ABB: Rise in Profitability Reaps the Rewards of Stricter Cost Control; Raising Our FVE

Equity Analyst

Matthew Donen

ABB enjoys a number one or two market position in two thirds of its product segments, which is largely derived from centuries of deep-domain expertise in supplying mission-critical equipment with a high cost of failure for a variety of end markets. Its wide range of product categories and operating businesses have led to several costly restructuring programs and underperformance versus its European capital goods peers, due to the complexity of the organization. The divestment of its capital-intensive Power Grids business and the appointment to CEO of turnaround specialist Björn Rosengren have helped simplify the group through decentralization and active portfolio management, and subsequently improved the profitability of the business. The departure of Rosengren as CEO in 2024 is a likely indication that the major components of the restructuring have been executed, but the foundations have been set to enjoy the operating leverage from higher volumes.

ABB is well positioned to benefit from the secular trends of automation, electrification, and reshoring production, which will support long-term structural growth. Its large installed base of long-dated equipment provides the foundation for recurring aftermarket sales that account for approximately 20% of revenue. Given the group’s large market share in existing markets and high barriers to entry, acquisitions have been the easiest method to expand its geographic presence and product range. ABB has the most extensive industrial robot and automation portfolio, and is also the second-largest electrification business globally, thus its runway for transformational deals within existing verticals is likely to be limited. 

While its products are rich in software content, ABB does not have its own in-house design and simulation software, which has likely contributed to its lower growth rates. We believe this places the group at risk of losing market share to competitors such as Schneider Electric and Siemens, which have managed to establish more meaningful relationships with customers by providing end-to-end software solutions to help design, operate, and maintain industrial processes.

Business Strategy & Outlook

We award ABB a wide moat derived from a combination of intangible assets and switching costs. The ABB brand enjoys a reputation for reliability and leadership in product innovation, which is underpinned by engineering expertise built up over centuries and has pioneered the development of several industrial products. In addition, the long life span of its products, stretching several decades, is mission-critical and exhibits a high cost of failure, resulting in high switching costs. Recent divestments of its capital-intensive Power Grids business and improved operational performance within its several business divisions have elevated profitability and ROIC comfortably above WACC—levels that better reflect the group’s competitive advantage. We expect the current ROIC spread above WACC to be maintained for at least the next 20 years. ABB is number one in two thirds of its segments, allowing the group to outspend competitors on research and development (4% of sales or above $1 billion) and also utilize its close relationship with customers to foster future product development.

We believe the electrification segment possesses a wide moat. Its products are deeply embedded into critical infrastructure (buildings, utilities, and data centers), as well as industrial processes, with a high cost of failure through expensive downtime (via the loss of power) and damage to human health. In 1891, it became the first company to transmit high-voltage power and has since developed several electrical applications. ABB can command premium pricing due to its brand reputation, close relationships with customers (intangible assets), and the high cost of changing suppliers with minimal benefit (switching costs). Over 70% of ABB’s electrification product portfolio goes inside the electrical panel, placing greater importance on the brand's reputation for reliability than front-of-wall products that are subject to changing trends and aesthetic features. Industrial projects are complex, often involving high currents of energy distribution as well as more stringent regulatory standards than low-voltage electrical components. Therefore, customers tend to be risk-averse in selecting suppliers, creating formidable barriers to entry. The largest business within the segment is Distribution Systems, where ABB is the global leader in medium voltage electrical components, of which over 50% of its products are engineered-to-ordered, requiring significant engineering know-how and subsequently resulting in close relationships with its customers. 

ABB’s extensive low-voltage products—used mostly by buildings—benefit from similar competitive advantages relating to intangible assets, having first manufactured electrical lighting products in the 19th century. In addition, its global scale but local production/offering also ensure ABB is a preferred supplier to distributors that prefer to stock brands with a strong reputation and are readily available. Our channel checks confirm that ABB is the leading provider of switchgear products, which mostly consists of a handful of multinationals and some local manufacturers. The acquisition of General Electric Industrial Solutions solidified the group’s global number two position, allowing ABB to penetrate the US market and expand its scope of products with faster-growing end markets. Its scale supports reinvestment into product innovation, which reinforces its close relationships with key decision-markers (wholesalers and installers). Switching costs are also present, via the extensive training provided to installers, who are extremely loyal to the brand they habitually use. Market share data obtained from filings received by the European Commission prior to the conclusion of the ABB and GE IS acquisition, reflects a market share of 40% and upward in many geographies, highlighting how difficult it is to enter new geographies. In many product categories, the entire market only consists of between two to five suppliers in certain geographies.

