Hubbell: Low Requirements To Continue Growth, Watching Valuations Closely

seekingalpha2024-11-22

Hubbell continues to present with attractive economic characteristics.The company demonstrates strong financial health and efficiency, making adding to the investment opportunity.Valuations may be a ...

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overflow: hidden}\n.head .h-thumb { width: 30px; height: 30px; margin: 0; padding: 0; border-radius: 50%; float: left;}\n.head .h-content { margin: 0; padding: 0 0 0 9px; float: left;}\n.head .h-name {font-size: 13px; color: #eee; margin: 0;}\n.head .h-time {font-size: 11px; color: #7E829C; margin: 0;line-height: 11px;}\n.small {font-size: 12.5px; display: inline-block; transform: scale(0.9); -webkit-transform: scale(0.9); transform-origin: left; -webkit-transform-origin: left;}\n.smaller {font-size: 12.5px; display: inline-block; transform: scale(0.8); -webkit-transform: scale(0.8); transform-origin: left; -webkit-transform-origin: left;}\n.bt-text {font-size: 12px;margin: 1.5em 0 0 0}\n.bt-text p {margin: 0}\n</style>\n</head>\n<body>\n<div class=\"wrapper\">\n<header>\n<h2 class=\"title\">\nHubbell: Low Requirements To Continue Growth, Watching Valuations Closely\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-11-22 22:44 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4739612-hubbell-low-requirements-to-continue-growth-watching-valuations-closely><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Hubbell continues to present with attractive economic characteristics.The company demonstrates strong financial health and efficiency, making adding to the investment opportunity.Valuations may be a ...</p>\n\n<a href=\"https://seekingalpha.com/article/4739612-hubbell-low-requirements-to-continue-growth-watching-valuations-closely\">Source Link</a>\n\n</div>\n\n\n</article>\n</div>\n</body>\n</html>\n","isBrief":false,"type":0,"news_type":1,"symbol":"LU2298322129.HKD","symbol_name":"BGF SUSTAINABLE ENERGY \"A2\" (HKDHDG) ACC","start_time":0,"source_url":"https://seekingalpha.com/article/4739612-hubbell-low-requirements-to-continue-growth-watching-valuations-closely","article_id":"2485627552","we_media_id":null,"thumbnails":["https://static.seekingalpha.com/cdn/s3/uploads/getty_images/1220627489/image_1220627489.jpg"],"rights":null,"url":"https://stock-news.laohu8.com/highlight/detail?id=2485627552","pubTimestamp":1732286652,"columns":[],"sourceInfo":{"source_id":"seekingalpha","name":"Seeking Alpha"},"weMediaInfo":null,"summary":"Here I'll run through HUBB's competitive advantages and how they show up in its financials when properly analyzed. Net-net, I reiterate HUBB as a buy. Figure 1.   TradingView Why HUBB is a great business . Competitive advantages observed at the margin Let's see what HUBB is up against here to provide context. The electrical components and equipment industry is a commodity-type business, meaning it suffers from commodity-like economics. Products are not differentiated in any consumer-important way such as appearance or taste, such that price is typically a determining factor in purchase decisions. Those with the highest operating efficiencies tend to flourish given it is often a profitless race to the bottom, and only those with outsized ratios of sales to assets employed on the balance sheet tend to gain market share. More often than not these names typically sell when I dub as timeless essentials, in this ca","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"LU2298322129.HKD":"BGF SUSTAINABLE ENERGY \"A2\" (HKDHDG) ACC","LU1978683503.SGD":"Blackrock Sustainable Energy A2 SGD-H","BK4585":"ETF&股票定投概念","LU0124384867.USD":"贝莱德新能源基金A2","IE00B3CCJ633.GBP":"GUINNESS SUSTAINABLE ENERGY \"C\" (GBP) ACC","HUBB":"哈勃集团","LU0724618433.USD":"BGF NEW ENERGY \"A4\" (USD) INC","BK4588":"碎股","BK4096":"电气部件与设备","IE00B2PGVK34.USD":"GUINNESS SUSTAINABLE ENERGY \"C\" (USD) ACC","IE0034235188.USD":"PINEBRIDGE GLOBAL FOCUS EQUITY \"A\" (USD) ACC","IE00BGHQF417.EUR":"GUINNESS SUSTAINABLE ENERGY \"C\" (EUR) ACC"},"translate_title":"哈贝尔：持续增长的要求较低，密切关注估值","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"HUBB":0.9},"content_text":"Hubbell continues to present with attractive economic characteristics.The company demonstrates strong financial health and efficiency, making adding to the investment opportunity.Valuations may be a little stretched but are tempered by the outlook on growth, returns on capital, and comparable risk.   Pgiam/iStock via Getty Images Investment Update Following my last report on Hubbell Incorporated (NYSE:HUBB) in October '23 [rated buy] the sock is +43% on the combination of asset factors, earnings power and multiples expansion. The stock now sells at 27x fwd earnings and ~5x the net tangible + intangible assets required to operate, having stretched to these marks gradually over the last 2 yrs. In the last report, I noted the following investment factors which remain relevant:  HUBB is a low-margin, high-capital turnover business where economic returns have lifted since 2020. The business earns attractive rates on its existing asset base. But returns on all new capital employed in its operations to maintain its competitive position and grow have been satisfactory. Post-tax operating profits increased from ~$9.50/share in '22 to >$17/share in the last quarter (TTM values) vs. a $24/share increase in capital (30% ROI). The prospect for an expansion in multiples was high for this business 12 months ago, in my view. With management's capital allocation decisions + acquisitions completed, investors realized that a dollar invested in this business was worth multiples higher than peers, and that, as all HUBB's new investments matured, underneath every dollar of sales was likely to be ~$0.15–$0.20 of free cash flow. Such has been the case for HUBB, so all valuation expansions to date have been justified in my opinion. As such, the business is worth far more than it was ~12mo ago on a multiples basis (20x fwd P/E vs. 27x today; 2.8x EV/IC vs. 4.9x today).  