Rockwell Automation Facing A Slowing Cycle, High Expectations, And Sector Rerating, All While Sporting A Hefty Valuation

 

Maybe it’s premature, but it finally looks as though the rerating I had been expecting in the industrial sector is finally happening (and no, I’m not saying I was early, I’m saying I was wrong). Rockwell (ROK) is one of the names seeing that, with the shares underperforming the industrial group by around 10%, while the wider industrial group itself has modestly lagged the S&P 500 since my last update on Rockwell.

This is going to be a really interesting year to watch at Rockwell. The Street expects a lot of short-cycle industrial end-markets to start decelerating over the next few quarters, but there are some secular drivers at Rockwell that could offset that. By the same token, expectations are high and management seems to be guiding to a near-term order peak. Against a still-high valuation, that’s a challenging set-up.

My issues with valuation are the biggest concern with Rockwell. Companies like Siemens (OTCPK:SIEGY), Schneider (OTCPK:SBGSY), Emerson (EMR), ABB (ABB) and others are going to be meaningful competitors for years to come, but I like a lot of the strategic moves Rockwell has made. I don’t really expect to see Rockwell become a “value stock” unless something goes grievously wrong, but I do think this pullback is worth watching if you’ve been thinking about Rockwell but are concerned about valuation.

 

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Rockwell Automation Facing A Slowing Cycle, High Expectations, And Sector Rerating, All While Sporting A Hefty Valuation

Rockwell Automation Stands Out On Growth... And Valuation

 

I sometimes wonder how much of a stock’s valuation can be explained by “behind the scenes” factors like convenience. Take Rockwell Automation (ROK) – these shares often look quite pricey, even relative to above-average growth, but they’ve continued to perform, and I wonder if that’s because it’s an easy call for institutional portfolio managers. Need exposure to automation? Buy Rockwell and call it a day.

I don’t mean that to sound as glib as it might – Rockwell is a legitimately strong player in automation, and management has taken serious steps to improve its positioning in attractive growth markets like logistics, semiconductors, and life sciences, as well as embrace industrial software. I just find the valuation a tougher sell given that the growth outlook isn’t as differentiated as the valuation might lead an investor to think.

 

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Rockwell Automation Stands Out On Growth... And Valuation

Rockwell Stumbles A Bit Operationally, But The Street Doesn't Mind

Driven by strong long-term trends in automation, a reshoring story, and ongoing investments in its own software capabilities, Rockwell Automation (ROK) remains a relative darling in the U.S. industrial space. This year (2021) should be a recovery year for the company, with recoveries in important markets like autos and healthy ongoing trends in other large markets like food/beverage, semiconductor, and life sciences.

I've thought for some time that Rockwell shares are pricey, and the shares have modestly underperformed the broader industrial sector over the last three and six months, but the longer term outperformance has remained robust. I don't deny the validity or strength of the drivers behind a bullish call on Rockwell, but I just can't get comfortable with paying this much of a premium, and this remains I name I'd considering adding on a more significant dip.

 

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Rockwell Stumbles A Bit Operationally, But The Street Doesn't Mind

Rockwell Automation Knocked Back A Bit On Less Robust Outperformance

As one of the top-two discrete automation vendors in North America (alongside Siemens (OTCPK:SIEGY)), Rockwell (ROK) remains well-placed to take advantage of ongoing automation adoption in factories, as well as newer trends like industrial IoT, hybrid automation, and the automation of logistics and warehouse facilities. It remains to be seen if reshoring will hold the same appeal with a new administration taking over in Washington, but brighter prospects for an effective COVID-19 vaccine should at least reduce some of the risks to the 2021/2022 economic outlook.

I thought Rockwell’s valuation was high in my last update, and the shares have since underperformed by about 10% (relative to multi-industrial peers), though the long-term (three-year or five-year) track record is still quite favorable. While I don’t object to a “best of breed” premium for Rockwell, and markets like autos, food/beverage, and life sciences should be strong in 2021, the prospective return still isn’t all that compelling to me.

 

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Rockwell Automation Knocked Back A Bit On Less Robust Outperformance

Reshoring Rebuilding Sentiment Around Rockwell Automation

What has happened recently with Rockwell (NYSE:ROK) shares is a great reminder to make sure you take advantage of real-time price alerts for stocks on your watch list. If you moved quickly, you had the chance to buy Rockwell shares in March with a double-digit prospective annualized return - a very rare opportunity for a much-loved (if not over-loved) industrial company.

