Morningstar.com
Three Stocks to Play the Global Infrastructure BuildoutFriday July 20, 7:00 am ET
By Tom D'Amore, CFA
Over the last month, we significantly upped our fair value estimates for some of the largest companies in the global equity markets, namely the multi-industry conglomerates General Electric (NYSE:GE), Siemens (NYSE:SI), and ABB Ltd. (NYSE:ABB). In terms of size, these companies rank 2, 42, and 164, respectively, in terms of market cap on the global equity stage. The stocks have soundly trounced the global equity indexes over the last 12 months with ABB and Siemens rocketing up 112% and 96%, respectively, compared with 30% for the MSCI World Index. GE has turned in a 27% total return, a respectable rise for the second-largest company in the world by market cap.
Despite the runup, we think the stocks still offer attractive value to investors. What's going on? We have identified four key factors among our industrial infrastructure suppliers that are fueling substantially higher cash flows and improved financial results: 1) productivity benefits from business restructuring; 2) a favorable sales growth outlook due to massive investment in global industrial infrastructure; 3) rising financial returns as management decisions are increasingly driven by return on invested capital, and 4) relatively new management teams who have taken a fresh look at the strategic positioning of their businesses. In this article, we examine these factors and make the case that restructuring actions coupled with favorable macro trends will boost returns on investment at global industrial infrastructure companies and drive above-average stock price returns for equity investors.
Industrial Infrastructure Buildout Fueling Sales and Earnings Growth Our three industrial infrastructure stocks all boast market-leading positions producing industrial capital goods for fossil fuel power generation, and electrical power transmission and distribution equipment. We expect global spending on energy and power infrastructure to grow at high single-digit rates for the next five years.
The rapidly growing Asian economies are vigorously investing in electrical power generation and power transmission infrastructure. China is a particularly voracious investor in power generation and transmission infrastructure; the Chinese government estimates that it will spend a total of $40 billion this year on power generation, or more than 10% of total global spending. We project spending on Chinese power infrastructure will continue to increase at a compounded rate of about 20% for the next five years. Furthermore, we forecast robust spending by European nations due to the deregulation of the electrical power industry, which officially launches later this year. In the United States, spending on an archaic power infrastructure should also fuel robust sales growth. We think the infrastructure buildout expansion will extend for 15 to 20 years. We estimate that total investment for power generation and power transmission equipment is currently running at approximately $150 billion per year. As shown in the following chart we estimate that the market will grow at a compounded rate of approximately 6% for the next five years. We think the leading original equipment manufacturers of power gen and transmission equipment will be able to grow at twice this rate on a compounded basis due to market share expansion and their ability to enhance sales with incremental revenue streams through aftermarket services.
Click here to see the graph:
http://news.morningstar.com/articlenet/art....aspx?id=198775GE, Siemens, and ABB are the three largest suppliers of energy and power infrastructure worldwide. We think the companies' massive installed base and superior distribution capabilities will enable their revenues to grow even more rapidly than the overall energy infrastructure market. We forecast sales from energy and power infrastructure products for the three companies will increase from $37 billion this year to approximately $75 billion by 2011, a growth rate of 12% compounded annually.
Trimming Business Portfolios and Sharpening Business Focus While GE, SI, and ABB each manage a variety of businesses serving a vast array of industrial end markets, over the last three years, each has significantly slimmed down its far-flung empires, dramatically shedding underperforming businesses. Each company has also taken meaningful steps to restructure lines of business to more vigilantly focus on core markets where they enjoy market leadership.
ABB divested its upstream oil and gas business and other smaller businesses in 2004. Since then, the company has made no major acquisitions and has concentrated on improving the performance of its existing lines of business. GE recently sold its plastics business and two large financial businesses, Genworth and GE Insurance Solutions. GE has targeted infrastructure markets for acquisitions, acquiring Smiths Aerospace, Vecto-Gray, and Ionics, serving the aerospace, oil and gas, and water markets, respectively. Siemens has been the most aggressive at trimming its portfolio of businesses, selling its telecom handset business in 2005, combining its communications networking business into a joint venture with Nokia (where Nokia is taking a dominant management role), and this year announcing a spin-off of its automotive supply business VDO Siemens. Annual sales of businesses that Siemens has divested over the past two years and businesses it plans to divest from its core portfolio sum to approximately EUR 23 billion, or 25% of our forecasted sales for 2007. Now that's some serious corporate downsizing!
Emphasizing Returns on Invested Capital (ROIC) and the Impact of Private Equity We think the active restructuring reflects an increased priority by the CEOs and their boards on returns on investment to shareholders. This trend has been particularly manifest at the Europe-based ABB and Siemens. Each has each weathered substantial upheaval and losses in a variety of businesses between 2001 and 2004. Management routinely made strategic decisions that sacrificed operating profits in order to maintain market share in highly competitive markets. The result was poor financial performance and intermittent charge-offs that distracted management and contributed to underperformance at many other lines of business. Starting around 2004, new management was less tolerant of poor performance and took decisive actions to restructure or sell underperforming units.
We also think the aggressive activity of private equity firms in buying up poorly managed industrial companies played a role in changing the industrial investment landscape. By providing an attractive market to sell off underperforming units, private equity firms have helped facilitate restructuring as well as stimulate management changes to improve efficiency by entering into industrial markets and competing more efficiently.
