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Morningstar | Bargains Like Rockwell in December Can Quickly Become Fairly Valued in as Little as a Month. See Updated Analyst Note from 30 Jan 2019

Wide-moat rated Rockwell had a great fiscal first quarter that performed broadly in line with our expectations. This high-quality, automation pure-play stock tripped 4-stars back at the end of December toward the beginning of January and closed as low as $141 on Christmas Eve over general market fears from an economic slowdown. Rockwell clearly defied those odds as its stock price has appreciated over 20% in that time. Organic sales for the quarter grew 5.7% year over year, with Logix rising 7%. Segment operating margins are up 40 basis points year over year on tough comps and are ahead of our full-year expectations. However, we expect these to moderate somewhat through the year (mostly on higher R&D spend, which was lighter through the fiscal first quarter). Adjusted EPS of $2.21 is up 13% year over year against our full-year adjusted EPS expectations of $9.13. This is slightly ahead of the midpoint of management’s guidance of $9.05, which management again maintained, but still below the high end of consensus estimates. We raise our fair value estimate by nearly 2%, about 1% related to time value of money and the remainder related to some updated balance sheet figures since our last model update as well as slightly higher return assumptions during our stage II forecast.

Turning to the firm’s segments, most of Rockwell’s overall margin improvement was propelled by a 100-basis-point margin expansion within the firm’s Architecture & Software segment. Increased sales drove margin gains in both of Rockwell's segments, but slightly higher investment spend was an offset. At the regional level, North American growth of 6.2% was led by consumer and heavy industries; the latter also propelled Latin American organic growth of 19.9% but off a significantly smaller base. For reference, Latin America typically constitutes 7% to 8% of Rockwell’s sales compared with about 60% for North America. Heavy industry was a tailwind in Latin America, but it was a headwind in EMEA.

On the call, CEO Blake Moret did express some concerns over geopolitical and general trade tensions. Nevertheless, Rockwell mostly expects to offset these incremental costs through supply chain changes and negotiations with its vendors. Like other high-quality diversified industrials, to an extent, we believe Rockwell can offset some of these adverse consequences through pricing actions. More importantly, Moret conveyed to analysts that project quoting activity was still strong. Given the short-cycle nature of Rockwell’s business, key metrics like backlog levels that are useful in other industrials are less useful when analyzing Rockwell. Nevertheless, Rockwell reported increased backlog, which we view as a net positive.

One bit of color on the call we found interest concerned activity in China. Management reported that China is actually up midsingle digits (Rockwell typically has about 13% to 15% of its sales coming from the Asia-Pacific region). Some areas of differentiation include both the metro system and life sciences. The latter is the hybrid automation space, which combines both the benefits for process and discrete offerings. Process offerings slowed to midsingle digits year over year for the fiscal fourth quarter (they have been running in double-digit increases recently), but Rockwell expects that this should improve throughout the year. While Rockwell is a leader in discrete automation offerings, we believe it will be one in a small handful of players trying to find success and expanding its reach into other categories (like oil and gas, for example). Finally, management also provided an update on the Emulate3D acquisition (announced Jan. 29). We don’t expect this will have a material near-term impact on results, but the technology sounds interest. It allows customer to simulate the configuration of their system without having to trying it out with hard tooling on the line. We think this is very similar to Emerson’s digital twin technology, and we’re excited about this offering and its future potential.