In any case, Rockwell is one of the very rare U.S. industrial stocks that's almost in the black on a year-to-date basis, as sentiment has quickly recovered. Not only does it seem like investors are getting more comfortable with the idea of a 20% or so drop in the June quarter for many businesses, they're also counting on that recovery to start before the end of 2020. In the case of Rockwell specifically, not only is the company leveraged to some markets with relatively attractive recovering potential, it's also a direct play on a trend of reshoring that is increasingly working its way into base-case scenarios.

With the big rally since the March panic, Rockwell shares are back to their typical premium pricing, and I think there may be more risk here from slower end-market recoveries and disappointment on the scale of future reshoring.

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Reshoring Rebuilding Sentiment Around Rockwell Automation

Rockwell Automation Shares Spike As Investors Play A Favorite For The Recovery

While many industrial companies used the third quarter earnings cycle to talk down expectations for 2020, Rockwell Automation’s (ROK) strong beat-and-raise quarter seemed to stoke optimism that the end of this cyclical slowdown is in sight and the company will return to growth relatively soon. As a well-loved name among the industrials, that newfound optimism has launched the shares about 25% from their pre-earnings level.

When I last wrote about Rockwell, I suggested considering the shares if/when they slipped below $150, and they subsequently did for a couple of weeks. If you bought then, you’ll already sitting on healthy gains, but also holding a stock that is back to a premium valuation despite a trend of shrinking outgrowth versus the industry in recent years and plenty of concerns still in play regarding 2020. The prospective returns here aren’t the worst among what I follow, but there definitely are names with more interesting valuations.

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Rockwell Automation Shares Spike As Investors Play A Favorite For The Recovery

Rockwell Automation Pressured As Short-Cycle Headwinds Spread

I don't believe there's much debate anymore about whether weakness in short-cycle industries is spreading, though longer-cycle industries have continued to hold up better (even if they're wobbling a bit) and some investors are still pinning their hopes on a second-half rebound. That's all bad news for Rockwell Automation (ROK), as this leading pure-play in industrial automation continues to see slowing markets that are sapping its growth and momentum.

The short-cycle slowdown is manageable; Rockwell has always been a cyclical business, and that's just part of the landscape. Beyond that, though, there are some interesting arguments about Rockwell's operating philosophy and its place in the future of industrial automation. I like buying proven operators when these sorts of questions crop up, but I'd rather hold off in the hope of getting another crack at the shares below $150.

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Rockwell Automation Pressured As Short-Cycle Headwinds Spread

3M Decimated On Autos, Electronics, And Execution

Thursday’s first quarter earnings report was the worst day for 3M (MMM) shareholders in a long, long time, as a huge double-digit miss at the segment profit line drove a double-digit decline in the share price. While 3M is not going to burn down, fall over, and sink into the swamp, the shares are going to be in the penalty box for a while, and management needs to prove convincingly that they can not only improve margin execution, but restructure the business in the direction of both great margins/returns and at least decent growth.

3M’s valuation is much more reasonable than it has been in some time, but it’s fair to ask and wonder if turning around this supertanker is going to be a longer process. If the problems really are confined primarily to auto and electronics, this is a name to investigate further, but I don’t think investors need to make a snap decision for fear of missing out, as the concerns about 3M’s growth and execution capabilities have been building for a while and won’t go away in quarter.

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3M Decimated On Autos, Electronics, And Execution

Strong Energy Management Providing A Spark For Schneider Electric

I’ve liked Schneider Electric (OTCPK:SBGSY) for a little while now, as I’ve thought the Street hasn’t fully appreciated what I think may be the best energy management/electrification business out there and an underrated automation business that is getting stronger in hybrid/process and is well-placed to benefit from expanding IoT adoption.

Although these shares have lagged peers/rivals like Rockwell (ROK) and Eaton (ETN) (another stock I’ve liked for a while) over the past year, as well as the broader industrial segment, the relative performance has been much stronger on a year-to-date basis and since my last update in mid-February. With the move in the share price, I think Schneider looks more fully and fairly valued now, but it’s still a name that I believe is worth holding and it’s definitely a name to look at again if there’s a market/sector sell-off.

