UHVDC contract holds out promise for ABB's future

ABB, a heavy electrical equipment manufacturing company, has received an order worth Rs 4000 cr to set up a transmission project that will use Ultra High Voltage Direct Current (UHVDC) technology for the first time in the world. Following this news, the company's scrip rose by 3.54% to Rs 590.45 by the end of trade on Friday, Dec 23, 2011.

The project was awarded to ABB by the Power Grid Corporation of India (PGCIL). It will supply power from the hydro-power capacities in North East India and will transmit it to load centers 1700 km away, in Central India. The transmission lines will travel through the narrow patch of Indian territory between Nepal and Bangladesh, which is called the ‘chicken neck area’. The project will be under execution with immediate effect, and would be operational in 3 years' time, i.e. by 2015. According the filing made by ABB with the BSE, the whole transmission project is worth Rs 5000 cr. ABB will execute a Rs 4000 cr order, while BHEL will operate on the remainder of the order.

UHVDC technology is a highly advanced transmission technology that transmits high voltage electricity in DC form through the lines. In addition, it is a highly efficient technology and transmits real power. Hence, there are minimal transmission and distribution losses. We, at DSIJ, believe that with this new technology, ABB has propelled itself into a better position than its competitors in the market of power equipments.

The company derived about 54% of revenues from power systems and power products for the 9 months ended Sep 2011 Its EBITDA margins stood at 5%, which marks a significantly decline compared to earlier years, when they had been in the range of 9%-12%. During the first 9 months of this year, ABB earned total revenues of Rs 3036 cr through these 2 segments. The EBITDA margins remained less than 1% in power systems and close to 4% in power products for same period. Considering 4% EBITDA margins, the company will be able to make close to Rs 160 cr in EBITDA. At the net level, this will be slightly above to Rs 100 cr. In a conference call with analysts in Nov 2011, the company's management clearly indicated that margins may improve to 8%-10% going ahead, though they did not comment on the exact time frame.

PGCIL has been awarding some big ticket transmission projects over the last few months. With the new Five Year Plan in the offing, we further believe that PGCIL will award a few more transmission projects. In our opinion, ABB will be a major beneficiary as the Indian govt. wishes to enhance the country's transmission network in the future. The aggregate technical and commercial losses (AT&C) in the country currently stand in excess of 30%, which the Power Ministry wishes to reduce significantly. To do this, it will look to implement new technology like UHVDC, and thus, ABB stands at on the winning side.

We believe that this particular order is also significant for ABB, as the Capital Goods sector is currently facing a slump in orders due to a slowdown in the economy. In the analyst call, the company has also said that there is significant hesitation in investments in the industry at the moment.

ABB's stock has fallen by 17% following the announcement of its Sep 2011 quarter results. We see some further downside in the scrip, given the negative sentiment in the power sector. Indian firms have set their growth plans aside for some time to fight the rising interest rates as well as the current economic uncertainty.

The business of power transmission is largely dominated by the govt-owned company, PGCIL. With the participation of private companies set to increase, we foresee good order inflows in the future. Besides, we can also see decreasing competition pressure once the govt. levies an import duty of 14% on foreign power equipments. For now, however, investors should wait for dips and buy this stock in a staggered manner, as it would prove to be a good investment in the future.