Pandemic-related lockdowns in China. The global semiconductor shortage. The war between Russia and Ukraine. ABB Ltd (NYSE:NYSE:ABB ) has had to navigate some turbulent waters recently.

The industrial giant, under the thumbs of its large institutional investors including Cevian Capital and Capital Group, had been streamlining itself to increase shareholder value and design a more focused business, with notable divestitures of ABB Power Grids to Hitachi, Ltd. ( OTCPK:HTHIY) in 2020 and ABB Dodge to RBC Bearings Inc. ( ROLL) last year. Its turbocharger business will, in short order, be spun off as a separate entity, Accelleron, trading on the SIX. As a lighter company, ABB is now composed of 21 divisions spread across its 4 operating segments: Electrification (“EL”), Process Automation (“PA”), Motion, and Robotics and Discrete Automation (“RA”). But, CEO Björn Rosengren is careful to point out that he does not view the company as a “mere” conglomerate – i.e. just a collection of businesses. Rather, each segment, and each division for that matter, is expected to operate as a market leader, contributing to the greater whole – with that whole set on exploiting “megatrend” opportunities, such as the move away from fossil-fuels and a smaller global labor workforce, with those opportunities driving needs in both electrification and automation.

Coupled with its geographic diversification and reasonably good financial condition, management believes the company is well-suited to weather the uncertain conditions that have plagued markets as of late.

Figure 1: ABB Resiliency Model (ABB Earnings Presentation Q2 FY '22)

On those simple points alone, long investors might consider a few ABB shares for their portfolios. But, it is also worth noting that the firm does appear to be something of a relative bargain as compared to other industrial players when considering valuations.

Figure 2: ABB and Selected Competitor Statistics (Yves Sukhu)

Data from Polygon.io except P/S, P/B, and trailing P/E multiple data from Yahoo Finance; and EMR sales, liabilities, and margin data from/calculated using data from Yahoo Finance.

Data as of market close September 9, 2022.

Admittedly, firms like GE, HON, and EMR, as listed in Figure 2, may not be the best “yardsticks” with which to gauge ABB against. Still, given expectations of an improving profitability and cash flow picture in 2H FY ‘22, I think there is a solid bull argument to be made in favor of ABB shares heading into the end of the year.

Any quotes or statistics in this section without a specific reference are sourced from ABB’s Q2 FY ‘22 Earnings Webcast and ABB’s Q2 FY ‘22 Earnings Presentation Let’s first consider the 3 headwinds mentioned at the outset of the introduction and their impact on ABB’s business, particularly in Q2 FY ‘22:

1. Lockdowns in China. The unexpected, and prolonged, lockdowns in China due to the ongoing COVID-19 pandemic were estimated to have negatively impacted Q2 FY ‘22 sales by (2%). Moreover, RA was hit particularly hard with its largest factory in Shanghai shut down for several weeks. RA net sales of $732M in Q2 decreased (5%) in constant currency versus the prior period.

2. Semiconductor shortage. The global shortage of semiconductors weighed on RA results in 1H FY ‘22, with the segment realizing book-to-bill ratios of 1.79x and 1.52x in Q1 FY ‘22 and Q2 FY ‘22, respectively. Management noted that the EL segment was also impacted by semiconductor shortages, but not to the extent experienced by RA given that EL segment revenues grew 10% in Q2 FY ‘22 in constant currency versus the prior period.

3. War between Ukraine and Russia. ABB operates all over the world, including Russia. Management made the decision in Q2 FY ‘22 to exit the country and will incur a related charge of $57M.

2H FY ‘22 seems set to deliver a reprieve of sorts for the business and for investors with respect to these 3 dynamics. As per management following Q2 FY ‘22 results:

1. Sales in China expected to rebound in the second half. While China remains unpredictable, management thinks that 2H FY ‘22 performance should be substantially improved, including double-digit sales growth in Q3 FY ‘22 for the Motion segment in the country, now that the lockdowns have been lifted. As ABB’s second-largest segment in terms of sales and operating EBITA, Motion volumes were hampered by lockdowns in China, sending operating EBITA margin down (70) bps excluding the ABB Dodge divestment impact. However, as already mentioned, 2H FY ‘22 should see an improving performance from Motion driven by a recovery in the country. Also, despite relatively strong results in the second quarter, the distribution side of EL was noted to have been impacted by softness in the Chinese residential buildings market. Again, with lockdowns lifted, EL is likely to see a better result from its Chinese operations in Q3 FY ‘22 and Q4 FY ‘22.

