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Morningstar | Rockwell’s Sluggish Fiscal 2Q Doesn’t Alter Our Long-Term Thesis on the Stock

Wide-moat Rockwell Automation reported disappointing fiscal second-quarter results, but this outcome was off of difficult year-over-year comps. Nevertheless, we don’t expect to materially change our fair value estimate, as our fundamental long-term outlook remains the same. The stock traded down on the earnings announcement between 6% and 7% to about $176, or just north of our $172 fair value estimate. Rockwell’s sales grew only 0.4% year over year, but currency translation was a big culprit, as organic sales grew 3.6% year over year. Nevertheless, Rockwell’s top-line organic growth appears to be decelerating from the peak periods of last year and in 2017, which we think confirms our investment thesis.

The end markets that once served as a boon to Rockwell, like automotive sales, are now facing appreciable headwinds. Moreover, while the trend toward electric vehicles is a secular growth driver for many industries, Rockwell has a comparably smaller amount of exposure. Automotive sales were down 20% year over year, and management expects full-year totals will see automotive down 10% for 2019. By contrast, the process side (for example, oil and gas), where we’ve historically believed Rockwell has been less competitive, saw strong top-line organic growth of 10% year over year. Oil and gas specifically grew double digits, while heavy industries, like pulp and paper, increased the top line in the high single digits year over year. Rockwell had a nice win with Green Bay Packaging, which purchased a significant paper machine project with ancillary equipment; this order alone was worth over $10 million for Rockwell.

Management also reported some mining projects that added to Rockwell’s top-line results. Since Rockwell is more exposed to upstream and midstream, we expect Rockwell’s process business should continue to have some cyclical tailwinds. Encouragingly, our unchanged 2019 revenue forecast sits at the midpoint of management’s full-year 2019 top-line guidance, while our adjusted EPS projection still falls at the top end of lowered EPS guidance. The firm also managed to increase it segment profit margin by 40 basis points to 21.3%.

During the fiscal second quarter, management also reported that it bought back a significant number of shares, with diluted shares outstanding down 8.4 million, or about 6.5% from last year (just over 1.2% sequentially). While the stock trades relatively in line with our fair value estimate today, we suspect that management bought back a majority of these shares during January, when prices hovered around $150 per share. At those prices, we would consider buybacks a prudent use of cash (since that price implies a greater than 10% undervaluation by our count).

Life sciences and the hybrid space continue to be areas of interest for us that we believe represent opportunities for Rockwell, with customers like Pfizer and Lonza in Europe. Hybrid manufacturing represents a nice cross section of process and discrete technologies, and it appears to us that no one player has any dominant control in this space. Finally, Rockwell’s other verticals, including food and beverage, as well as tires, which also combines Rockwell’s discrete and process technologies, also performed strongly during the second quarter.