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Schneider Electric Standing Out In An Increasingly Challenging Market

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Schneider Electric Standing Out In An Increasingly Challenging Market

August 20
20:06 2019

Schneider’s Energy Management business was a star this quarter, growing almost 7% and propelling the company to a beat-and-raise quarter despite weaker automation markets.

Automation is going through a down-cycle now, but Schneider is well-positioned with electrical products, controls, and software to ride the next major cycle in factory and process automation and digitalization.

Schneider shares look fairly valued now, but a pullback towards $16 would be an attractive long-term opportunity.

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.

Getting The Job Done

Schneider’s second quarter wasn’t perfect, but it was quite good and maybe one of the best I’ve seen in the industrial/multi-industrial sector so far. Revenue beat expectations by a little more than 1% on a stronger result in the Energy Management business, while both segments contributed to a 2% beat at the EBITA line. With upgraded guidance, Schneider is one of the relatively few beat-and-raise stories with some signs of acceleration in the business.

Revenue rose almost 6% as reported and more than 5% on an organic basis, doing well against the broader multi-industrial sector that has seen roughly 3% to 3.5% organic growth on average for this quarter.

Energy Management was the stronger of the two, growing almost 7% organically on the top line for the second quarter and delivering 12% first-half EBITA growth (with margin up 50bp). The mix-and-match between second quarter and first half is due to the fact that Schneider does not provide margin/earnings information on a quarterly basis. For the Industrial Automation business, sales disappointed with 1% organic contraction, but Schneider outperformed on margins, with profits up 4% and margin expanding 40bp. Combined, the company saw nearly 11% EBITA growth in the first half, with 40bp of margin expansion.

With these results and ongoing momentum in the Energy Management business, management raised guidance, lifting the revenue outlook by 0.5% at the midpoint to 4.5%, and guiding toward the “upper half” of its prior 20-50bp margin improvement target range.

Feeling The Surge

Schneider’s Energy Management is performing well pretty much across the board. Revenue was up 3% in Europe on good results in residential construction and data centers, while Asia was up almost 7% with healthy growth in the Chinese construction/infrastructure market (despite overall market headwinds). North America was the standout, with almost 12% growth and management pointing to strong results in residential, commercial, and industrial markets.

Next, to ABB’s (ABB) 4% growth in Electrification, Schneider’s results look even better. Schneider appears to still be taking share from the GEIS business that ABB bought and is in the process of turning around. Schneider also continues to benefit from its leading position in data centers, as companies continue to build and expand their data centers.

Although Schneider’s Industrial Automation results were lower than expected, it’s an unsurprising surprise in the wider context of what we’re seeing in that sector now. Schneider’s three major geographies were all down, with Europe down almost 2% on weakness in discrete automation across the region. Asia being down less than 1% qualifies as a good result in my book, particularly given the weakness cited in that market by companies like ABB, Nidec(OTCPK:NJDCY), and Yaskawa (OTCPK:YASKY), and management noted stronger trends in process automation (arguably positive/encouraging for HollySys (HOLI)).

As for the U.S., Schneider saw a 5% decline in its automation business, worse than the slight growth in the predominantly North American Rockwell (ROK) results. Discrete automation remains soft and management expects it to remain so in the second half as companies are delaying investment decisions due to the mixed signals coming from the administration on tariff and trade policy. On the process side, project phasing and tough comps hurt this quarter, but management sees a generally strong level of investment in oil/gas and chemicals – good news for Honeywell (HON) and Emerson (EMR) and also emphasizing some potential share loss at ABB (where management reported less momentum for their process automation business in those markets).

Risks To Consider

While Schneider has become less short-cycle dependent than in the past, it’s still outperforming against slowing overall trends, and that’s a tricky spot. As management themselves guided, automation is likely to have a few more tough quarters, particularly on the discrete side. What’s more, I’m concerned that non-residential construction will slow more significantly in 2019, hurting electrification product demand. I’d also keep an eye on the spending plans of Amazon (AMZN) and Google (GOOGL) – they represent a significant portion of Schneider’s data center business, and a deceleration in data center buildouts would clearly have a negative impact.

Longer term, I’d also note the risks from ongoing shifts in the target markets. While I believe Schneider has done a lot of smart things repositioning its business for the next wave of automation, investing in electrical products critical to building and factory automation, as well as controls and software on the industrial automation side, business needs are still evolving. It’s also a highly competitive market, with Siemens (OTCPK:SIEGY) spending roughly as much on automation R&D as its four biggest rivals combined (including Schneider).

The Outlook

Schneider is coming along more or less as I’d modeled (my numbers were above the sell-side averages), and I’m not making many significant changes now. Longer term, I still expect Schneider to be a share-gainer and to generate mid-single-digit revenue growth and mid-to-high single-digit free cash flow growth. I’m also expecting about one point of operating margin improvement over the next two years (from mid-2019 to mid-2021) and further improvement in ROIC.

The Bottom Line

With not a lot changing in my model, not a lot changes in my fair value estimates, and the ongoing strength in the share price make it a harder name to recommend. I do think Schneider shares will be higher in three to five years, but I can’t rule out pullbacks along the way, particularly given that I think the industrial sector overall is trading too high and has too much riding on a second half rebound in growth. A good hold today, a pullback closer to $16 would be a good opportunity to reload on what I believe is a very good way to play the long-term growth of urbanization, data traffic growth, and automation.

About Schneider Electric

Schneider Electric is leading the Digital Transformation of Energy Management and Automation in Homes, Buildings, Data Centers, Infrastructure and Industries. With global presence in over 100 countries, Schneider is the undisputable leader in Power Management – Medium Voltage, Low Voltage and Secure Power, and in Automation Systems. We provide integrated efficiency solutions, combining energy, automation and software. In our global Ecosystem, we collaborate with the largest Partner, Integrator and Developer Community on our Open Platform to deliver real-time control and operational efficiency. We believe that great people and partners make Schneider a great company and that our commitment to Innovation, Diversity and Sustainability ensures that Life Is On everywhere, for everyone and at every moment.

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