Hubbell Stock: Confident In Its Own Growth Trajectory (NYSE:HUBB)

Investment Thesis

Company Overview

Hubbell (NYSE:HUBB), founded in 1905 in Connecticut with headquarters in Shelton, CT, is a manufacturer that provides electrical and utility solutions to enable customers to operate critical infrastructure with reliability and efficiency. It has more than 75 brands serving three parts of energy infrastructure: In Front of the meter, on The Edge and Behind the Meter. It has two reportable segments: Utility Solutions and Electrical Solutions.

Strengths and Weaknesses

Hubbell provides a complete solution plan from the front to the back of the meter and everything in between. The company’s Utility Solutions segment design, manufacture and sell a range of electrical distribution, transmission, substation, and telecommunication products that can implement utility transmission & distribution components such as arresters, insulators, connectors, anchors, bushings, enclosures, cutouts and switches are In Front of the Meter. This segment also provides smart meters, communications systems, and protection and control devices that serves The edge of the utility infrastructure. For its Electrical Solutions segment, the focus is on stock and custom products in standard and special application wiring device products, rough-in electrical products, connector and grounding products, lighting fixtures and others. This segment has applications in the light industrial, non-residential, wireless communications, transportation, data center, and heavy industrial markets that used by the contractors or electricians. Moreover, its lighting fixture, wiring devices and electrical products can be used in residential IoT enabled technologies.

The following is the 35 major brands in Utility Solution segment out of its total 75 offerings. “Systems Control” is a new brand to it through the recent acquisition of Northern Star Holdings.

Its namemake brand “Hubbell” is part of the 24 offerings in the Electrical Solutions segment. The “Progress Lighting Design”, which is part of the residential lighting business that it has sold recently, is no longer in the portfolio. We will cover more on its corporate actions later.

By the end of last fiscal year, Hubbell’s two segments were about 60 to 40 split in net sales contribution, with Utility being the larger one. The operating margin is also higher in Utility at 21.7% compared to Electricals’ 15.7%. This makes Utility its most important segment in driving revenue and profits.

Hubbell just reported its quarterly results on July 30 with its EPS of $4.37 beating by $0.16, and revenue of $1.45 billion missing by $31.01 million. Its revenue still maintained a 6.34% YoY growth, and EPS with a 9% YoY growth.

The company is evidently in an expansion mode. On a TTM basis, its rising net income strongly boosted its operating cash flow that even an almost-doubled CapEx spending couldn’t deter its free cash flow from rising at in a similar proportion.

The growth engine highlighted by the management was the utility substation switches and electrical grounding. These are typically the solutions installed at early stages of the large project lifecycle, and they have seen 30-40% plus sales growth.

The backdrop of the growth in Utility Solution is the almost 7% compounded annual growth rate of CapEx for utilities across the publicly traded electrical utilities since 2010, according to S&P Global. Among those spending, transmission and distribution is the focus, which includes replacing aging substations, transformers and lines. No doubt Hubbell will continue to benefit from this trend.

More significantly, as earnings from operations rise, Hubbell’s net operating working capital also rises. With its earnings from operation growing from around 150 million in 2020-21 to now about $300 million, the company continues to strengthen its net working capital from $1.2 billion to now around $1.6 billion. The strength in its liquidity will help it to implement more growth strategies through M&A’s or other business initiatives.

Hubbell’s management sees its free cash flow as an indicator of its ability to generate cash without relying on external financing, and furthermore, to evaluate its resources to invest back in the business or strategic acquisitions, or paying down the debt. The company has been active in its corporate actions lately. It executed a divestment of its Residential Lighting business to Kingswood Capital Management, LP in February this year to improve the operating margin of its Electrical Solution segment. Prior to that, it completed three acquisitions for its Utility Solution segment in 2023. In December last year, it acquired Northern Star Holdings, Inc. (commercially known as Systems Control) for about $1.1 billion, net of cash, for substation turnkey control building solutions and relay panels for the Utility Solution segment. This is on the heel of acquiring Balestro, a manufacturer of arresters, insulators, fusing and variable resistors, and Electro Industries Gaugetech (“EIG”), a manufacturer of integrated energy management and power quality monitoring, to boost the Utility Solution segment.

The most notable front of Hubbell’s application this year is the incorporation of AI. The company’s division Aclara became the first company to embed a distributed AI platform called “Karman” by Utilidata, an AI-powered company that processes utility data, into its product to enable a connected grid that delivers clean energy reliably. Karman uses NVIDIA (NVDA)’s Jetson platform to build a custom module that is capable to capture and analyze data to improve grid operations and manage distributed energy resources (“DER”). The implication of this is to combine a fast processing power of Utilidata with Aclara’s 30 million electric meters deployment in North America into one platform to help its customers to understand at the edge of the grid and to predict grid conditions from the impacts of DER. Will there be strong customer utilization of this platform? It has already been happening. In October last year, Portland General Electric and Duquesne Light Company were awarded by the DoE to deploy over 100,000 Karman units to increase reliability and accelerate decarbonization and electrification, as part of its announced $3.5 billion program to fund grid modernization projects.

We can see a strong decade-long spending trend from the industry utility companies that will continue to benefit Hubbell’s smaller Electric Solution segment. And the recently established government-led programs that modernization utility would spur more growth of Hubbell’s larger Utility Solution segment. The company’s consecutive corporate actions in the past 12-18 months show strong conviction that its strategic development has been on Utility, but with its strong balance sheet, we won’t be surprised if it pulled off additional acquisitions for the Electrical Solution segment in the future. The robust cash flow and earnings growth can be expected to continue.

Financial Review & Valuation

For the five years from 2017 to 2023, Hubbell has been generating close to double of the total return by the broader markets. This outperformance was more pronounced when the broader markets’ total return started to tread water in 2022 to 2023. Hubbell continued to grind higher and eventually

Peer comparison shows that within the past ten years’ period, Hubbell staged the fastest EPS growth and is now leading its peer group by a large lead.

After the surge in its top-line and bottom-line, its valuation is still in the middle range, relatively speaking. If anything, its valuation has mostly in 20-30x in the past ten years, and the current level of 26.54x is also in the middle historically for it.

Although its yield is only 1.35% currently, with its strong free cash flow, we wouldn’t rule out that it could increase its dividend payout, given that its historical average is about 2.5%. Hubbell’s stable history and robust outlook should add some appeal to investors looking to anchor their portfolio in a volatile period.

The risks to our valuation are mostly coming from two corners. One is the macro environment, which could face more volatility going into Q3. There could be a liquidity squeeze that eventually impacts Hubbell’s price, but it is not a major concern and could prove to be short-lived. Another one is from the election. Depending on which candidate enters the White House, the fiscal policy on infrastructure spending could change in direction, focus, and funding amount. But we reckon that modernizing our utility has such a fundamental impact on the economy, even if there is dial-back in fiscal spending, the change could be small.

Conclusion

We cross-examined Hubbell’s growth momentum with the industrial and macro backdrop, finding that both segments have potential tailwind support in the medium term. The company’s frequent M&A activities in the past 18 months show a strong conviction and confidence in its growth trajectory. We think the price is fairly valued but the yield could pick up in the medium term. We recommend a buy for the stock.