Hubbell's (NYSE:HUBB ) first investor event since the pandemic unveiled a clear plan to achieve above-market growth led by secular electrification themes as well as a pick-up in new product innovation. On balance, the GDP plus outlook for 3-5% organic growth through 2025 and $13 of EPS power seem achievable, given the significant utility tailwinds and the prospect of a cyclical upswing across its key end markets. In the near-term, management's conviction in hitting the upper end of the 2022 guidance range of $9.0-$9.40/share (despite ongoing recession fears) is also good news at this stage of the year. While I like the mid-term prospects, much of the positives are already in the price at the premium ~14x fwd EV/EBITDA valuation and thus, I'd hold off until we get to a better entry point.
HUBB's mid-term organic growth target now stands at 3-5% (+8-11% including M&A) over the 2023-2025 period, helped by faster market outgrowth of 1.5-2x GDP (comprising ~2x for the utility business and ~1.5x for electrical) as well as ~100bps from share gains and innovation. Unsurprisingly, much of the organic growth contribution will come from within utility (up mid-single-digits), followed by electrical (3-4%), as thematic growth across grid modernization and electrification pickup over the coming years. In particular, management called out high-growth areas like distribution automation, EV charging, and the data center - markets where HUBB has a right to win over the long run, even if its current penetration is small.
With HUBB building off a solid base, I view the growth targets as well within reach. Thus far, orders have significantly outpaced revenue amid strong demand - in fact, much of the company's current challenges revolve around its inability to fulfill demand (given supply challenges). Approximately half of the current backlog (already significantly above where it was in 2020) comes from new orders as well, highlighting the extent to which HUBB is under-earning due to supply constraints. With the size of new orders (defined as <90 days) continuing to rise, I feel confident in underwriting demand resilience near term. That said, HUBB is not immune from macro trends, and thus, a worst-case scenario (i.e., a recession) risks growth numbers getting pushed out or revised lower.
On a positive note, the +8-11% total sales growth target (6-8% organic, 2-3% M&A) will be accompanied by a ~17% operating margin target and double-digit EPS growth. In aggregate, this implies a margin expansion guidance of +20bps/year through 2025, led by restructuring actions and a mix shift toward the faster growth, higher margin utility segment. Having seen a notable step down in 2021, restructuring is guided to contribute ~$20m in 2022 and slightly below that level going forward, driving a solid two to three-year payback period.
All in all, this gets us to $3.60-$4.00/share of EPS accretion on top of the 2022 EPS guidance of $9.00-9.40/share - an implied double-digit growth path to ~$13/share in 2025. If the near-term guidance raise is anything to go by, there could be more earnings power to be unlocked, given how well the volume side has held up through the macro dip. With HUBB also beginning to tap into its pricing power at a surprisingly strong +7% in 2022, the company is well-equipped to outpace inflationary headwinds going forward.
A key feature of the HUBB business model is its ability to sustain cash flow through the cycles - cumulative operating cash flow is guided within the $2.7-2.8bn range through 2025, with free cash flow at $2.2-2.3bn (95-100% adjusted FCF conversion). So, even with an accelerated mid-term capex plan (~$125m/year capex run-rate) earmarked to grow the HUBB footprint and invest in productivity/automation, HUBB will maintain a surplus ~$1.5bn balance sheet capacity. Of note, this also accounts for >$1bn of M&A as well as ~$1.35bn of capital return (~$1bn dividends and a ~$350m buyback). The capital return plan, in particular, could prove conservative - HUBB's projected dividend payout ratio only runs at ~40% of earnings, while the ~$350m buyback allocation is only being used to neutralize stock comp dilution.
On the M&A front, HUBB plans to deploy >$1bn through 2025 to add +2-3%pts to the annual revenue growth rate. This represents an acceleration relative to its historical pace of investment as the company looks to further penetrate higher-growth verticals such as data center, EV charging, and distribution automation to diversify the overall growth profile. Thus far, HUBB has shown good discipline as well -the ~32 bolt-ons worth ~$1.2bn transacted over the past decade have come at ~9x EV/EBITDA (impressive given the low-rate environment), adding an implied ~$100m of incremental EBITDA generation. A portion of the funding will also come from divestments - HUBB plans to further prune low growth/low margin assets that do not fit within the portfolio, building on the recent disposal of its C&I Lighting business this year. With the residential lighting business likely to follow suit, HUBB could see an inflow of another >$200m (based on the ~$300m of sales and ~$25m of EBITDA in 2021) to fund its acquisitions in the next year or so.
Net, the HUBB case is compelling, particularly from a thematic perspective, providing investors a differentiated avenue to play the electrification trend via utility and transmission & distribution. While the near and medium-term financial targets look well within reach, the company remains exposed to the broader macro trends, and thus, a recession scenario could leave earnings vulnerable to downward revisions. Plus, the premium ~14x fwd EBITDA valuation has likely accounted for the positives (i.e., consistent FCF generation and core portfolio stability), leaving the risk/reward balanced, in my view. On the flip side, any decline in raw material prices (e.g., steel) would unlock incremental near-term earnings power, while HUBB's outsized exposure to secular electrical infrastructure modernization provides long-term growth optionality.
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