Timo Ihamuotila, Chief Financial Officer of ABB, speaks about the industrial group's growth prospects, President Joe Biden's infrastructure plan, as well as the company's dividend and acquisition policies.
ABB is getting into gear. The conglomerate, a disappointment on the stock market for years, has fundamentally reorganized itself under the leadership of CEO Björn Rosengren and CFO Timo Ihamuotila. The cumbersome matrix structure has been abolished, and ABB now consists of four business units and 21 divisions that operate largely autonomously.
As a result, momentum has returned to the share price. Year to date, the shares have gained almost 20% on a total return basis and are in the top group of the Swiss Market Index. The recovery of the global economy and the prospect of major infrastructure programs speak for ABB.
In an in-depth conversation with The Market, CFO Timo Ihamuotila talks about the course of business, the recently announced share buyback program, acquisition plans and the three divisions currently up for sale. A spin-off of the Turbocharging division with a separate listing is still an option, he says. «A spin-off could be a very good possibility to maximize value for our shareholders», says Ihamuotila.
Mr. Ihamuotila, 2020 has been a challenging year. How has your business started into 2021?
As we said after our results announcement in February, we have seen a clear pickup in the shorter cycle business, which in our case first comes through in the business area Electrification and then in some parts of the business areas Motion as well as Robotics and Discrete Automation. In Process Automation, which represents longer-cycle businesses, we are also coming back, but at a slower pace. That’s the picture by business areas.
And by geography?
We have a very strong recovery in China. This is a testament to the company having built a strong position in China, which today is our second largest market. Our portfolio is very balanced geographically, with about one third in Asia, one third in Europe and one third in the Americas. This gives us a strong footing. So currently, China is very strong, the US appears to be coming back quite nicely this year, while Europe is a bit slower due to the Covid-19 situation.
Many industrial companies are warning of disturbed supply chains, of component and semiconductor shortages. Is this an issue for ABB?
We are following this on a day-to-day basis, but we are currently not seeing any significant impact. What is good for us is that our supply chains tend to be fairly regional: US for US, China for China, Europe for Europe. Of course, we have some supplies moving across regions, but we don’t have a supply chain where everything would, for example, come from Asia. We are aware of the situation, but I would say so far, so good. There is one thing I should point out though: There are some expectations of a very brisk growth in the US economy this year, perhaps by 6 t0 7%. This would be a very fast ramp-up and would lead to hiccups in different supply chains.
But you don’t have any problems with semiconductor shortages in your robotics business?
When you published your outlook for 2021 in February, there was, among analysts, some confusion about your growth prospects. What is your target for organic revenue growth this year?
We said that it’s somewhere between 3 and 5%. During the coming three years, we expect to grow at least as fast as our addressable market. For that three-year period, it would be in the 5% area per year.
In the Robotics business area, there was some disappointment in terms of your outlook for this year, especially given the order intake your Japanese competitors have shown. Why this sub-par performance of the robotics business?
We believe that our Robotics and Discrete Automation business is running in-line with our ambitions, and it will be one of the growth engines for the company going forward. But we have scaled back some business there, especially the full-turnkey line installation business for automotive customers. We think automotive is still a very important customer base, but our job is not to be a systems integrator. Without that effect, we are able to show a strong growth in the Robotics and Discrete Automation business area.
Will Robotics and Discrete Automation reach an Ebita margin of more than 10% this year?
That is our target, yes.
You have recently announced a further share buyback of up to $4.3 billion within one year, before the next Annual General Meeting. The speed of this has surprised many. Why so fast?
First, I think it’s important to note that we are now committing again to give back the proceeds of our sale of 80% of the Power Grids business. We bought back $3.5 billion in shares last year, which is a bit less than 6% of the company’s capital. And we felt that the right thing to do is to continue to execute expeditiously. But I must point out that we are saying «up to» $4.3 billion. That means we will run the buyback in a professional way and not in autopilot mode. We will do it responsibly, taking into account market volatility.
A share buyback can be seen as a lack of imagination in terms of investment into the business. Are there, in this environment, no interesting acquisition targets for which you could use that cash for?
