Siemens' Ongoing Underperformance Is Curiouser And Curiouser

 

“How much should numbers matter?” is not a new question in investing, but Siemens (OTCPK:SIEGY) provides an interesting case study. By just about any metric, Siemens has mediocre-to-weak margins, ROIC, ROA, ROTA, and so on when compared to other multi-industrials, including peers in the electrification and automation space like ABB (ABB), Eaton (ETN), Emerson (EMR), Rockwell (ROK), and Schneider (OTCPK:SBGSY). But it also has strong market positions (if not leadership) in many attractive growth areas, including automation (factory and building), digitalization, electrification, and healthcare.

I’m generally a big believer in the idea of skating to where the puck is going to be – in other words, not letting weak trailing/current results overshadow what you think the likely future trajectory will be. Still, in looking for reasons why Siemens continues to look undervalued, I do think the relatively poor profitability metrics are worth noting, but I think leverage to growth markets and improved profit/FCF opportunities counts for more, and this is still a stock worth considering.

 

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Siemens' Ongoing Underperformance Is Curiouser And Curiouser

With Attractive Exposure To Multiple Secular Growth Markets, Siemens' Undervaluation Is Unusual

 

Follow stocks long enough and your initial reaction to seeing an undervalued mega-cap will probably be less "what a bargain!" and more "what am I missing?" That seems particularly relevant in the case of Siemens (OTCPK:SIEGY), as this slimmed-down and refocused industrial conglomerate is well-positioned in attractive end-markets like industrial automation, industrial software, electrification, building modernization/control, healthcare, smart infrastructure, and mobility… and yet the shares still trade at what appears to be a long-term discount to other quality industrials.

Siemens shares (the ADRs) have risen a little more than 25% since my last write-up, doing a little better than the S&P 500, but lagging the broader industrial space. While automation companies haven't really been posting outstanding performances in that time, Siemens' performance is still toward the lower end of the range, with Emerson (EMR), Fanuc (OTCPK:FANUY), and Yaskawa (OTCPK:YASKY) outperforming, and ABB (ABB), Rockwell (ROK), and Schneider (OTCPK:SBGSY) posting similar performances (likewise for more software-driven names like Dassault (OTCPK:DASTY) and Hexagon (OTCPK:HXGBY).

At this point I still think Siemens is attractive on a relative basis. Further portfolio refinement seems highly likely, and while I think M&A may still be on the docket, the company doesn't need to do large-scale M&A to participate in numerous attractive end-markets with above-GDP multiyear growth potential.

 

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With Attractive Exposure To Multiple Secular Growth Markets, Siemens' Undervaluation Is Unusual

A Slimmed-Down Siemens Looks Oddly Undervalued

It's unusual to find a quality industrial trading at a reasonable valuation these days, so the very reasonable valuation on Siemens (OTCPK:SIEGY) has me puzzled. I don't think my long-term revenue outlook for 4% growth is out of line relative to other quality automation, electrification, and healthcare plays like ABB (ABB), Eaton (ETN), Philips (PHG), and Schneider (OTCPK:SBGSY), and likewise, I don't think an outlook for long-term FCF margins in the low-to-mid teens is that bullish relative to peers, particularly considering Siemens' above-average leverage to software.

Operationally, I like a lot of what Siemens has been doing. Siemens was an early mover in the "de-conglomeritization" movement, and I think Siemens is stronger for having moved on from Osram and Siemens Energy while keeping a strong position in Siemens Healthineers (OTCPK:SMMNY). Although there are some areas where I think Siemens could upgrade its business (robotics, low-voltage, and building controls), I think Siemens is well-leveraged to a near-term recovery in industrial automation and a longer-term recovery in process automation, as well as longer-term trends like green electrification and mass transit.

 

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A Slimmed-Down Siemens Looks Oddly Undervalued

New Tariffs Create New Headaches For Rockwell Automation

At the time of Rockwell’s (ROK) fiscal second quarter earnings report in late April, I commented that I thought investors would have an opportunity to buy shares in this high-quality automation enabler at a lower price. Since then, the shares have dropped more than 15%, significantly underperforming industrials in general, on growing concerns about a slowdown in the industrial end-markets that make up a large part of the discrete automation market. Now with the prospect of significant tariffs on Mexico on the table, Rockwell is taking another body-blow.

I do believe that Rockwell management is underestimating the risk of a broader slowdown in industrial end-markets, even though I do basically agree with its more bullish medium-to-long-term outlook. With a real risk of a “lower-for-longer” end-market demand situation and now potential pressures from new tariffs, I’m inclined to keep waiting even though Rockwell shares now trade below my estimate of fair value.