2. Semiconductor shortages are easing. Obviously with supply chain issues related to semiconductors disappearing, RA should have a much stronger second half than first half.

3. Russia represented a very small part of ABB’s overall business. Management noted that Russia represented about 1% of revenues in FY ‘21, and thus – in the grand scheme of things – was a very small proportion of the total business. Of the total charge of $57M to exit the country, ABB will realize a relatively minor cash flow impact of ($23M) in Q3.

With their major headwinds subsiding, ABB’s second-half FY ‘22 story looks enticing. But, there are additional points to consider:

Operating EBITA is expected to increase in Q3 FY ‘22. Even when excluding the positive one-time 60 bps operating EBITA impact from corporate operations in Q2 FY ‘22, ABB still noted a sequential operating EBITA margin improvement of 14.9% in Q2 FY '22 from 14.3% in Q1 FY ‘22. And, as seen below, operational EBITA margin has generally been trending higher over the last several quarters.

Figure 3: ABB Operational EBITA Trend (ABB Earnings Presentation Q2 FY '22)

2H FY ‘22 should be characterized by good cash generation from inventory conversion. Management noted that the biggest tie-up in cash during the first-half was in inventory. Investors should expect this inventory to be converted to cash in Q3/Q4 FY ‘22.

Figure 4: ABB Cash Generation Analysis (ABB Earnings Presentation Q2 FY '22)

Overall operating profit was held back by sales volume/mix in Q2 FY ‘22. The improved business climate in China and supply chain relief with respect to semiconductors should drive better overall sales volume/mix in the second half, in turn fueling net revenues and operating EBITA.

Is ABB going to “blow the doors off” with their Q3/Q4 FY ‘22 performance? That remains to be seen of course. But, the ingredients for a strong finish to FY ‘22 certainly seem to be in place. And while Q1 and Q2 were nothing to get too excited about, I would remind readers that the company still realized revenues of $6,965M and $7,251M for Q1 and Q2 respectively, reflecting respective growth of 7% and 6% in constant currency versus the prior periods. That top-line performance came in spite of the headwinds discussed earlier.

Even though they offered investors a strong bull case for the second half, management still seemed to hedge 2H FY ‘22 expectations a bit during the most recent earnings call. They noted:

1. COVID is still “not over” in China, hinting at the possibility of new lockdowns.

2. Softness in China’s residential buildings market may have deeper, underlying causes beyond effects from the pandemic.

3. RA is underperforming. As per Mr. Rosengren, the business should be operating with a EBITA margin of 15% and growing at a CAGR of 10%. This stands in contrast to 8.2% operating EBITA margin and a (-5%) comparable revenue decline in Q2 FY ‘22.

As such, there are risks as there always are. However, I would argue that the outlook for Q3/Q4, bolstered by the company’s relative value as presented in Figure 2, suggests ABB offers investors an enduring, geographically diverse business characterized by reasonable risk – and one with a healthy $19.5B order backlog at the end of Q2 FY ‘22. Moreover, with shares down quite a bit this year so far, the stock may obviously rally heading into FY ‘23 based on the expected dynamics for 2H FY ‘22.

Figure 5: ABB and Selected Competitor Performance (Yves Sukhu)

Figure 6: ABB Stock Price Performance (Yves Sukhu)

Data as of market close September 9, 2022.

While analysts are mixed on the stock, the average price target using the limited dataset below is 32 CHF, or $33.37/share using a conversion ratio of $1.04 USD/1 CHF. That average reflects a nearly 15% premium to today’s close of $29.09.

Figure 7: ABB Selected Analyst Ratings (Marketscreener)

And, it wasn’t too long ago that activist investor Cevian Capital suggested shares should be trading closer to 35 CHF. Investors may not get fabulously wealthy off ABB. But, the stock appears well-positioned to rally over the next few months while offering a nice 3.2% dividend yield based on today’s close. Longer-term, I think management, driven in part by its institutional investor base, will continue to unlock shareholder value, shedding those parts of the business that are better served as individual entities, as with Accelleron. On that point, and in consideration of an expectation of stability/reasonable growth from the core business relative to the megatrends mentioned earlier, I think the firm offers long investors an excellent “foundational” position for their portfolios.

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Disclosure: I/we have a beneficial long position in the shares of ABB either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.