We have a very systematic capital allocation thinking. First and foremost, we want to invest in organic growth. Then we want to pay a rising sustainable dividend per share. Then we invest in value-adding acquisitions, and then only, in fourth place, comes the buyback. We’re not saying that there would not be opportunities to invest: We are actually increasing our R&D investment portion as a percentage of revenue, and we also said at our capital markets day in November that part of our growth going forward should come from acquisitions. We are constantly looking to add companies to the ABB portfolio. But this buyback is really driven by the money that came from the Power Grids exit. And don’t forget that ABB is very cash generative. We expect that in 2021 and onward, we will have a free cash flow that will well cover the dividend and gives us room for further investment opportunities.
So we can expect a steadily rising dividend per share going forward?
The dividend has been at 0.80 Francs per share for a couple of years now, but our aim is to perform in a way that we can continue to drive rising and sustainable dividends.
CEO Björn Rosengren said at the capital markets day that he sees five to ten bolt-on acquisitions per year going forward. Is that still the case?
Yes, but it will take a little bit of time to ramp this up because this is a completely different acquisition strategy than what was previously in place. In the new, decentralized ABB Way operating model, the business areas and divisions are in the driver’s seat to do bolt-on acquisitions, and we have to build up the pipeline of deals first. So I would say in 2021 maybe we don’t quite get to those levels, but I’m sure we’ll get something done, and then we will continue to ramp up from there. This is very important for the company because we want to make sure that the acquisitions the divisions are doing are value-adding to their business. They have the responsibility that the strategy execution works. They do their integration. They also then have to carry the goodwill and make sure that the return on capital including that possible goodwill comes through.
Is the new divisional structure fully in place now? Can we say that the new ABB is running?
Yes, the structure is fully in place, with the four business areas and 21 divisions. The execution and implementation of the ABB Way operating model came to its finalization at the end of 2020. We are now making sure that the business decisions are done as close to the customer as possible. We also have the whole setup in place from the financial perspective: The divisions are independent, there are no allocations to divisions anymore from corporate, so they have the accountability and responsibility for their performance. We manage them through a scorecard system so that we can compare the performance of the 21 divisions in a way that we can easily see what is going well and where there might be the need for some form of correction.
Is it possible to think that if an acquisition target comes along, that you would decrease the announced buyback?
We do not see that kind of scenario at the moment for the announced $4.3 billion buyback. We went through a wide-ranging capital structure optimization program last year, way beyond just the buyback: We deleveraged the company by about $2.9 billion, out of which we also bought back some of our high-coupon debt of about $1.2 billion. That changed our capital structure significantly. We outsourced some of our pension management, and with that we took our pension liability down by about $2.5 billion, while the unfunded pension liability decreased by $770 million. We paid about $360 million in cash for that, so it was a very efficient way to deleverage. With all these transactions, we have created a balance sheet that gives us a lot of flexibility, so that even if we were to do an acquisition that is a little bit bigger, we could continue to execute the buyback and still have a lot of capacity.
What is your current firepower with that balance sheet?
You have to take different components into account. We have quite a significant amount of money coming in from planned divestitures. Plus, we still have the 19.9% ownership of the Hitachi Power Grids business, where we will get approximately $1.5 billion in a little more than two years’ time. We have a strong single-A rating with a stable outlook. So, we have billions of capacity if needed.
Three divisions are under review for a possible sale: Turbocharging, Mechanical Power Transmission – which runs under the Dodge brand –, and Power Conversion. Where do you stand there?
We are moving systematically forward. Dodge, which is predominantly a US business, is expected to be benefitting from a strong US recovery in the shorter cycle industrial sectors. So, this is moving forward very nicely. Turbocharging will take a little bit longer because that market has a rather high cruise ship industry exposure. You can imagine that this needs some more time to recover. We are doing all the separation work and then we will see how we run that process. In the Power Conversion division, we already prepared the ground earlier, so we are in a good place to move forward when the time is right. We are in no hurry; we are not looking to do any fire sales. We want to maximize the value of each of these assets for ABB shareholders.
So in terms of the timing sequence, it will be Dodge first, then Power Conversion, then Turbocharging?