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New Tariffs Create New Headaches For Rockwell Automation

Valeo's Outperformance Relative To Underlying Volume May Be The Start Of The Turn

I can understand why sell-side analysts would see light at the end of the tunnel at Valeo (OTCPK:VLEEY) (FR.PA) and assume it’s an oncoming train. That’s what happens when you miss guidance for two and a half years, offer vague and unconvincing explanations of those misses, and generally make any bulls look foolish. And yet, the markets tend to have short memories if and when companies turn around their performances, so maybe, finally, my bullish thesis on Valeo doesn’t feel so foolish.

I’m not changing any of my core assumptions in any meaningful way, as there’s still a lot of “show me” to this story. Still, 5% revenue growth for a company with a strong hybrid/EV order book (if they can deliver…) and strong FCF growth (if they can deliver…) doesn’t seem out of line, and would support a meaningfully higher share price from here, even after a recent rally that has seen the stock outperform peers/rivals like BorgWarner (BWA), Continental (OTCPK:CTTAY), and Schaeffler (OTC:SFFLY).

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Valeo's Outperformance Relative To Underlying Volume May Be The Start Of The Turn

Rockwell Skids On A Weaker Auto End-Market

The last three months haven’t been particularly kind to Rockwell (ROK), as the share price of what is usually a darling among industrials has lagged the broader industrial sector, and automation peers like Yaskawa (OTCPK:YASKY), Fanuc (OTCPK:FANUY), Nidec (OTCPK:NJDCY), Emerson (EMR), Schneider (OTCPK:SBGSY), and even ABB (ABB). To be fair, it was the significant slide after second quarter earnings on Thursday that did the damage, though the shares had still been lagging most automation companies (except ABB) and were only slightly better than the average industrial before the report.

Like 3M (MMM), Sandvik (OTCPK:SDVKY), SKF (OTCPK:SKFRY), Illinois Tool Works (ITW), and the Japanese automation companies, weakness in autos is a major contributor to Rockwell’s present weakness, but I took management’s guidance and comments as reflective of some potential warnings about spreading weakness in other industrial end-markets – something that I’ve been expecting as this year rolls on. Rockwell shares are now in a tough situation valuation-wise; they’re not so clearly undervalued that I’m inclined to say “just buy and wait for the cycle to reverse), but the valuation is getting more reasonable and this is a stock to watch more carefully now.

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Rockwell Skids On A Weaker Auto End-Market

Valeo Hits The Wall, And The Wall Falls On Top Of It

The last year was a tough one for auto parts suppliers in general, particularly after midyear and especially for European suppliers, but it was an abysmal year for Valeo (OTCPK:VLEEY) [VLOF.PA] as the shares lost about half their value on successive miss-and-lower quarters that eventually saw management's outlook for 2019 erode from double-digit growth to low single-digit growth with lower margins.

I don't believe that Valeo is fundamentally broken, but investor confidence in management clearly is, and I can't say that that is unfair. The magnitude of the guidance revisions has been significant, as has been the discrepancy with order growth and the large order write-off in China, all of which leads to ample uncertainty about the company's outlook. While I do believe that Valeo has assembled a very strong position and platform for electrification, that assembly has led to high upfront costs with the payoff coming further down the road. I do still believe that Valeo is undervalued, but this is a company that is deep in the doghouse and will need time to reemerge.

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Valeo Hits The Wall, And The Wall Falls On Top Of It

Schneider Slowing, But May Be Better Positioned For The Downturn Than The Street Thinks

Concerns have been growing about the health and durability of the short-cycle upturn, and the performance of the stocks of companies like Schneider Electric (OTCPK:SBGSY) have reflected at least some of that. While a strong post-earnings run has lifted Schneider’s performance over the average industrial and peers like Eaton (ETN) and Rockwell (ROK) since my last update, the shares spent most of the second half of 2018 lagging broader industrial indices.

I’ve made no secret of my concerns about a slowdown in the global economy, and as it pertains to Schneider, I am concerned about the near-term outlook for non-residential construction and factory automation. On the other hand, Schneider isn’t as short-cycle-dependent as in the last cycle, and the company’s position in process automation, oil/gas, grid automation, and data center could help offset some of the weakness. With a long-term growth outlook roughly similar to Emerson (EMR), and sandwiched between Eaton and Rockwell, I do think these shares are undervalued, but 2019 could be a tricky year for the stock as sentiment has seemingly shifted to a point where there is a “show me” story.

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Schneider Slowing, But May Be Better Positioned For The Downturn Than The Street Thinks

Between Soft Guidance, Erratic Orders, And Flat Margins, It's Tough To Love Wartsila

I liked Finland’s Wartsila (OTCPK:WRTBF) (WRT1V.HE) back in late 2016, and for about two years that call worked, as the company benefited from an improved mix in its Marine Solutions business and good order momentum driven by the need for commercial shippers to install scrubbers ahead of IMO2020 pollution regulations. What hasn’t been so good, though, is progress on margins, with the company’s cost-cutting efforts offset by increased price competition in its business – a particularly disappointing development given generally good share – and a less profitable revenue mix.

