Hubbell Inc.’s (HUB.B) third quarter earnings beat the Zacks Consensus by 17 cents, or 16.7%. Strong revenues and margin expansion together contributed to the earnings surprise. Despite softness in key end markets, Hubbell has had a positive surprise history, exceeding the Zacks Consensus by an average of 2.01% in the fur preceding quarters.
Total Revenue
Hubbell’s revenues for the quarter came in at $685 million, up 6.0% sequentially, 15.3% year over year and exceeding the Zacks Consensus by 3.6%.
The non-residential construction market (Hubbell’s largest) was a dampener, with private spending particularly weak, having been impacted by supply/demand imbalance and difficulty in obtaining finance. However, public spending was helped by stimulus activity, positively impacting Hubbell. Building automation and control, solid state lighting and retrofit lighting remained areas of strength, positively impacted by the ongoing drive for energy efficient lighting.
Hubbell saw strong revenues from the industrial market. Additionally, management was optimistic about signs of improvement at utilities and even mentioned that the residential market (for Hubbell) would likely bottom in the current quarter.
Revenue by Segment
Electrical Products accounted for around 72% of total revenue in the third quarter. Segment revenue was up 7.0% sequentially and 18.4% year over year. The Burndy acquisition contributed 13% of the year-over-year increase, while the rest was on account of strengthening end markets, particularly industrial. The industrial business was fueled by high-voltage and test products that more than offset the weakness in non-residential construction. The wiring product line also gained from the strength in the industrial market, with volumes growing 14%.
The weak point within industrial was commercial and industrial (C&I) lighting, which declined 4% and pulled down the overall lighting business by 3%. The company’s sales typically lag the residential market by a couple of quarters. Price realization gains were minimal and are likely to remain difficult for a while.
Power Systems sales made up the remaining 28% of revenue, increasing 3.4% sequentially and 8.2% year over year. The business was driven by improvement in utilities’ spending on the distribution side, offset by slower spending on the transmission side.
Margins
Gross margin for the quarter was 34.3%, up 169 basis points (bps) sequentially and 186 bps from the year-ago quarter. A number of factors combined to generate the gross margin improvement in the last quarter. However, management stated that benefits of cost-cutting actions taken over the past year and longer-term investments being made (possibly a reference to the new Chinese facillity) were the primary reasons for the improvement. A higher mix of industrial business and the contribution from Burndy were other reasons. Commodity costs remained a headwind and price increases were not sufficient to offset the negative impact.
Operating expenses of $117.6 million were flat sequentially and 15.7% higher than in the September quarter of 2009. However, the operating margin of 17.2% was up 270 bps sequentially and 179 bps year over year, as both R&D and SG&A declined as a percentage of sales and gross margin also increased.
Segment Margins
Both Electrical Products and Power Systems operating margins grew on a sequential basis, although Power Systems was down year over year, negatively impacted by commodity cost headwinds (particularly steel and copper) and positive price increases that will not impact results until later in the year. Electrical Products is the business that saw a significant revenue increase, as well as a significant reduction in cost. These two factors combined to raise margins for the segment.
The Electrical Products segment had an operating margin of 17.1% (up 377 bps sequentially, up 467 bps year over year). The Power Systems segment had an operating margin of 17.3% (up 10 bps sequentially, down 481 bps year over year).
Net Income
Hubbell reported a net income of $71.7 million in the second quarter, or a 10.5% net income margin, compared to $57.9 million, or 9.0% in the previous quarter and $57.5 million or a 9.7% net income margin in the prior-year quarter. Although there were no one-time adjustments in any of the above quarters, the share of profit to non-controlling interests took a penny off the EPS.
Accordingly, the fully diluted GAAP EPS was $1.18 in the quarter, compared to $0.96 in the June 2010 quarter and $1.01 in the September quarter of 2009.
Balance Sheet
The balance sheet is highly leveraged, with a net debt position (including short term debt and long term liabilities) of $3.02 a share, down from $8.75 at the end of the June 2010 quarter. The main reason for the improvement was the cash balance, which improved $64.0 million to $342.8 million.
Cash generated from operations was $82.9 million, up from $69.2 million generated in the second quarter. Hubbell spent $21.5 million on dividends and $71.4 million on capital expenditure in the last quarter.
Inventories were up 6.3% to $294.0 million, with annualized inventory turns decreasing from 6.3X to 6.1X. Days sales outstanding (DSOs) were up from 52 to around 55.
Our Recommendation
Hubbell reported a very strong quarter, indicative of broad-based recovery in its end markets. We were always concerned about the company’s non-residential business, which remains the slowest to recover from the recession. This quarter’s results indicate that this business is now being positively impacted by stimulus spending.
Additionally, growing demand from the industrial market has also been a boon to the company. Hubbell’s growth bears a strong correlation to GDP growth in the U.S. and this metric has shown positive trends. We are therefore, increasingly positive about the company’s growth prospects.
Given the improving end-markets and the company’s strong position within them, we believe that there will be upside to the shares. Consequently, we have a Zacks #2 Rank on the shares, implying a short-term Buy recommendation.
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