Schneider Electric’s Strong Performance And Long-Term Potential Complicate The Valuation Argument

August 30 11:25 2021

Summary

  • While Schneider Electric’s second quarter performance wasn’t eye-popping in the broader context of the short-cycle recovery that’s driving multi-industrials, the relative performance in electrification and automation was strong.
  • Short-cycle recoveries can drive Energy Management and Industrial Automation a little further, and longer-cycle industries will start contributing more in 2022.
  • Schneider has strong share in multiple markets that is likely to grow noticeably above GDP growth – including automation, electrification, decarbonization, and digitalization.
  • I can’t argue that Schneider is cheap on cash-flow or multiples-based valuation approaches, but there is still at least a “pay up for superior quality” angle in play.

“Let your winners run” is good advice … right up to the point where you end up seeing long-term underperformance because you held on to shares that were overvalued and valuations eventually returned to their long-term norms.

I bring that up because it’s a concern I have with Schneider Electric (OTCPK:SBGSY). Operationally, I have no meaningful doubts that this company will be a long-term winner in electrification, digitalization, and automation, and I still see upside to long-term expectations. This is where “let your winners run” can be good advice – great companies have a habit of outperforming expectations and “growing into” their valuation over time.

On the other hand, in the short run at least, I can’t say Schneider shares are particularly cheap. The valuation isn’t bad relative to many other high-quality industrials, but I find the sector increasingly expensive. All in all, I still lean bullish given Schneider’s strong share in, and leverage to, markets that should outgrow the overall economy, but I wouldn’t fault any investor who holds off in the hopes of buying in on a pullback.

Better Q2 Results, But Not A Blowout

Schneider Electric had a good quarter. Not great, but just “good”. The beats were modest versus sell-side expectations, and the results didn’t diverge that much from the broader multi-industrial space. That said, within its own corner of the industrial world, the relative performance was still pretty good.

Second quarter revenue rose 24% year over year in organic terms, beating expectations by about 3%, and the company grew 6% organically over Q2’19 revenue. The Energy Management business grew 26%, beating, by more than 3%, while Industrial Automation rose 18% and beat by about 1%. System and software sales were relatively weaker (compared to product sales), but that’s not so surprising for this stage in the cycle.

Schneider only reports detailed financial information on a half-year basis, so it’s worth looking at the first-half results as well. Revenue rose 19%, beating by 1%, with adjusted EBITA up 50%, beating by 5%. On the segment level, Energy Management EBITA rose 44%, beating by 8%, with margin improving 340bp to 20.5%. Industrial Automation EBITA rose 40%, beating by 1%, with margin up 300bp to 18.2%.

Good Relative Performance

Schneider’s numbers compare pretty well to the broader industrial space, with 24% organic growth in a quarter where growth averaged out in the low-20%s, but the comparisons to its peers were likewise strong.

In the electrical business, Schneider’s 26% growth was quite good compared to the high-teens growth at Eaton (ETN) (around 18% on a blended basis) and the 17% growth at ABB (ABB). Other comps include Siemens’ (OTCPK:SIEGY) 15% growth in Smart Infrastructure, nVent’s (NVT) 28% blended growth in Enclosures and Electrical and Fastening, and Legrand’s (OTCPK:LGRDY) 33% growth.

Turning to the automation business, Schneider’s 18% growth compares to 10% blended growth across ABB’s businesses, 17% growth at Siemens (Digital Infrastructure), 26% growth at Rockwell (ROK), and 8% growth at Emerson’s (EMR) automation business.

Near-Term Recoveries, Long-Term Growth

There weren’t many surprises in Schneider’s end-market commentaries, and certainly nothing thesis-changing.

In electrification, data center and utility markets remain strong (particularly data center), and residential markets in North America and the EU are likewise very strong. In commercial buildings, Schneider did see some weakness in larger buildings in the U.S., and I’d attribute that as possibly being due to less leverage to repair/retrofit types of components, but that’s speculation on my part. Overall, there were no surprises that warehouse and healthcare were strong categories, while hotels and offices were weak. Likewise, strength in consumer goods and mining (within the industrial customer base) makes sense, as does weakness in oil/gas.

Like other automation companies, Schneider saw more strength in discrete automation than hybrid or process automation, but both of the latter two are starting to improve. I suppose I’m a little surprised that management didn’t call out more strength in areas like mining or pulp/paper, but then those are strong areas for ABB, Honeywell (HON), and Siemens, and not so much so for Schneider.

I expect the short-cycle recovery to last at least a few more quarters, and then the question becomes whether the economy will transition to an expansion phase (I believe it will). Hybrid and process markets will lag a bit, but should be notably strong in 2022.

Longer term, Schneider remains leveraged to attractive macro themes, including industrial electrification (to support automation, et al), building automation, factory automation, digitalization in industrial, commercial, and civil markets, data center growth, and decarbonization.

On the latter point, keep an eye on the company Energy & Sustainability Services (or ESS) business. Schneider is already working with several companies here, including Walmart’s (WMT) Project Gigaton, with varying degrees of responsibility (for Walmart, it covers design to implementation). While I suspect that the “headline” revenues for these projects aren’t that large, it’s an opportunity to sell a range of products, software, and services to entire supply chains and participate in the automation and digitalization of industries where penetration rates are still low.

The Outlook

If I have any real concerns about Schneider Electric now, it’s that expectations for the November Capital Markets Day are really ramping up. At this point, if Schneider doesn’t meaningfully upgrade its multiyear revenue growth guidance (with at least 6% growth in Energy Management given long-term targets from Eaton and Siemens) and its margin targets, it will likely be seen as a disappointment.

Given how Schneider’s key long-term opportunities (automation, electrification, et al) are shaping up, I’ve nudged up my model estimates, and the long-term revenue growth rate is now pretty much 5%. I’ve also moved my margin estimates higher, in part due to expectations of a higher contribution from higher-margin revenue streams like software (I’d recommend investors check out the recent Capital Markets Day presentation from Schneider’s majority-owned AVEVA (OTCPK:AVVYY)). With a long-term mid-teens FCF margin in my model, the FCF growth rate moves to around 6%.

Schneider is more middle-of-the-pack when it comes to margins and returns on invested capital and tangible assets, and that is a limiting factor with respect to forward multiples (historically, there’s a strong correlation between multiples like forward EV/EBITDA and margins and returns). That said, given the arguments that analysts and investors will make to goose up forward multiples (cycle/market exposure, margin improvement potential, et al), you can easily make similar arguments for Schneider.

The Bottom Line

Schneider really only looks “cheap” in the context of even more expensive-looking ideas like Eaton, Honeywell, Rockwell, and so on, and the mid-single-digit DCF-driven implied long-term return is not all that compelling. Still, I do absolutely believe that Schneider is a long-term winner with not just exposure but strong market share in multiple markets that are likely to grow well above global GDP for the next decade.

With that, I’m still bullish on Schneider, even though I do think that the sector is pricey and that there could be a pullback at some point – but that point could be another 20% higher from today’s price.

About Schneider Electric

At Schneider, we believe access to energy and digital is a basic human right. We empower all to do more with less, ensuring Life Is On everywhere, for everyone, at every moment.

We provide energy and automation digital solutions for efficiency and sustainability. We combine world-leading energy technologies, real-time automation, software and services into integrated solutions for Homes, Buildings, Data Centers, Infrastructure and Industries.

We are committed to unleash the infinite possibilities of an open, global, innovative community that is passionate with our Meaningful Purpose, Inclusive and Empowered values.

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