The questions now are 1) can these economics continue to grow the intrinsic worth of the business, 2) can they continue at all, and 3) has the stock got ahead of the business at present valuations? Here I'll run through HUBB's competitive advantages and how they show up in its financials when properly analyzed. Net-net, I reiterate HUBB as a buy. Figure 1.   TradingView Why HUBB is a great business (1). Competitive advantages observed at the margin Let's see what HUBB is up against here to provide context. The electrical components and equipment industry is a commodity-type business, meaning it suffers from commodity-like economics. Products are not differentiated in any consumer-important way such as appearance or taste, such that price is typically a determining factor in purchase decisions. Those with the highest operating efficiencies tend to flourish given it is often a profitless race to the bottom, and only those with outsized ratios of sales to assets employed on the balance sheet tend to gain market share. More often than not these names typically sell when I dub as timeless essentials, in this case, electrical components. Substantial excess supply already exists in market, meaning industry prices really are determined by a less benign pricing environment through competition – and because there is such high competition, it's often that customers care little about product or distribution choices. Typically, in this type of business, management must lower costs to competitive levels otherwise face oblivion. Secondly, capital turnover must remain exquisitely high to make up the slack on low-profit margins on sales. If this languishes, inevitably it produces inadequate returns on capital. Most of the time, management tries to increase volume or turnover, committing more capital and doing so. The other option is to improve profit margins. There are plenty of ways to do this, ranging from product differentiation to cost efficiencies, but the issue is, that all competitors are just as diligently doing the same things, rendering them effectively useless. Mostly, businesses in these types of industries must earn inadequate returns except when there are times of short supply in inflationary periods. HUBB possesses competitive advantages that see it outshine industry peers on several of these core competencies:  Gross margins are ~2x the industry average, and 500 ps above the industry median, suggesting the business prices its offerings above peers. Operating margins are also ~3x the median peer at 19% in the last 12 months, versus 6% for the industry (note HUBB's has crept up the last two years, as will be discussed later). The fact it turns over all assets employed on the balance sheet at a rate of ~1x is highly constructive and illustrates the efficiency the business enjoys over competitors. Continuing the discussion from earlier, a company like HUBB doesn’t necessarily have to lay out huge amounts of capital to maintain competitiveness or necessarily to grow, given it can pass on prices to its consumers.  Figure 2.   Seeking Alpha For HUBB, the capital investment required to produce a dollar revenue is subsequently low – at $0.80 in the last 12 months, but has been as low as $0.60 over the last 2 yrs. Said otherwise, each dollar investment that’s been put into this business is returning $1.20 in revenues. Because the sales per dollar of capital are high, funds can be aggressively allocated toward producing more volume. Figure 3. Company filings, author  For HUBB this has been the case. It now sits on the right side of the distribution for several industry factors, such as 1) business returns, 2) asset turnover, and 3) profit margins. I am after businesses that sit towards the right tails of the distribution within their industry for these factors, but towards the centre or left side of the distribution in terms of valuation. For this, it deserves high marks. Critically, my view is that it is not positioned so far towards the tails of the distribution to present a risk of mean reversion. I also believe that the present figures will show persistence. There is good evidence to suggest that operating margin shows high persistence over a 3 yr periods (see: Credit Suisse- Base rates book, 2016) so if this is the case, we are in a good position.  