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Hubbell: Near-Term Headwinds Outweigh The 7% FCF Yield (NYSE:HUBB)

Hubbell (NYSE:HUBB) remains a solid option for investors looking to gain exposure to trends in the utility, non-residential, and general construction markets in the US. However, I am less upbeat about the near-term prospects – despite the positive utility outlook, I see a relatively muted fiscal 2021 recovery on continued headwinds in non-residential construction and LEDs, which could weigh on the Electrical segment results. Additionally, HUBB could also see margin pressure as the recent rise in commodity prices hits fiscal 2021 results, while the mix shift in the Utility business alongside the Aclara installation ramp-up could also prove unfavorable. Therefore, I am neutral on HUBB shares despite the c. 7% FCF yield.

A Solid FQ3 with Caveats

HUBB’s latest headline numbers were solid, beating consensus estimates across segments on the top and bottom lines. By segment, Power Systems (part of the Utility Solutions segment) was the standout, with solid +9% Y/Y headline growth. This includes a c. 4% Y/Y benefit from storm-related tailwinds, while resilient utility demand from aging grids and renewable demand also helped the top-line result. Nonetheless, the Utility segment’s organic growth was only up 1% Y/Y as Aclara (also part of Utility Solutions) was down in the mid-teens % Y/Y, offsetting Power Systems’ strength. The Electrical segment was also a drag, declining c. 14% Y/Y for the quarter.

Source: Hubbell FQ3 ’20 Press Release

As a result, overall revenue was ahead of consensus at $1.1 billion (down 8% Y/Y on an organic basis). However, if we were to adjust for the one-off benefit from increased storm activity (c. 4%pt contribution to Power Systems growth), revenue growth would have been in line with consensus. Nonetheless, the fact that FQ3 improved sequentially to down c. 8% Y/Y (up from -20% Y/Y in the prior quarter), with order patterns in the first three weeks of October also on the uptick, is positive. However, these trends mainly reflect execution on delayed projects – as pent-up demand at Aclara eventually fades, the pace of a top-line recovery could falter.

FQ3 ’19

FQ4 ’19

FQ1 ’20

FQ2 ’20

FQ3 ’20

Sales

$1,204.0

$1,103.3

$1,090.3

$949.2

$1,108.6

Organic Sales Growth

2.9%

-3.3%

0.5%

-20.8%

-8.0%

Acquisitions/Divestitures

-0.6%

0.0%

0.5%

0.1%

0.1%

FX

-0.2%

-0.2%

-0.7%

0.0%

0.0%

Total Sales Growth

2.1%

-3.6%

0.3%

-20.7%

-7.9%

Source: Company Data

FQ3 Margin Outperformance Could Fade

While the stronger top line helped, the EPS beat was mainly driven by margins, which rose a very solid +50bps Y/Y, despite the temporary cost cuts in FQ2 returning in FQ3. While solid price/cost trends boosted margins this quarter, this tailwind will likely fade heading into the next year as commodities return to inflation. Nonetheless, management sees more productivity gains in FQ4 (part of which will be reinvested in innovation) and raises fiscal 2020 EPS guidance range to $7.45-$7.60 (up from the prior $7.00-$7.25).

Source: Hubbell FQ3 ’20 Presentation Slides

However, I see margin headwinds in fiscal 2021, as the near-term benefits from HUBB’s self-help initiatives are offset by the recent rise in commodity prices across copper, steel, and aluminum. The lagged impact means commodities will likely reverse from being a fiscal 2020 tailwind to a fiscal 2021 headwind. Additionally, HUBB could also face margin pressure from a negative mix shift in the Utility business as lower-margin Aclara installations ramp up.

Mixed End-Market Outlook

There were some pockets of optimism in the end-market outlook – within residential for instance, management pointed to strength ahead in e-commerce and big-box retail channels. Meanwhile, Aclara (Utility Solutions) continues to experience COVID-19-related project delays, but this should moderate in FQ4 and beyond. Additionally, I think it is worth noting that HUBB could be a beneficiary of a Biden presidency should the $1.5 trillion “Moving Forward Act” pass – the package will allocate as much as c. $70 billion for grid modernization over a five-year period. Longer term, the push towards green energy is positive for HUBB, as renewables typically require transmission over longer distances.

Source: Hubbell FQ3 ’20 Presentation Slides

Despite the positive Utility outlook, a 2021 recovery is likely to be muted as HUBB continues to face headwinds in the Electrical segment. With the outlook for non-residential construction negative into fiscal 2021, I see near-term LED demand remaining weak, which should weigh on the Electrical segment performance going forward.

Cash Generation Boosts the Balance Sheet Position

HUBB remains a consistent cash generator, with the updated FCF guidance for fiscal 2020 raised to $550 million following the $404 million FCF generated YTD. The net debt position has also improved to $1.2 billion (net debt/EBITDA at 1.5x), underpinning a strong balance sheet to be deployed for growth.

FQ3 ’19

FQ4 ’19

FQ1 ’20

FQ2 ’20

FQ3 ’20

Net Debt

1,450.0

1,389.4

1,404.0

1,270.6

1,189.0

Net Debt/EBITDA

1.78

1.70

1.71

1.61

1.52

Source: Company Data

Recent M&A include the acquisition of AccelTex (an industry leader in wireless solutions) in October, which extends HUBB’s presence into 5G. Leveraging HUBB’s scale, management is also positioned to expand AccelTex’s market reach further. The immediate contribution will be minor as AccelTex only has c. $10-$15 million in annual sales, but the company does generate high margins. Additionally, HUBB also announced a dividend increase this quarter, with the quarterly payout now at 98c (implying a c. 2-3% dividend yield), in addition to a new $300 million share repurchase program.

Source: Hubbell FQ3 ’20 Presentation Slides

Final Take

Despite the sizeable EPS beat in FQ3, I am less upbeat about HUBB’s near-term prospects. This is primarily due to the result being aided by one-offs such as increased storm activity in the quarter and positive price/cost trends, with the latter likely to reverse in upcoming quarters. Additionally, a challenged non-resi outlook will likely weigh on the Electrical segment, with margin pressure from commodity prices also a concern. Coupled with the lack of near-term catalysts, I am less upbeat on HUBB despite its attractive c. 7% FCF yield and am neutral on shares.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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