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Morningstar | Hubbell’s Successful Playbook in the Electrical Components Market Remains Strong. See Updated Analyst Note from 13 Jun 2019

We initiate coverage on Hubbell with a $136 fair value estimate. We also assign the firm with a narrow moat, stable trend, Standard stewardship, and medium uncertainty rating. Our fair value estimate implies just over a 17 times 2019 EPS multiple and just over an 11 times 2019 EV/adjusted EBITDA multiple. We believe Hubbell is an intelligent play on industrial infrastructure spending, particularly from improvements made to the U.S. power grid.

Over 90% of Hubbell’s total consolidated sales are made in the U.S., and according to a 2015 U.S. Department of Energy report, 70% of power transformers are 25 years of age or older, 60% of circuit breakers are 30 years or older, and 70% of transmission lines are 25 years of older. Industry research adds that the significant level of investment to replace, upgrade, and expand T&D infrastructure over the next two decades is nearly a three-fold increase over the prior two decades. As a result, we think this prolonged investment cycle is still in its early stages, which gives us confidence in our 10-year forecast period of Hubbell’s excess returns.

Positive growth drivers in the Power segment include the transition away from fossil fuel generation to renewables, the hardening of the grid, and technology adoption like smart meters. About two thirds of Hubbell’s sales flow through distributors, of which one third are made to most of the 10 largest distributors like Wesco or Grainger. Hubbell differentiates itself in a competitive market with strong brands, its breadth of product offering, and its ability to lower a customer’s total cost of ownership while managing a high degree of SKU complexity. Large product lines help distributors eliminate the back-office cost of dealing with multiple suppliers.

Hubbell’s large suite of products also allows it to generate ample volumes that lead to cost efficiencies in key portions of its supply chain. Cost-efficient customer service allows Hubbell to receive superior pricing when it negotiates with distributors. The acquisition of Aclara smart meters (completed on February 2018), which provides smart meter and communication solutions, are the kind of offerings that are being introduced at an unprecedented rate relative to the history of the industry, a trend that we also expect to continue. We think the acquisition of Aclara, furthermore, is a less common instance where an industrial company acquired a target that made sense both strategically and financially.

While many competitors have divested portions of their respective Lighting businesses, we still believe nonresidential national account sales are sticky and place a premium on high-quality offerings outside of mundane white lighting, including horticultural lighting, color tuning technology, and Power of Ethernet (PoE) offerings that use enterprise software and cloud analytics. Other positive growth drivers we see in Hubbell’s Electrical segment include energy code compliance, energy costs, financial incentives, and the adoption of new technologies, which we believe plays to Hubbell’s core strengths.

Finally, we have a positive view on Hubbell’s management team and CEO David Nord. We think Nord has wisely chosen to keep Hubbell focused on the electrical components market, wisely avoiding larger players with global scale as well as the more commoditized portions of the market. Hubbell’s management has also maintained margins in the face of certain markets by driving lean initiatives throughout Hubbell’s operations. We like Hubbell’s shareholder-friendly initiatives and point out that Hubbell has also raised its dividend for the eleventh straight year, aiming for a payout ratio of 40% to 50% of earnings.