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Strong Energy Management Providing A Spark For Schneider Electric

Emerson Not Expensive, But Slowing Growth Is A Concern

Emerson Electric (EMR) hasn’t been left behind in the recent industrials rally, but it also hasn’t really distinguished itself as an outperformer, as it seems that the Street is concerned about the risks of slowing non-residential spending (particularly in China) and weaker process automation spending in the face of weaker oil prices. My concerns have more to do with the fickleness and short attention spans of institutional investors; Emerson has most likely passed through its point of peak growth, and I have some concerns that the shares could underperform as investors look for more exciting stories.

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Emerson Not Expensive, But Slowing Growth Is A Concern

As Cyclical Headwinds Rise, Rexnord Not Getting Much Love

Between the rally in industrial stocks from December and what appears to be rising headwinds in many end-markets, I don’t think investors are exactly spoiled for choice for great ideas in the industrial sector, but Rexnord’s (RXN) case stands out a bit for me. I wasn’t crazy about the shares back in May of 2018, and the stock has lagged the sector by about 10% since then, but the shares seem oddly valued relative to a decent motion control business and growing water business. I am worried about a slowdown in factory capex spending as well as shrinking growth in U.S. commercial construction, but those concerns seem magnified in Rexnord’s valuation.

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As Cyclical Headwinds Rise, Rexnord Not Getting Much Love

High Expectations Mitigate Some Of Rockwell Automation's Outperformance

A lot is expected of Rockwell Automation (ROK), a seemingly perennial favorite in the industrial space, and those high expectations may be the biggest challenge for the company as 2019 looks to be a year of slowing capex investments across a range of industries. Although I think mid-single-digit revenue and free cash flow growth are attainable over the long term, I’m not sure Rockwell’s share price today really reflects the risk of slower spending as 2019 goes on.

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High Expectations Mitigate Some Of Rockwell Automation's Outperformance

PTC's Long-Term IIoT Potential Is Attractive, But The Near-Term Macro Outlook Isn't

Considering that companies in the auto, electronics, and industrial categories make up about 60% of PTC’s (PTC) revenue base, I can understand why analysts and investors might be concerned about the near-term revenue growth outlook for the company, and particularly so considering the sizable shortfall in new subscription bookings for the first quarter. Management believes deal slippage, not macro issues, are the culprit, though, and it’s well worth noting that 2019 will be the year in which partnerships with Rockwell (ROK), Microsoft (MSFT), and ANSYS (ANSS) start to show some impact.

I wasn’t keen on PTC’s valuation back in July, and the nearly 20% drop since then doesn’t have me regretting that call, as these shares have lagged the market and rivals like Dassault (OTCPK:DASTY) and Autodesk (ADSK). I do like this business, though, and I’m still very bullish on the prospects for the company’s industrial IoT (or IIoT) platform to drive meaningful revenue growth and some synergistic sales with the legacy CAD/PLM/SLM offerings. Valuation remains a concern for me, though, and particularly with potentially building macro headwinds; it’s a toss-up call for me now, but definitely a name I’d revisit at a lower valuation.

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PTC's Long-Term IIoT Potential Is Attractive, But The Near-Term Macro Outlook Isn't

Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

The good times keep rolling for Emerson (EMR), as the company is enjoying a strong recovery/expansion phase in its core process markets, as catch-up spending on MRO, brownfield investments, and greenfield projects all combine for strong near-term revenue and margin improvements and a healthy outlook over the next year or two. At the same time, Emerson continues to reinvest in its business to better-position it for less cyclicality and better competitiveness in hybrid automation markets.

As was the case a few months ago, I see Emerson as a so-so value proposition, but a stronger near-term growth/momentum story. The shares don't seem unreasonably priced on forward EBITDA, but it's a little harder to see strong FCF-based undervaluation, and I think the share price performance is very much tied to ongoing momentum in orders, revenue, and margin leverage.

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Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

Will Two Straight Good Quarters Mark A Turn For ABB?

As far as ABB (ABB) is concerned, the industrial recovery that has propelled names like Honeywell (HON), Emerson (EMR), Rockwell (ROK), and Schneider (OTCPK:SBGSY) over the past couple of years is just something that happens to other companies. Hampered by large exposures to industries that have been much slower to recover, and troubled by some of its own restructuring and execution issues, ABB has been a frustrating laggard at a time when investors are banking solid profits in many other industrial names.

