• The P/E ratio is comfortably below the ten-year average of ~21x and getting close to the levels it reached during the worse of the Covid crisis.
• We believe shares are priced to deliver high-single digits to low-double digits for long-term investors.
Schneider Electric (OTCPK:SBGSF) is rarely cheap given it has many characteristics investors value highly. It operates in attractive markets with long growth runways, and the company is rated as one of the most sustainable corporations in the world.
Currently, Schneider is more attractively priced than it has been in a long time. A combination of solid financial performance and a sliding share price have worked together to make the valuation very attractive. After reaching a high of close to $200, shares have declined all the way to less than $120. That is in spite of the company reporting record numbers for 2021, and a very strong start to 2022.
For 2021, the company reported sales of €29 billion, net income of €3.2 billion, adjusted EPS of €6.13. Note that this performance exceeded pre-pandemic (2019) levels, with sales +7% higher than in FY2019 and net income +33% compared to FY2019.
Similarly, the company reported a very strong start to 2022, with Q1 revenues +10% organically, with the two main segments of Energy Management and Industrial Automation performing very well.
It seems that Schneider Electric’s strategy is working well, in particular, its use of software as a competitive advantage to make its products more ‘sticky’ with customers. Despite software being only ~10% of sales, it has greatly helped with customer retention and provides very attractive recurring revenue. Schneider has made some important acquisitions to reinforce its software strategy, such as Aveva, OSIsoft, and Invensys.
Energy management has an important tailwind in that its products will be critical to manage the growth in the grid of increased renewable energy and EV vehicles. Industrial automation also has a number of tailwinds, including onshoring and the need for increased factory efficiency and productivity.
Financials
Schneider has been making great progress improving its profit margins. Gross profit margin has improved to ~41%, up about 300 bps since 2016. The main drivers of these improvements have been increased industrial productivity, being net price positive through the cycle, and mix improvements including higher weight of software revenues. What is great is that the gross profit margin improvements flowed all the way to the operating margins as well, which speaks well of the operating discipline at the company.
Schneider believes it can deliver €4 billion in free cash flow by 2024. For comparison, the company is currently trading with a market cap of ~€65 billion. So we are talking about a ~16x multiple on free cash flow a couple of years from now.
Growth
From 2017 to 2021, Schneider’s markets grew at ~2% per year, with Schneider growing ~2x faster. For 2022-2024 Schneider expects its markets to grow by ~4% per year, with Schneider continuing to outpace them thanks to its focus on electrification, digitization, and sustainability.
Balance Sheet
Schneider has a strong balance sheet with a good amount of liquidity, and a manageable debt load. It has a credit rating of A3/A-, and Schneider is committed to maintaining a strong investment grade credit rating going forward.
Its net debt / adj. EBITDA is relatively modest, it was only 1.22x at the end of 2021. This gives Schneider Electric a lot of financial flexibility for things like increasing its share buybacks and M&A.
2022 Guidance
Schneider reaffirmed its guidance for 2022 Adjusted EBITA growth of between +9% and +13% organic. This target is expected to be achieved through a combination of organic revenue growth and margin improvement. It expects revenue growth of +7% to +9% organic, and adjusted EBITA margin to be up +30bps to +60bps organic.
Schneider expects further recovery in late-cycle segments, and all regions and end-markets to contribute to growth. It expects ongoing global supply chain pressures to continue having an impact in the coming months, and increased pressure in input costs due to inflation in raw materials, labor, freight, etc. Despite the overall inflationary environment, and current supply chain pressures, the company aspires to be net price positive for the full year (including impacts of freight and electronics).
Valuation
Taking a look at valuation multiples for the last ten years, it quickly becomes evident that Schneider got a little ahead of itself around late 2020 and all of 2021. That overvaluation appears to have been fully corrected now, with shares trading with an EV/EBITDA below the ten-year average of ~12.5x.
The price/earnings ratio tells a similar story, now comfortably below the ten-year average of ~21x, and getting close to the levels it reached during the worse of the Covid crisis. The difference is that the level of uncertainty now is much lower compared to early 2020.
For a high-quality company with a good amount of growth ahead, we believe that a ~17x p/e ratio is very reasonable.
We estimate a net present value for the shares of Schneider Electric of €117. Our key assumptions are €6.13 in earnings per share for 2022, and 7% growth per year for a decade. Given that we expect Schneider’s markets to continue growing above GDP for a very long time, we assumed terminal growth of 4%. For the discount rate, we used 10%.
Given that the Euro and the dollar are currently very close to parity, our estimated fair value would translate to ~$117 for the shares trading in OTC (OTCPK:SBGSF), and ~$23.5 for the ADRs (OTCPK:SBGSY). This is very close to the current share price for Schneider Electric, which leads us to believe that shares are fairly valued and priced to deliver high-single digits to low-double digits for long-term investors.
Risks
There are several risks to consider, including macroeconomic and geopolitical. If the company fails to pass on price increases to customers, its margins could deteriorate. So far, it has shown it has pricing power, but there could be a limit as to how much its customers will accept in price increases. Another important risk is that since the company operates in attractive markets, this could attract more competition, putting pressure on growth and profitability. An economic downturn would also affect growth and profitability for the company, but the risk is mitigated by its strong balance sheet which should allow it to survive until the economy recovers once again.
Conclusion
We believe this is a great time to buy Schneider Electric, given that its valuation has improved substantially thanks to a combination of strong financial results and a declining share price. At current prices, we believe long-term investors can realistically expect high-single digits to low-double digit returns. We believe this to be an attractive return potential from an investment grade company, operating in stable and growing markets, and that has proven to be very well managed.
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