This year (2019) should see Wartsila deliver some of the best revenue growth among multi-industrials as it delivers on its record order book, but orders seem likely to flatten out, and margin leverage is probably a 2020 event and I don’t have a lot of confidence that the company will reach its 14% target in the next five years. While Wartsila does look undervalued and should benefit from improving power gen orders at some point, this is a hard company for me to trust at this point and there are a lot of industrials with similar or better undervaluation and both less volatile business mixes and more credibility on hitting their margin targets.

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Between Soft Guidance, Erratic Orders, And Flat Margins, It's Tough To Love Wartsila

Fanuc Beaten Down On Sharp Order Declines

Japanese automation leader Fanuc (OTCPK:FANUY) (6954.T) has a loyal shareholder base that can lean toward the fanatical, but the last couple of quarters underline that for all of Fanuc’s quality, it’s not immune to macro-driven cyclicality. What’s worse, competition has ramped up in many of the company’s businesses and management’s projections that conditions won’t get significantly worse may prove too optimistic.

From where I sit, the argument that Fanuc is too cheap now only works if you expect a pretty dramatic reversal (basically a V-shaped recovery) in recent machine tool and automation demand trends in China and a quick return to double-digit ROEs. I don’t believe that’s going to happen, and I think Fanuc has more vulnerability to traditional rivals like ABB (ABB) and Yaskawa (OTCPK:YASKY), non-traditional rivals like Teradyne (TER) and local Chinese automation companies, and shifting market trends than its more bullish supporters acknowledge.

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Fanuc Beaten Down On Sharp Order Declines

Atlas Copco's Better Fourth Quarter Offset By Ample 2019 Uncertainties

The past year (2018) was a relatively rare year where Atlas Copco (OTCPK:ATLKY

) underperformed its industrial peers, as worries mounted throughout the year about the company's semiconductor-exposed Vacuum Technique business. Performance has improved on a relative basis over the last few months, though, as investors start considering whether semiconductor orders may recover in 2019 and whether other industrial markets may not slow as much as feared.

I'm still in the camp that thinks economic growth will slow more noticeably in North America, Europe, and China as 2019 goes on. Atlas Copco may well outperform in that environment (it certainly did in the fourth quarter), but investors considering the shares have to accept the risk of conditions getting worse before they get better. Atlas Copco isn't a clear-cut bargain today, but it's close enough (and seldom gets truly cheap) that I'm tempted to take the risk.

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Atlas Copco's Better Fourth Quarter Offset By Ample 2019 Uncertainties

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

Yaskawa Electric Taking A Beating On Diverse Headwinds

Japan’s Yaskawa Electric (OTCPK:YASKY) (6506.T) has taken a beating over the past six months, with the shares down about a third as the emerging weakness I saw in the summer has grown into full-blown troubles across the business. With auto demand likely to weaken from here and no real near-term drivers for improved handset or semiconductor order trends, Yaskawa could be looking at a rough trough period, particularly if management won’t step up and cut costs and production in anticipation of tougher times.

When I wrote about Yaskawa back in July I thought the shares weren’t cheap enough relative to the risk, and that’s basically my position now as well. I think the shares are more or less fairly valued now, and could have some upside if conditions improve, but I really don’t expect that to happen and I think there could be more cuts to expectations on the way. The overall quality and market exposures of Yaskawa make this a name to consider for the long term, but I don’t think today is the best time to buy.

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Yaskawa Electric Taking A Beating On Diverse Headwinds

ABB Punting Power Grids, But Priming The Pump For Growth Will Take Time

ABB’s (ABB) relatively successful turnaround of its Power Grids business ends the way many, if not most, investors hoped it would – the company is selling off the business. While the transaction is messy, I think management got decent-to-good value for a hard-to-move asset. I also believe the subsequent corporate restructuring is logical and should boost long-term margins, but there’s a grumpy skeptic part of my brain that says a lot of these costs, charges, and restructuring efforts could be used to mask lackluster underlying performance over the next 18-24 months, and I don’t like the extent to which management tried to celebrate their current market positioning.

I still own these shares and I still believe this can be a better-run, more profitable, and more successful business than it is. Whether management has the talent to make that happen is still up for debate. I’m not changing my fair value ($25 per share) at this point, but I would note that the risks and costs are weighted to the near term, while the benefits are weighted further down the line.

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ABB Punting Power Grids, But Priming The Pump For Growth Will Take Time

Rockwell Automation Still Poised Between Excellence And Uncertainty

Looking into 2019, Rockwell Automation (ROK) seems to be in familiar territory – nobody’s really questioning the operational excellence of this leader in discrete automation, but there are plenty of concerns about end-market health, where industrials sit in the cycle, and whether Rockwell is as well-positioned for the next phase of automation as it was for the last.

