a long list of other industrial names.

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ABB Still Has A Lot To Do And A Lot To Prove

Schneider Slowing, But May Be Better Positioned For The Downturn Than The Street Thinks

Concerns have been growing about the health and durability of the short-cycle upturn, and the performance of the stocks of companies like Schneider Electric (OTCPK:SBGSY) have reflected at least some of that. While a strong post-earnings run has lifted Schneider’s performance over the average industrial and peers like Eaton (ETN) and Rockwell (ROK) since my last update, the shares spent most of the second half of 2018 lagging broader industrial indices.

I’ve made no secret of my concerns about a slowdown in the global economy, and as it pertains to Schneider, I am concerned about the near-term outlook for non-residential construction and factory automation. On the other hand, Schneider isn’t as short-cycle-dependent as in the last cycle, and the company’s position in process automation, oil/gas, grid automation, and data center could help offset some of the weakness. With a long-term growth outlook roughly similar to Emerson (EMR), and sandwiched between Eaton and Rockwell, I do think these shares are undervalued, but 2019 could be a tricky year for the stock as sentiment has seemingly shifted to a point where there is a “show me” story.

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Schneider Slowing, But May Be Better Positioned For The Downturn Than The Street Thinks

ABB Punting Power Grids, But Priming The Pump For Growth Will Take Time

ABB’s (ABB) relatively successful turnaround of its Power Grids business ends the way many, if not most, investors hoped it would – the company is selling off the business. While the transaction is messy, I think management got decent-to-good value for a hard-to-move asset. I also believe the subsequent corporate restructuring is logical and should boost long-term margins, but there’s a grumpy skeptic part of my brain that says a lot of these costs, charges, and restructuring efforts could be used to mask lackluster underlying performance over the next 18-24 months, and I don’t like the extent to which management tried to celebrate their current market positioning.

I still own these shares and I still believe this can be a better-run, more profitable, and more successful business than it is. Whether management has the talent to make that happen is still up for debate. I’m not changing my fair value ($25 per share) at this point, but I would note that the risks and costs are weighted to the near term, while the benefits are weighted further down the line.

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ABB Punting Power Grids, But Priming The Pump For Growth Will Take Time

Rockwell Automation Still Poised Between Excellence And Uncertainty

Looking into 2019, Rockwell Automation (ROK) seems to be in familiar territory – nobody’s really questioning the operational excellence of this leader in discrete automation, but there are plenty of concerns about end-market health, where industrials sit in the cycle, and whether Rockwell is as well-positioned for the next phase of automation as it was for the last.

I typically shoot for double-digit returns when I invest, and Rockwell doesn’t seem priced to deliver that unless you think long-term FCF growth can reach that grey area between mid-single-digits and high single-digits – a level of performance that’s not impossible, but certainly not conservative to expect. Although I’m tempted to call today’s potential returns “good enough” for a stock that seldom gets all that cheap unless/until industrial stocks really go fan-ward, I do believe there could be another round of angst and stock weakness early in 2019 that could be an opportunity to pick up high-quality industrials like Rockwell.

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Rockwell Automation Still Poised Between Excellence And  Uncertainty

Schneider Electric's Business Is Outperforming, But The Stock Really Isn't

I can’t say that Schneider Electric (OTCPK:SBGSY) has been a terrible call this year, but I expected better from this European specialist in electrical and automation products than just sector-matching performance. Even though Schneider continues to outperform its peers in terms of its financials, and management continues to offer a pretty solid near-term outlook, the Street is most definitely not all-in on this name, as concerns about the health of end-markets like commercial construction and utilities remain in place and concerns are building about factory automation demand.

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Schneider Electric's Business Is Outperforming, But The Stock Really Isn't

For ABB, It's About Cycle, Self-Improvement, And Sentiment

A laggard for some time among the industrial automation and electrification players, ABB (ABB) has at least been a little “less bad” of late as sentiment has started giving the company some credit for its later-cycle end-market exposures. Now the question is whether those promising-looking exposures will deliver actual orders in the second half of the year and drive better revenue in 2019. At the same time, there is still more than casual interest in ABB’s willingness and ability to execute on some self-help moves that would largely involve slimming down and simplifying the business.

I’ve long been an owner and supporter of ABB, and I can’t say that it has done right by me. Still, compared to peers like Emerson (EMR) and Rockwell (ROK), the valuation is undemanding and offers some upside if ABB can deliver on those sentiment-shifting improvements in orders and portfolio composition.

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For ABB, It's About Cycle, Self-Improvement, And Sentiment

Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

The good times keep rolling for Emerson (EMR), as the company is enjoying a strong recovery/expansion phase in its core process markets, as catch-up spending on MRO, brownfield investments, and greenfield projects all combine for strong near-term revenue and margin improvements and a healthy outlook over the next year or two. At the same time, Emerson continues to reinvest in its business to better-position it for less cyclicality and better competitiveness in hybrid automation markets.

As was the case a few months ago, I see Emerson as a so-so value proposition, but a stronger near-term growth/momentum story. The shares don't seem unreasonably priced on forward EBITDA, but it's a little harder to see strong FCF-based undervaluation, and I think the share price performance is very much tied to ongoing momentum in orders, revenue, and margin leverage.

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Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

nVent Needs To Use Its Independence To Drive Growth

As the former Technical Products business of Pentair (PNR), nVent (NVT) has some important positive characteristics, including well-regarded brands, strong share in certain segments of the enclosure, heat tracing, and electrical fastening markets, and strong margins. What it has historically lacked, though, is growth, and that needs to be one of management’s foremost priorities if nVent is going to be a significant success as an independent company.

Although I do expect better growth relative to nVent’s track record, I don’t see enough growth to drive a compelling valuation today. To me, the shares look more or less like many industrials – not really attractively priced unless you have a pretty bullish outlook on the U.S. cycle and the company’s ability to pass on higher costs.

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nVent Needs To Use Its Independence To Drive Growth

Hubbell Looking To Self-Help And A Cyclical Boost

Later-cycle plays have gotten more attention as this year has gone on, and with that electrical product and lighting specialist Hubbell (HUBB) has closed some of its multiyear performance gap relative to industrials, with the stock actually outperforming the Industrial Select Sector SPDR ETF (XLI) over the past year as well as handily outpacing Acuity (AYI) as well. Add in the Aclara acquisition, ongoing restructuring efforts, and an apparent willingness to address the lighting business more directly, and I can see why these shares have done well in recent months.

As far as valuation goes, Hubbell is more of a lukewarm prospect to me now. I like the potential of what facility consolidation, automation, and supply chain improvements could bring, but margins have been weak for a while despite an ongoing effort to restructure. Likewise, while I like the diversification that Aclara brings, lighting remains a tough market. The perception of Hubbell as a late-cycle play should aid sentiment, and the shares do have some upside on an EV/EBITDA basis, but the overall long-term return potential looks more or less in line with most other industrial names.

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Hubbell Looking To Self-Help And A Cyclical Boost