Intangible assets and switching costs are also present in ABB’s motion segment. The businesses commands a market-leading position in motors and drives that are used to power mission-critical equipment used in mining manufacturing and food processing among others. Its track record for reliability stems from centuries of domain expertise, having invented the three-phase system for generators, transformers, and motors in the 19th century and several drive innovations in the mid-1900s. ABB’s installed base of 50 million motors and drives are deeply embedded into customers’ revenue-generating processes and have a life span of 20 to 25 years. Its long-life installed base forms the foundation of the division’s EUR 1 billion service business, which ensures costly equipment downtime is minimized. Its extensive service network in over 60 countries supplies spare parts and product upgrades during the life of the equipment. The high cost of failure means customers prefer to buy spare parts and modernizations from the OEM rather than third-party providers. ABB’s portfolio of products also includes tailored products for direct customers and OEMs, as well as the most comprehensive range of standardized products, which have helped establish close relationships across its sales channels and foster future product innovations. Most channel partners are willing to work exclusively with ABB due to its comprehensive product offering, creating formidable barriers to entry. ABB has also begun to add sensors to its equipment, initially during the warranty phase of the motor or on a trial-and-buy strategy, which can predict equipment failure and thus further increase a customer's dependence on ABB.

Process automation is likely ABB’s moatiest segment. Process automation involves continuous processes, where production is ongoing 24/7 and performed in batches (rather than units), making it close to impossible to switch suppliers without impacting production. Distributed control systems, or DCS, are at the heart of process industries, controlling several components of machines. Once installed, a DCS has a life span of between 20 and 50 years, which will require servicing and modernization throughout this period, often through long-term service agreements. It is too costly and dangerous for companies to make wholesale replacements of their existing control systems, creating very high switching costs. ABB has been the DCS market leader for 22 consecutive years, enjoying the leading position in many highly regulated sectors, such as mining, marine, and power generation. Customers within these sectors operate in potentially dangerous environments and are thus very conservative in selecting suppliers due to the catastrophic cost of failure, placing significant emphasis on brand reputation (intangible asset). ABB’s extensive service network, which often includes resident engineers on customers’ sites, not only helps generate service revenue but also reinforces close customer relationships and fosters future product innovation. ABB’s market-leading installed base allows recurring sales to be generated through a variety of aftermarket services that account for half of process automation’s segmental revenue. 

The robotics and discrete automation division has similar characteristics to process automation, where its hardware is deeply embedded into customers operations and its vast installed base provides ongoing aftermarket revenue for decades. While we don’t believe the moat is as strong as process automation due to a shorter life-span of robotic equipment and lower cost of failure than process automation, it still warrants a wide moat. Approximately 70% of sales are direct to customers, which have created close customer relationships and valuable insight into manufacturing plants. ABB can command premium pricing by providing a full suite of equipment (robotic products and cells) as well as software used to program robots to perform specific functions. Tailor-made solutions and the significant upfront capital investment for robots and cells, such as vision systems and grippers that can cost as much as the robot product, create high switching costs and allow ABB to earn decades of aftermarket revenue on its installed base of over 500,000 robots. 

ABB’s acquisition of B&R in 2017 added discrete automation to its industrial automation portfolio, augmenting its strong position in process automation and robotics. Programmable logic controllers, or PLCs, used in discrete manufacturing are deeply integrated into production processes and can't be overhauled without incurring expensive downtime, resulting in high switching costs. Software embedded into the controllers provides a further layer of switching costs customers face. We believe ABB can utilize its existing relationships with robotics customers, that are primarily in discrete industries, to grow its installed base of PLCs, where it currently has a top-five market share. While we believe switching costs for PLCs are marginally lower since they control individual components or machines instead of a whole process, once they are installed they are never ripped out, and thus we still think they are worthy of a wide moat.

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ABB Ltd. is a technology company, which engages in the development and provision of electrification, motion and automation solutions. It operates through the following business segments: Electrification, Motion, Process Automation and Robotics & Discrete Automation. The Electrification segment manufactures and sells electrical products and solutions which are designed to provide safe, smart and sustainable electrical flow from the substation to the socket. The Motion segment manufactures and sells drives, motors, generators, traction converters and mechanical power transmission products that are driving the low-carbon future for industries, cities, infrastructure and transportation. The Process Automation segment develops and sells a broad range of industry-specific, integrated automation and electrification and digital systems and solutions, as well as digital solutions, life cycle services, advanced industrial analytics and artificial intelligence applications and suites for the process, marine and hybrid industries. The Robotics & Discrete Automation segment delivers its products, solutions and services through two operating Divisions: Robotics and Machine Automation. The company was founded on January 5, 1988 and is headquartered in Zurich, Switzerland.

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