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Schneider Electric: 60% RoR In 9 Months, Moving To Hold (Rating Downgrade)

• Schneider Electric, a French multinational company, has outperformed the S&P 500, doubling the RoR found there, both without and with dividends

• I refute the notion that French stocks should be avoided, stating that they are a key reason for the market outperformance

• Despite the company’s success, I suggest it’s time to change my stance from “Buy” to “Hold” for Schneider Electric

• Looking for more investing ideas like this one? Get them exclusively at iREIT on Alpha

Schneider Electric (OTCPK:SBGSF) represents a decent-sized industrial holding in my commercial and private portfolio. I view the company on par with Siemens (OTCPK:SIEGY) in terms of appeal, and that’s why I invested heavily back in September of 2022 and called the company a “BUY”, going deeper into my position and increasing it to a significant 1.5%. Since that stance, the company has vastly outperformed the S&P500, more than doubling the RoR found there, both without and with dividends.

So to those that say that French stocks should be avoided as a whole – and yes, I’ve fielded questions and stances like that – I say that French stocks are a key reason why I keep outperforming the market as a whole. I will continue to invest in undervalued stocks regardless of where they are found if I can make the risk/reward work for me.

With this investment though, the time has come to throw in the “BUY”-towel, by which I mean that it’s time to change my stance.

I’ll show you why that is in this article.

Schneider Electric – This means a “HOLD”

Such an outperformance comes from very strong fundamentals. This company, unlike Siemens, is divided into Energy Management and Industrial Automation. Beyond that, the company has a lot of similarities with Siemens, in that it’s a margin leader in its segment. With a GM of 40%+ and a net margin in the double digits, this is a market leader in terms of profitability – and at less than 1.7x net Debt/EBITDA, this company is extremely conservative when it comes to its overall financial strength.

Schneider has a very streamlined organization, despite being a manufacturing-oriented company as well as services, its COGS is less than 60% of its revenues, and its OpEx is below 25%. These are what I view as hallmarks of an efficient business model in this segment because this enables double-digit net margins, which is a bit of a “gold standard” in the industrial segment.

The latest results we have for the company are 1Q23, and these go some ways to explaining the outperformance we’re seeing here, given that the company managed a top-line growth of 16%, with energy management seeing almost 20% YoY growth in sales. Every portion/segment of the company is “humming”. Customers are buying more products, and this is despite a very slow start in China for the year, and they’re also buying more software and services. This confirms that Schneider Electric may in fact be managing double-digit growth on a forward basis.

These latest results come with some extremely strong and prominent customer wins that are worth highlighting in this report. They come from the US and Europe and are found in a variety of different industries, showcasing the multi-sector appeal of the company’s solutions and exactly how Schneider Electric is helping these organizations reach their respective goals.

Demand for the company’s services remains at a very high level, despite these recent macro trends. Backlog is up 15.8% since the end of the calendar year of 2022, and those are numbers from the end of March, when the company reported 1Q23. These trends are primarily coming from customers in Machine, Budlings, Residential RE, Utilities, Transportation, and Plumbing/Water. The company fully expects the positive trends to continue, which they have, and for Schneider to execute on its impressive backlog. The company expects the demand to moderate somewhat – China is unlikely to see a full reversal to high demand soon – but US and Europe is expected to drive things until China really starts reversing.

The company also expected, back in 1Q23, a slowdown to the inflationary trends which we’ve been able to confirm across Europe since then. So many of the positives that the company works from, and things we’ve expected to see, are things we’re now actually seeing.

This led to the company increasing its guidance.

This is, of course, a significant increase in guidance, and it’s also part of why the company has been doing so well in terms of share price, and why I am sitting on a portfolio-wide RoR on my position that’s up over 70%, commercial and personal portfolios together. A very successful investment, given the timeframe.

So what exactly, in terms of Schneider, should be we looking at or looking for on a forward-going basis?

Well, the company has been ROIC/WACC positive for over 10 years, so I don’t expect any massive issues there. All of the fundamental indicators for Schneider are showing us a very healthy and positive view of the company – what I would consider the equivalent of a “health check” – such as cash, cash flow, debt, revenues, net income, outstanding share trends, margin trends, shareholder ownership in % of total assets. The company remains impressively diversified, in fact, one of the best-diversified companies in this entire sector in terms of overall geography.

The company lacks meaningful insider trading trends/buys or sells, but also has no majority shareholders. The largest shareholder is in fact the company’s employee stock ownership plan, at 3.8%. After that, we have multiple institutions such as Vanguard, the Norwegian Sovereign Wealth Fund, and the company itself at 2%. The French government is a shareholder, but only at 1.78%. So large investors do not exist.

Instead, what I would keep an eye on are higher-level order book and industry trends – macro trends that the company can do nothing about, but that nonetheless influence and somewhat dictate where the share price of this company actually goes. The broad-level P&Ls are what we’re interested in here because I am unable to really identify any one sector, trend, or geography that’s really impactful, with the exception of perhaps China. The reversal in China is something that without a doubt would be influencing several sectors and thousands of companies – but Schneider would without a doubt be one of the major beneficiaries of such a trend.

One of my questions for the company, when the earnings call came, was to what percentage the company owed its revenue from price increases due to inflation. However, this was answered – and the company’s results are around 11% from price, 5% from volume. So there is a mix there that’s price-heavy – but the company is doubtful that significant price increases will be coming again, as inflation is, once again, dialing down. Further increases in results will be more volume-oriented.

The supply chain has been a challenge but has more or less normalized over the past few months and half-year or so. Some constraints in Industrial automation remain, but not to any degree that they would massively change the outcome here.

So in the end, it’s all small things, as I see it. I get the feeling that the market has reacted quite positively to all of these trends which I was expecting last time I covered Schneider. This is not unexpected, as overreaction is the modus operandi for the short-term trends in the market, but this will also dictate why I end the end, come to a rating change to “HOLD” for Schneider.

Schneider Electric – The new rating is “HOLD”, and here is why.

Schneider Electric is without a doubt a company that deserves a decent amount of premiumization. The A-, the yield of around 2% coupled with its market position, there’s little here to me that argues against a premium for the company. Remember though, that the valuation and price of almost €170-€180, that was what I viewed as a clear overvaluation.

That’s why I was so positive when the company nearly dropped to double digits, and why I was at a high conviction that upside was to be had there. Nothing in the company’s prospects in the long term had changed. The drop was almost entirely sentiment.

So I was able to really “ride” that wave back up to premium, which we can see illustrated here.

However, while we’re not yet back at 25x P/E, it’s my clear view that the company is not worth 25x.

When I last reviewed the company, it was below €150/share and a “BUY”. At this level, it’s at €162 for the native SU ticker. This represents a 21.41x normalized P/E for the native, with a forward growth rate of around 9.5% annually, forecasted by FactSet and S&P Global (variance of around 50 bps).

Despite being relatively safe, there’s an above-expected range of forecast inaccuracy to this company, where analysts miss targets 33-40% of the time even with a 10-20% margin of error. The latest miss in 2020, with almost 33%. Based on this, I would be more careful investing in Schneider on the higher end of the valuation spectrum than in other similar companies.

S&P Global has the company at targets of €145 on the low side and €200 on the high side. I agree with the low one and disagree with the high one. The average is €172, which I also think is somewhat too expensive.

The company’s current potential RoR based on a 20-21x P/E is barely double digits. It’s in fact below double digits at the 5-year average of 20.6x.

Thesis

The company discussed in this article is only one potential investment in the sector. Members of iREIT on Alpha get access to investment ideas with upsides that I view as significantly higher/better than this one. Consider subscribing and learning more here.

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