Schneider Electric: Continued Outperformance, Now Significantly Overvalued

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Schneider Electric has significantly outperformed the S&P 500 but is now trading at an unsustainable 30.5x P/E, making it overvalued and a rotation target.Despite strong fundamentals and record ...

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Brett_Hondow  Dear readers/followers, I covered Schneider Electric (OTCPK:SBGSY) about 10 months ago, give or take. At the time, I gave the company a neutral \"Hold\" rating, and did not touch my stake in the company, either to sell or to add more. Since that time, the company has outperformed the S&P500 by a significant margin. You can find that particular article here. The outperformance since that particular article has made all but certain that the company is now significantly above its trading average, and despite expectations of growth, I see Schneider as a problematic investment at this point. That isn't just in relation to its overall appeal, where overvaluation has sometimes been a thing - but we are now, at 30x+ P/E as of 29th October 2024, at a level that the company hasn't typically been at for very long. For some time, I have considered what I am going to do with Schneider as an investment - now I believe I have the answer, and my answer is to rotate this investment in order to invest in more appealing and better-valued companies. By more appealing, I don't necessarily mean more fundamentally safe - because very few companies are really \"safer\" than this one in this particular segment. Let's see at this time what Schneider offers, why I am selling, why the company has outperformed, and what the company could generate from here. After all, there are still those who consider the company a \"Buy\" here. Schneider Electric - The upside following the latest updates and valuation is almost non-existent Given Schneider's outperformance over the past year, it's fair to raise the company's fair valuation - that's what I am going to do here. The company is worth more than where I put my fair value during my last article. Schneider Electric is very well-positioned to enjoy the ongoing convergence and movement from software and hardware - and the results show this. Its product portfolio has exposure to both electrical power and industrial automation. These markets have extremely high entry barriers, and this combined with digital growth and the trend of digitization will support long-term growth for the company. Several M&A's have enabled market share growth for Schneider as well, and much like other companies, they're moving away from a direct sales model to a digital revenue model, which has the net effect of smoothing out the peaks and valleys of the company's otherwise cyclical operating trends. These are positives. We do not yet have 3Q24 results. Those will be coming in a bit (tomorrow), which is why this article will also work as an earnings preview prior to the earnings and why I believe investors should be considering rotation - but we do have half-year results to look at here. 2Q24 was a good quarter. The company saw strong execution, recording record-level revenues and overall record levels of adjusted EBITA. For those interested in sustainability, Schneider is now actually considered by many to be the world's most sustainable company.   Schneider Electric IR (Schneider Electric IR) But for me, the financials are more interesting. This is a company that recorded record revenues on a quarterly basis, for any quarter in its history, at €9.6B and closing in on a run rate of €40B. This is a 7.1% growth. Schneider remains a two-segment play between energy management and industrial automation. Here the company's results become somewhat different. Energy management results are actually up by almost 10% organically - whereas the results in Industrial Automation are heavily impacted by ongoing exposure to the industrial macro, dropping 6.6% in 1Q, and another 3.5% in 2Q. This hasn't changed the 1H24 impressive trends in EBITA, net income, OCF, EBITA margin (up 100 bps), and Gross margins (up 100 bps as well). The overall global macro continues to drive long-term sales. This includes investments into data centers and technical infrastructure, being some of the more interesting correlations for the company. Growth markets such as India, EMEA/Africa are leading growth, not necessarily Europe. There's also strong progress on the movement to a subscription-based model, like many companies are working towards here. And despite somewhat lower organic growth in Industrial Automation, expectations for the company's various end markets remain very high.   Schneider Electric 1H24 Presentation (Schneider Electric 1H24 Presentation) Unlike other companies in this field, Schneider Electric has a very balanced exposure to various geographies across the world. This includes, but is not led by China, where the company is expecting only moderate future growth. Instead, the charge is likely to be led by EMEA, India, and USA, which also marks the company's largest foci for further investments over the coming years. The company also already has market leadership in all of these areas, except the Middle East & Africa. This is leading to new capacity investments.   Schneider Electric 1H24 Presentation (Schneider Electric 1H24 Presentation) Company profitability and growth are set to be secured by things like Software - because the company's subscription-based services are delivering double-digit revenue growth rates, with organic growth for the SaaS model at 140% in H1 alone, and AVEVA delivering Revenue growth of 16% in terms of Annualized Recurring revenue. So what we can see here is a lot of interest in the company's technological and software solutions. The company is an enabler of hyperscaling, or hyperscalers, working a lot with modular, scalable, and prefab designs - such as in current projects in Saudi Arabia. This is specifically for data centers at this point, where solutions for energy management have been built entirely on the company's ecosystem, EcoStruxure. This can also be seen in China as well.   Schneider Electric 1H24 Presentation (Schneider Electric 1H24 Presentation) The avenue for future company growth is reflected by its segments - with significant growth in Software & Services, in System, but with products (the largest of the segments) trailing at only 1% growth. Still, for the macro that we're in, that's not a bad growth performance.   