2023-05-10 05:30:22 ET
Summary
- ROK reported strong 2Q23 results, with an adj EPS of $3.01, which exceeded the consensus estimate, and an organic growth rate of 27%.
- Management has revised their guidance for the FY23, projecting an organic sales growth rate of 13% to 17% and an adj EPS forecast of $11.50 to $12.20.
- The demand outlook for ROK remains uncertain with orders for 2H23 expected to decline sequentially from 1H23 and last year.
Thesis
Rockwell Automation ( ROK ) offers products such as control systems, motor control devices, sensors, and industrial control panels. I think ROK is a fantastic company because it capitalizes on the current craze for investing in technology to boost productivity and has a solid distribution network. The visibility of its financial model is also well supported by its installed base of customers. Given the nature of ROK business, it tends to follow the cyclicality of the manufacturing CAPEX cycle, which also means it generally follows the broad economic cycle. As such, I am recommending a neutral rating today given the uncertain economic outlook. However, I would note that ROK is likely to be one of the first few to benefit from the recovery, especially as the high-margin MRO products ramp up with factory utilization globally.
2Q23 results
ROK has released their financial results for the 2Q23, reporting an adj. EPS of $3.01, exceeding the consensus estimate of $2.58. The segment EBIT also surpassed the consensus forecast of $427 million, coming in at $484 million. The company's top-line performance demonstrated a strong organic growth rate of 27%, with Intelligent Devices growing by 27%, Software & Control by 42%, and Life Cycle Services by 12%. Despite the prevailing economic uncertainty, ROK's management has revised their guidance for the FY23, raising their adj EPS forecast to a range of $11.50 to $12.20. Moreover, they project an organic sales growth rate ranging between 13% to 17%.
Demand outlook
Given the uncertainty, I think the biggest question for ROK is the demand outlook for the upcoming quarters. Results from the 2Q23 show that orders to ROK totaled $4.8 billion in the 1H23, with comments that they were stable sequentially. which effectively means volume is down if we adjust for some price increase. My estimate that underlying volume is declining is pretty much reaffirmed by FY23 order guidance. Management issued FY23 order guidance of $9 billion, implying that 2H23 orders will be worth $4.2 billion, a sequential decline from 1H23 and an annual decline from last year. Considering the state of the economy as a whole, I don't find this surprising. The $9 billion in orders is also expected to help ROK exit FY23 with a backlog of $5 billion. I believe that while this provides clarity to revenue growth this year, ROK may face difficulties in FY24 as lead times normalize and order levels decline. At that point, there will be a lack of backlog to provide visibility (given the lower orders today), and orders might decline further as well if we go into a steep recession. While I am bearish in the near-term, I still believe North America has plenty of opportunities for ROK to continue capturing demand given the strong economic growth and might of North America. Management stated at the Goldman Sachs Industrials & Materials Conference that ROK has been successful in capturing semis projects and that the company has been able to expand its offering portfolio in the market. These are the kinds of ongoing improvements that should pave the way for even better prospects for future success (in other words, a more prosperous upcycle for the company). ROK also mentioned EV as an exciting industry where green field opportunities exist. Despite the lack of details, I am confident that there will be future opportunities as a result of this foray into this massive and rapidly developing industry. The Software Division of ROK Company deserves focus too. Even though the company is still relatively small, management has stated that they anticipate growing to $1 billion in annual sales.
Supply chain
In my opinion, management is taking the right actions to strengthen the company's competitive advantage by investing in the supply chain during this downturn. Management discussed the company's redesigned product line and investments in internal capacity to improve product movement through their facilities at the GS conference. What stood out was how the company adapted its pricing model to become more nimble, allowing it to better respond to the ever-changing dynamics of inflation. In my opinion, this nimbleness will be a vital asset in optimizing its product prices in the coming deflationary period. It was also noted by management that, while there has been some improvement in availability, there has been even more noteworthy progress in the reliability of their suppliers. This reassures me that ROK has a solid relationship with its suppliers and that it will be able to handle the anticipated increase in demand during the next upcycle.
Conclusion
ROK reported a strong performance in the 2Q23 with an adj EPS of $3.01, which exceeded the consensus estimate, and an organic growth rate of 27%. Despite the uncertainty of the economic outlook, management has raised their guidance for the FY23, projecting an organic sales growth rate of 13% to 17% and an adj EPS forecast of $11.50 to $12.20. However, the demand outlook for ROK remains uncertain as orders for 2H23 are expected to decline sequentially from 1H23 and last year. Therefore, I am recommending a neutral rating on ROK stock for now, but I see potential for the company to benefit from the recovery and for a more prosperous upcycle in the future.
For further details see:
Rockwell Automation: Neutral Until Next Upcycle