With two straight better-than-expected quarters and improving orders, though, maybe ABB’s late-cycle leverage is about to start shining through. The outlook for transmission and distribution is still not particularly strong, but the company is executing well in its automation operations and there are signs of life in the low/medium voltage business as well. There remain good reasons why ABB continues to trade at a discount to its peer group, but if ABB can make the most of this late-cycle move, the shares could finally close some of that performance gap.

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Will Two Straight Good Quarters Mark A Turn For ABB?

Yaskawa Electric's Earnings Report Underlines The Uncertainties In Automation

Investors looking to get a clear sense of the near-term direction of key automation segments like servomotors, drives, and robotics will need to wait a little longer, as Yaskawa Electric’s (OTCPK:YASKY) (6506.T) fiscal first quarter earnings report confirmed some worrying trends but also showed some better than expected strength in other areas.

Although Yaskawa shares are down another 10% from when I last wrote, I’m still not completely sold on the valuation argument at today’s price. This “lull” in smartphone-related capex could go on a little longer than expected, and I’m likewise concerned about the potential for weaker semiconductor, machine tool, and auto-related orders. Long term, I like Yaskawa’s position in both motion control and robotics, and the valuation is getting more interesting on an EV/EBITDA basis, but I’m inclined to stay on the sidelines here for now.

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Yaskawa Electric's Earnings Report Underlines The Uncertainties In Automation

A Short-Cycle Deceleration Is Hitting Rockwell Automation

Rockwell Automation (ROK) does well when the economy is expanding and companies are spending more on factory capex - Rockwell’s performance correlates reasonably well to U.S. industrial production. Now, though, it is pretty clear that the vital auto end-market has slowed considerably, and there are signs that electronics is going the same way, while growth in heavy industries will weigh on Rockwell’s margins.

Rockwell is by no means a bad company, but the shares have often carried a premium for presumed superiority that may not be entirely deserved. What’s more, expectations for the second half of the year are not exactly easy. I definitely believe Rockwell is the sort of name you want to buy on pullbacks, but investors who want to start adding today should at least be prepared for the risk that things will get worse before they get better.

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A Short-Cycle Deceleration Is Hitting Rockwell Automation

Margin Challenges And Growing Cyclical Worries Have Dimmed Rexel

The performance of industrial distributor stocks on a year-to-date basis really covers the map. Grainger (GWW) has been performing exceptionally well, Ferguson (OTCQX:FERGY) has done alright, HD Supply (HDS) is more or less flat, but the electrical distributors Wesco (WCC) and Rexel (OTCPK:RXEEY) are each down about 15%. Although some of Rexel’s trouble can be attributed to frustration and disappointment in the pace of margin improvement, I also believe growing worries about the industrial cycle are playing a role.

I like the value in Rexel shares, but there are risks with both execution and macro factors – it is tough to hold a good/improving company when investors are selling out of the sector. I’m bullish on the prospects for construction in Europe and ongoing improvements in the U.S. business, but if discrete manufacturing is slowing down, it will be harder for management to hit its margin improvement targets.

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Margin Challenges And Growing Cyclical Worries Have Dimmed Rexel

Emerson Getting A Strong Push From Recovering Process Automation Markets

In a market where many multi-industrials have started to see signs of fading end-market growth, Emerson's (EMR) exposure to process automation, and particularly U.S. onshore oil and gas, is helping the company drive noticeably better growth. Better still, management has been positioning this business to be more competitive outside of its core petrochemical end-markets, while also showing that it is committed to supporting its non-automation business as well.

Valuations have slid back for many multi-industrials, but Emerson has been a relative outperformer this year and doesn't look particularly cheap on a cash flow basis. That said, investors pay up for growth and will pay higher near-term multiples for companies with strong ROICs and Emerson is likely to offer both strong top-line growth and robust ROICs for the near-term.

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Emerson Getting A Strong Push From Recovering Process Automation Markets

High Expectations Remain The Theme For Rockwell Automation

In turning down a rather rich bid from Emerson (EMR), Rockwell (ROK) certainly signaled that the board has a lot of confidence about where this leading automation player is heading. Although Rockwell isn't, and never has tried to be, "all things to all customers", the company's strong presence in process and hybrid automation and its emerging industrial IoT platform doesn't make that confidence completely unfounded.

As is so often the case with Rockwell, valuation continues to be my primary concern. While there are some valuation approaches that suggest Rockwell's valuation isn't excessive, it's not a bargain either, even if Emerson was willing to pay more than today's price to own the company.

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High Expectations Remain The Theme For Rockwell Automation