Schneider Electric 1H24 Presentation (Schneider Electric 1H24 Presentation) Likewise, the company's margin improvements came due to a better mix and better volumes - while headwinds for the company contained inflation, kept in check by strategic initiatives and cost savings. R&D costs were up, but only a third of the other margin improvement. Schneider, overall, has many arguments for its services and products. The enabling of megatrends is probably the core one here, and when it comes to this, Schneider is best-in-class with its growth outlook across the European capital goods sector. Demand for the company's products is high and, given the way the trends are going, unlikely to significantly decline. With an increasing amount of digital-oriented and SaaS revenues, the company's cycles will be smoothed out and the company will become a business that only during the worst of environments will see any sort of significant decline. Negatives or arguments against Schneider are few and limited in their scope, but even aside from valuation, they do exist. The company's end markets are, some of them, cyclical - good examples are the ones exposed to industrial macro and construction, such as building tech and process industries. The company, as things become more digital, loses some of the scale advantages it has in the software sector. The M&A of Aveva opens the company up to competition from non-trivial competitors, many of which in the software field also have experience and scale. And if the company wants to grow the software arm further, I don't see Schneider doing this organically as much, but probably having to M&A further. These M&As will likely come at higher/potentially high multiples, and this could be a problem. All in all, Schneider is a qualitative and good company, an easy \"Buy\" at the right price. However, this is very far from the right price. Schneider Electric - The company's valuation is now irrational; I'm rotating my stake Schneider Electric, at this particular time, is trading at a 30.5x P/E. No matter how you approach this valuation, this is a level that isn't sustainable and never has been by the company for long; Ergo, by every metric that I typically follow, this company is now overvalued. We can illustrate this using the following.   F.A.S.T graphs Schneider Electric Valuation (F.A.S.T graphs Schneider Electric Valuation) As you can see above, the company's valuation has reached proportions that I consider to be remarkable. Even with an A-rating, a sub-30% long-term debt to cap, the company trading at above 18x P/E is rare. Now it's approaching multiples of twice that level. The yield is down to 1.43%, which is significantly worse than a savings account. Forecasting the company at even a 5-year premium of 22.7x P/E - which is too much in my view - and assuming the company's growth rate of 12% is accurate - and this comes with a 33% negative miss ratio potential for the 2-year basis even with a 20% margin of error - the upside here is less than 1% per year annualized, and that's with the dividend already included. If we take into account that the company may decline to 18x, which it did less than 2 years ago several times, the negative potential RoR at this time comes to negative double digits, with a negative potential RoR of 23%. That's very significant to me - and not something that can be argued away using the company's quality as a shield. This is a wide-moat company in a peer group that includes other wide-moat companies. All of its closest peers, including Siemens (OTCPK:SIEGY) ABB (OTCPK:ABBNY) and Legrand are, in fact, overvalued to me here. I retain a somewhat conservative PT for Schneider, but I'm raising it based on better earnings potential, and organic revenue growth until 2027, making the company one of the best-in-class across the European capital goods sector. The company is an enabler in a way that makes it hard to ignore. But that still makes it subject to the laws/rules (as I view them to be) of valuation. What goes up this high, will eventually come down. And I don't want to \"be there\" when that happens. I bought Schneider in 2023. The company is now up materially - I'm happy with my returns, and I am therefore rotating here. And for 3Q24, I expect the company to further confirm the upside for the full year - it'll be a good quarter on a YoY basis. However, I don't expect the company to materially improve in valuation from this, based on the price it's already commanding. At least, I am not willing to take this risk in terms of valuation. I'm rotating the company here. My thesis updated for Schneider and for 3Q24 is as follows. Thesis  Schneider is one of the leading, global energy solution companies. It's a 186-year-old dividend payer with one of the strongest records in all of Europe. With solid fundamentals and a great upside, this company is a must-own in a conservative portfolio at the right valuation. I keep my \"HOLD\" on Schneider Electric due to it once again being fully valued, even if we consider increasing my original PT of €145/share. I'm increasing it even further from my previous article to reflect the excellent performance, and would now say Schneider is worth €165/share. Therefore, the company should not only be approached carefully here - but you should consider it, in my view, a rotation target. I already said in my last article that I may consider trimming my position here again and realizing some of this profit, much like I did in 2023. As of October 2024, I am rotating the company's stake and investing in cheaper potentials and companies.  Here are my criteria and how the company fulfills them (italicized).  This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside based on earnings growth or multiple expansion/reversion.  The company fulfills 3 out of 3 quality indicators, but 0 out of 2 valuation indicators. Based on this, and where I see a risk/reward-adjusted upside that's attractive enough for me, I give the company a \"Hold\" rating as of October 2024. I am rotating my stake in Schneider at this time because the company's conservative upside is now in the low single digits.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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