I would say first Dodge and then the other two.
Do you think Dodge will happen in the first half of this year?
That would be quite aggressive. But we would expect it to happen some time this year.
As far as Turbocharging is concerned, Björn Rosengren has said that a spin-off to shareholders with a listing in Switzerland is a possibility. Is that still the case? Or would you rather sell the division to private equity or an industrial buyer?
All these alternatives are open, and we look at which one would maximize the value for ABB shareholders. The spin-off is definitely a very interesting alternative because this is a solid standalone business. The profitability characteristics of Turbocharging are very good. So we think that this is an asset that could trade with a premium multiple if it was fully exposed to the market.
There have been reports that most likely Turbocharging will go to a private equity buyer. So you are saying a spin-off is still on the table?
Yes, that is correct. A spin-off could be a very good possibility to maximize value for our shareholders.
If we look at the medium-term, you have, at your capital markets day, set a mid-term target of an Ebita margin of 13 to 16%, with a tilt to the higher end in 2023. Is that still in place?
Correct, no change to that.
Many analysts are sceptical that you will be able to achieve these margins on a group level. What is your answer to them?
We basically need to execute. Of course, we need to set targets which are ambitious but also achievable. But these targets come from the divisions; it’s not something that the CEO or me set centrally. Now, we have to apply our continuous improvement thinking and our decentralized operating model where we drive value creation as close to the customer as possible.
Critics of your new operating model say that ABB gives up synergies between divisions. Why are they not correct?
It’s very clear that there is no matrix organization anymore and there is no overlap in any of the operating activities on a corporate level. With that comes an important principle: The principle for speed in decision making over synergies. We are not trying to drive central synergies by cost savings. We optimize for speed, and this is by placing the divisions as close to the customer as possible. But we have another principle: We say good leaders cooperate. This means it’s up to the division heads to decide if they want to have a common account manager or a common distribution center. We just do not force that from headquarters. They are allowed to drive synergies as they see fit from the business perspective.
ABB has gone through a huge reorganization in the past two years. Looking forward, what are the biggest challenges?
We need to make sure that we live this model. As you know, you can put a setup in place, but you also have to create the culture that drives that setup. To give you an example from my perspective: In this model, I am not controlling how many finance people division X or Y has. That is not what I should do. So, I have to learn to let go. That’s how we get speed into the system. Just imagine: We don’t do yearly budgets anymore. We run a five-quarter rolling performance management system instead, without taking months and months of putting a budget together. That’s not our philosophy anymore, instead we want to drive for continuous improvement.
ABB has been a laggard in terms of performance for years. Will you finally be able to turn the corner and outperform your peers?
Clearly, we think that this is the right way to drive better profitable growth. It’s early days with ABB Way, we introduced the concept nine months ago, so it would not be right to now say: «Boom, everything is working». But we definitely think we are moving in the right direction.
There is a perspective of a big infrastructure investment program in the US under the Biden Administration. What would that mean for ABB?
Our overall offering is supporting secular growth trends. It’s clear that electrification will be a secular growth trend when it comes to fight global warming, and that goes back to your point about US infrastructure investments. Of course, if we should have a speed-up from a US infrastructure investment program into green energy, it will be beneficial for us. If you look at our sustainability strategy that we launched in November, the most important of all our targets for 2030 is reducing the CO2 footprint of our customers through our technology. This ties in nicely with the Biden Administration’s sustainability angle.
And that would move the needle for the whole of ABB?
The US is 23% of our revenues, it’s our largest single market.
ABB board member Lars Förberg of Cevian recently said in an interview that most corporate sustainability goals are too fuzzy and set too far in the future. What do you make of this?
Our sustainability targets are very ambitious. Being carbon neutral by 2030 for the company’s own production is a very strong target. On top of that, what is even more important in our case, is that we are looking to reduce our customers’ CO2 emissions by at least 100 megatons by 2030 on an annual basis. We also want to have zero percent waste in the landfills and 80% circularity by 2030 on our products. Furthermore, the remuneration of the top 100 managers is linked to safety targets and also to CO2 reductions in our own operations. We address this issue head-on.