Strong Energy Management Providing A Spark For Schneider Electric

May 19 21:42 2019
Schneider exceeded expectations with a strong 6% organic revenue growth rate, driven by 7% growth in its Energy Management business.

Margin leverage is still a key unknown, but Schneider is well-placed for major trends like ongoing data center capex, industrial IoT, and increasing convergence between electrification, automation, and software.

Schneider’s is starting to get more credit for the quality of its electrification business, but its improvements in automation (particularly in process/hybrid) may not be fully appreciated.

Schneider’s rally makes it more of a good hold now than a buy, but this is a stock to watch for a pullback.

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.

Short On Detail, But Strong At The Top

Schneider follows the pattern of many European companies in reporting detailed financial information only twice a year. Say what you will about institutional investors being too short-term oriented, I tend to like to have more information than less. In any case, Schneider got the fiscal year off to a good start with a better than expected revenue performance and some relatively encouraging (albeit vague) information on margins.

Revenue rose 9% as reported and closer to 6% on an organic basis, coming in 3% better than expected.

Energy management led the way with 7% organic growth, headlined by an extremely strong nearly 12% growth rate in North America. The North American business saw strength across residential, commercial, and industrial, and I believe Schneider has been a major beneficiary of the weakness at GEIS – a business now owned by ABB (ABB) and that ABB intends to make more competitive over the next couple of years. The healthy commercial result would also broadly echo the strong results Honeywell (HON) reported in its Buildings business.

Given that Eaton, Siemens (OTCPK:SIEGY) and Legrand (OTCPK:LGRDY) haven’t reported, there’s limited benchmarking for Schneider’s performance. ABB’s Electrification Products segment showed 5% growth this quarter, though so it looks like Schneider continues to perform well, and I’d note that ABB called out a strong data center infrastructure market – an important market for Schneider. Schneider also saw 8% growth in Energy Management in Asia, with “solid” results in China driven by construction – a potentially encouraging development for a large number of companies.

Schneider’s automation business was not nearly so strong, with organic growth a little above 2% this quarter. Actual growth was a little stronger, but Schneider is nevertheless seeing the impact of a slowdown in discrete automation – something also reflected in ABB’s results and that may also show in Rockwell’s earnings (scheduled for Thursday, April 24).

Automation growth was healthy in Europe (up 5%) across the board (discrete, process, and hybrid), and while growth in Asia was weaker (up about 3%), China was positive in both discrete and process – an encouraging development for Schneider given weakness reported by other automation providers (including a slowing trend at ABB) and one that may indicate share gains. Growth in North America was more subdued on weaker discrete demand, but results were also hit by the company’s decision to exit the HVAC panel business and process automation demand remains healthy (particularly in oil/gas).

Ample Opportunities To Leverage Emerging Strengths

There are a lot of things I like about the Schneider story, including the company’s decision to invest in service and software capabilities before rivals like ABB and Rockwell really committed. Service revenue was up 11% in the first quarter.

I also like the increasing integration between Schneider’s automation, software, and electrification products (system sales were up 10% in the first quarter, while product sales were up 3%). A lot of casual observers don’t appreciate the interlinkage between electrification products and automation, and I believe that both Schneider and ABB will reap some long-term benefits by having capabilities in both of these segments.

I’m still somewhat bearish on the outlook for industrials in 2019, although the trend so far in the first quarter has been better than I expected, but I don’t value Schneider on such a short-term basis. My interest here is anchored in large part by the company’s opportunities in driving synergies between electrification, automation, and software, the ongoing growth in data center spending, and the emerging opportunities in IoT (which Schneider serves primarily through its EcoStruxure backbone).

I’d also note that when you plot the major players in electrification for both growth and margins, the strength of Schneider’s business really stands out – while Siemens is stronger in some specific areas (including its JV with Valeo(OTCPK:VLEEY) for electrical vehicles) and ABB has its strengths (LV systems, charging, and rail), Schneider has a strong suite of offerings for industrial and commercial markets.

The Outlook

I’m not making any major changes to my model at this point, but I am still looking for long-term revenue growth in the neighborhood of 4%. I’m looking for FCF margins to move into the low-double digits and drive high single-digit FCF growth, but I’d note that margins and FCF margins have historically been a weaker area for Schneider. Management has been addressing this by shifting its business toward higher-margin businesses, exiting lower-margin segments, and driving efficiency programs, but delivering on more of its margin potential is a key must-do for the stock to work long term.

The Bottom Line

Between discounted cash flow and margin/return-driven EV/EBITDA, I believe Schneider should trade around $17, so I think the shares are basically appropriately valued today. In an industrial sector that has gotten pricey again with the post-Christmas rally, I’d consider Schneider a better than average hold, but I’d love to see another pullback as an opportunity to go bullish again.

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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