I typically shoot for double-digit returns when I invest, and Rockwell doesn’t seem priced to deliver that unless you think long-term FCF growth can reach that grey area between mid-single-digits and high single-digits – a level of performance that’s not impossible, but certainly not conservative to expect. Although I’m tempted to call today’s potential returns “good enough” for a stock that seldom gets all that cheap unless/until industrial stocks really go fan-ward, I do believe there could be another round of angst and stock weakness early in 2019 that could be an opportunity to pick up high-quality industrials like Rockwell.

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Rockwell Automation Still Poised Between Excellence And  Uncertainty

For ABB, It's About Cycle, Self-Improvement, And Sentiment

A laggard for some time among the industrial automation and electrification players, ABB (ABB) has at least been a little “less bad” of late as sentiment has started giving the company some credit for its later-cycle end-market exposures. Now the question is whether those promising-looking exposures will deliver actual orders in the second half of the year and drive better revenue in 2019. At the same time, there is still more than casual interest in ABB’s willingness and ability to execute on some self-help moves that would largely involve slimming down and simplifying the business.

I’ve long been an owner and supporter of ABB, and I can’t say that it has done right by me. Still, compared to peers like Emerson (EMR) and Rockwell (ROK), the valuation is undemanding and offers some upside if ABB can deliver on those sentiment-shifting improvements in orders and portfolio composition.

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For ABB, It's About Cycle, Self-Improvement, And Sentiment

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

One Quarter Doesn't Break, Or Make, Rockwell Automation

Even though I understand the demands of the world in which they work, sell-side analysts still amuse me from time to time (and I used to be one). When Rockwell Automation's (ROK) fiscal second quarter came up light on growth, you could hear the wails of anguish and the rending of garments that the cycle was doomed to roll over and crush Rockwell's multiple with it. Now Rockwell posts a stronger than expected fiscal third quarter and it's all party hats and conga lines. As I said, sell-siders serve a client base (institutional investors) where "long-term" sometimes seems to mean two quarters, but it does help explain at least some of the volatility in the share price.

For my part, I'm still a little concerned about the cycle. Many industrial CEOs have gone on record saying they think there's another 12 months or more left in this expansion, but I do think the pace is likely to slow and historically that's been a hard environment for Rockwell's share price performance. I do still like this company, and I like its partnership with PTC (PTC) and growing focus on software and services within automation. But "automation" is not a growth panacea and I have some concerns about a high-multiple stock in a possibly slowing sector that could see multiple reversion to the mean.

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One Quarter Doesn't Break, Or Make, Rockwell Automation

Schneider Electric Not Getting Much Credit For Share Gains

Sometimes you have to love Wall Street logic. Grow slower than your peers? Well, you’re losing share, so that’s a “hold”. Outgrowing your peers? Well, looks like you’re at peak growth. Better go with a “hold”. Tongue-in-cheek cynicism aside, I do wonder what it will take for Schneider Electric (OTCPK:SBGSY) (SU.PA) to please the market, as this company not only posted one of the better organic growth rates for the quarter, it saw some operating leverage, and also raised guidance.

I understand concerns about a short-cycle slowdown, but the results and guidance posted by industrials so far this quarter suggest less risk of an imminent downturn, and Schneider is looking to boost prices in the second half of the year. With the shares down another 5% or so from my last write-up (when I thought the valuation was borderline), this is starting to slide into my “buy” zone, though I will admit the negative sentiment is a little bit of a concern in the near term.

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Schneider Electric Not Getting Much Credit For Share Gains

PTC Delivering On Its IoT Promises

There was plenty of skepticism, if not outright scorn, a few years ago regarding PTC's (PTC) plan to put its industrial IoT platform ThingWorx at the center of its growth plans. Fast forward back to the present, and not only has PTC continued to grow, the IoT business has grown to roughly parity with the legacy product lifecycle management (or PLM) software business on a new bookings basis. What's more, PTC has brought in Microsoft (MSFT) Azure and Rockwell (ROK) as partners to grow the IoT business, with partnering with Ansys (ANSS) to augment its legacy Creo CAD business with simulation capabilities.

I liked these shares back in the spring of 2017, and the 80% or so move since then has been gratifying to see, particularly as the business seems to be picking up momentum. Although my growth outlook is stronger now than before, in no small part due to the big-name partnerships PTC has added for ThingWorx, the growth in valuation has exceeded the growth in my expectations. Consequently, while I do still like this business and I fully acknowledge the potential that financial outperformance could drive higher multiples, I can't find the undervaluation to call this a good buy unless you're interested in trading more on momentum than value.

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PTC Delivering On Its IoT Promises