Figure 4. Bloomberg Finance LP, Bernard Investments (2). Business economics As to what is driven the tremendous upsides, it is a combination of 1) Capital allocation, 2) Operating efficiencies and 3) Successful acquisitions. Management has also shed capital over the past 2 yrs through major divestitures. It sold its commercial and industrial lighting business in 2021, and it’s residential lighting business in 2023. It has no more lighting businesses on its books. The specific economics have been twofold: First, post-tax margins are +700bps growth in the last 2 yrs. Operating margin growth is empirically a greater driver of returns on capital and earnings growth – both of which correspond to market values. This result here is the combination of acquisition led growth and operating efficiencies realized at the margin. Figure 5.   Company filings Second, earnings growth has rapidly outpaced the rate of earnings reinvested into the business. Since FY'22, sales have grown 1.7x And earnings at roughly 2.2x, whereas management has expanded the capital base only 2x to produce this growth (TTM values). The percentages work out to be a 33% increase in capital invested into operations, versus a 77% growth in operating earnings after tax. In other words, every dollar of investment produced ~$2.10 in profit. Per share this equals $32/share of additional investment for $7.30/share incremental operating earnings Figure 6.    Company filings Figure 7. Company filings Valuation insights My views are 1) The business can compound sales at ~6–8% per year over the coming 2 yrs, with 2) Pre-tax margins of ~19%. If it is to maintain the current rate of M&A activity, it would have to invest up to $1.09 for every $1 of incremental revenues, in my opinion. If it were to reduce this by ~20%, then capital turnover could retain a ratio of ~1x. This tells me HUBB could earn ~19% on capital this year. But my numbers [see: Appendix 1] suggest to produce an incremental $1 of revenues at 5–6% growth per year would require an incremental $1 of investment to achieve. Critically, the business has been repriced from a multiple of 2.8x EV/IC to 4.9x at the time of writing, but this to me has been completely justified by 1) Decompression of operating margin and 2) Earning more on each dollar of capital employed into the business. Assuming a 12% hurdle rate, the spread (ROIC–12%) HUBB has thrown off is expanding. That means every dollar of earnings that is retained, is valued at ~$5.00 in the market at present multiples. All funds that management can redeploy from freely available cash should be viewed highly in this regard. Figure 8.   Company fillings Figure 9.   Company filings Question is, how much can it redeploy over the next few years, and will it hold this multiple? There is downside risk with the business trading this high, and it could revert back toward an industry-level valuation of ~3x in my view (keyword = toward). But there's also upside risk on this given recent business performance. I am not here to speculate on either, but rather to provide a range of outcomes to the upside and the downside. As mentioned earlier, this business can run without having to lay out large sums of capital to maintain a competitive position. My view is it can survive comfortably by reinvesting ~8%–9% of operating earnings every year, producing large returns on these retained profits when reinvested. I get there as mentioned with fairly conservative estimates of 1-1.2x capital turnover and 19% post-tax operating margins. The outcomes are most sensitive to changes in operating margin. At the function of 1) present valuation multiples, 2) the estimated rate of reinvestment needed to grow sales ~5-6% annualized for the next 3 yrs, and 3) HUBB’s current business economics, my view is the business is worth about $450 today, and compound to a market value of $467-$470 per share by FY’26E (21% CAGR). Figure 10.   Author's assumptions Risks to thesis This risks section is really important, so investors should pay close attention. HUBB has outperformed the industry cross several metrics over the past 2 yrs. This has not always been the case, particularly the fact the gains have been driven by operating margin decompression. The question is on the persistence of these margins/returns. Being a defensive industry, base rates indicate a slower reversion to the mean. The risk, or my biggest concern, is a sharp regression in returns on capital towards industry levels of 5%. The risk is applicable to all the figures mentioned today. This could nullify the thesis and potentially change my view. Investors should recognise this moving forward. In short HUBB remains a buy in my view for 1) A long-term orientation, that is 2) Considering capital growth for 3-5 years. Current valuations are high, along with the abnormal business returns and operating margins relative to peers, could present a risk of mean reversion towards industry levels. So I am watching relative valuations very closely. There may be a risk the stock has got slightly ahead of the business, although this will smooth out over time for those long-term inclined. My view is the business can compound its intrinsic value at compounding rates above what investors could generally achieve elsewhere, with the business reinvesting 8–9% of its profits to expand and grow earnings power, where underneath every $1 of sales might be up to $0.15–$0.20 of FCF. These are highly conservative numbers for a steady-state value. Net-net, reiterate buy.  Appendix 1.   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