ROK - Rockwell Automation: Inflated Valuation But Strong Long-Term Prospects

2023-07-06 00:22:08 ET

Summary

• Rockwell Automation has seen a 27.3% increase in sales in the first quarter of 2023, with the Asia Pacific region being the fastest-growing market.
• The company has raised its sales growth guidance from 10-14% to 12.5-16.5% due to strong operational performance and easing supply chain issues.
• Despite strong growth and positive exposure to industries like EVs and renewable energy, ROK faces competition from major companies like Emerson Electric and ABB.

Investment Rundown

Rockwell Automation Inc. ( ROK ) has had a fantastic start to 2023 so far, with the last quarter highlighting the company's ability to grow sales organically as they were up 27.3%. ROK provides industrial automation and digital transformation solutions. The fastest growing region for the company is in the Asia Pacific where sales grew drastically.

The industry in which ROK operates is set to have several tailwinds moving it ahead, some of them being the increased demand to streamline business practices and create a better and more efficient operational performance. The easing of supply chain issues has had a major impact it seems on ROK and the management updated the guidance for 2023 impressively, which has caused the share price to surge in the recent months. I still like the company very much and think they will play a significant role, but the earnings multiple is at 27x right now. This seems a little high given that growth might slow down in the coming years, as the cycle goes up and down. I think therefore a hold rating for ROK is the best right now.

Company Segments

Within the company, there are three primary segments . These are as follows: Intelligent Devices, Software & Control, and finally Lifecycle Services. The segment which accounts for the largest amount of revenue is the first one, the Intelligent Devices. Here ROK generated over $1 billion in Q2 of FY2023. This an impressive feat as it meant a YoY increase of 26%, which was higher than the overall sales growth for ROK, reflecting strong organic sales from the segment.

The Intelligent Devices segment focuses on offering drives, motion, safety, and industrial components. As for the remaining two segments, they make together up a little over 50% of the total revenues. The software & control segment offers control and visualization software but also different security infrastructure solutions. Lastly, the lifecycle services provide customers with consulting and maintenance services. Interestingly the most profitable segment of the business is the second one, and the last one is the lifecycle services. Operating margins for software & control were over 33%. What I find bullish right now with ROK is that this segment has had very solid growth, 38% YoY in Q2 FY2023.

Markets They Are In

Operating as a solutions company that enables customers to weather disruption and volatility in their respective industries ROK has a global presence. ROK is still generating the vast majority of revenues from the North American market. This is much like the Asia Pacific region a fast-growing market that places a lot of demand but also opportunity on ROK.

As for the industries that ROK operates in, it's quite equal amount the primary three. The hybrid industry accounts for around 40% of the revenues, and the remaining two processes and discrete make up the remaining 60% at 35% and 25% respectively.

Talks of renewable energy and EV vehicles have been everywhere in the last few years and ROK has managed to enter this market too. Partnering up with Ford Motor Company ( F ) to advance the technology of electric batteries. This won't provide ROK with massive exposure to the industry, but it will enable them to make similar partnerships with other companies in the future in my opinion.

Raising Guidance

As mentioned in the beginning, the Q2 FY2023 results were quite frankly fantastic and had most investors pleased. This solid operational performance has also enabled the management of ROK to raise the guidance quite significantly.

Sales growth guidance now jumped from 10% - 14% to 12.5% - 16.5%. This shows the strength that ROK has in the industry and its ability to grow sales organically in an efficient manner. As for now, the company is trading at a p/e around 26x using the upper end of the diluted EPS guidance. I think that is realistic if ROK can maintain growth like they have had in the first half of 2023. One argument that this could occur is the easing of supply chain issues has left a market open for ROK to tap into as more and more companies seek to make their operations more sleek and efficient.

I think the exposure to several major and growing industries like EVs and renewable energy will have a very positive effect on the growth of ROK. The win of the contract with First Solar (FSLR) is proof of the strong reputation that ROK has gathered over the years.

Risks

As for risks with ROK, I think the biggest one is competition. There isn't a lack of major companies operating in this market, as the growth is both appealing and sustainable which of course attracts a lot of business to it. Some of the significant companies that ROK will have to compete against would be Emerson Electric ( EMR ) and ABB ( OTCPK:ABBNY ). These companies have a long-standing history in the industry and have established strong partnerships.

The challenge to maintain strong margins in this industry whilst also creating innovative products is difficult. Where ROK might be losing somewhat is compared to EMR. EMR spends less percentage-wise in relation to its revenues in R&D compared to ROK. Of course, ROK is a smaller business and large spending for R&D is necessary to capture market share, the truth is that margins will be lesser than the larger companies just because of the position that ROK holds.

Final Words

Rockwell has done a very good job so far in growing revenues and maintaining margins. The last report was evidence of this and resulted in a raised guidance for 2023. The easing of supply chain difficulties seems to enable ROK to expand more efficiently and market share in the industry. The revised guidance however seems to have caused the share price to jump very high in recent months, and right now the FWD p/e is approaching 27. I think this would be fair if ROK can maintain the same amount of momentum they've had so far, but the fierce competition makes me worried it might not be the case. As a reason, I will be rating ROK a hold for now instead.

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