What has happened recently with Rockwell (NYSE:ROK) shares is a great reminder to make sure you take advantage of real-time price alerts for stocks on your watch list. If you moved quickly, you had the chance to buy Rockwell shares in March with a double-digit prospective annualized return – a very rare opportunity for a much-loved (if not over-loved) industrial company.
In any case, Rockwell is one of the very rare U.S. industrial stocks that’s almost in the black on a year-to-date basis, as sentiment has quickly recovered. Not only does it seem like investors are getting more comfortable with the idea of a 20% or so drop in the June quarter for many businesses, they’re also counting on that recovery to start before the end of 2020. In the case of Rockwell specifically, not only is the company leveraged to some markets with relatively attractive recovering potential, it’s also a direct play on a trend of reshoring that is increasingly working its way into base-case scenarios.
With the big rally since the March panic, Rockwell shares are back to their typical premium pricing, and I think there may be more risk here from slower end-market recoveries and disappointment on the scale of future reshoring.
Another Better-Than-Expected Quarter
I don’t want to diminish Rockwell’s stronger than expected fiscal second quarter results, but the reality is that a fair number of industrials (so far) are delivering mid-single-digit beats and better operating profits. Likewise, it’s worth viewing these beats in the context of pretty significant downward revisions in sell-side estimates as the quarter went on. In other words, business conditions are better than expected, but those expectations have come down pretty significantly in the last month or two.
Revenue declined slightly on an organic basis, with the Architecture and Software (or A&S) business up 4% on 8% growth in Logix and Control Products and Solutions (or CP&S) down 4% on 3% contraction in control products and 4% contraction in Solutions. Rockwell outperformed peers and rivals like ABB (ABB), Emerson (EMR), and Schneider (OTCPK:SBGSY) overall, though ABB more or less matched Rockwell in CP&S and Yaskawa (OTCPK:YASKY) modestly outperformed.
Gross margin declined 110bp from the year-ago period, but operating income rose 7% on good corporate cost control, and segment income rose 5%, beating expectations by 13% (or $0.31). The A&S business reported 11% profit growth (and margin expansion of 230bp), beating by over 20%, while the CP&S business declined more than 3% (margins down 70bp), beating by about 2%. Given ABB’s Motion business saw a 13% profit decline on a similar 4% revenue decline, Rockwell’s margin structure once again stands out positively.
By geography, North America remained positive, benefiting from strong auto business that offset weaker oil/gas. Europe declined 2%, while Asia Pacific declined more than 6%.
Bracing For Impact
I credit Rockwell management for being one of the few companies to continue providing guidance, with management lowering full fiscal year revenue guidance by about 9% at the midpoint (organic contraction of 6.5% to 9.5%) and guiding to a 20% decline in the third quarter. That number, 20%, is coming up a lot, and it looks like that’s a pretty solid expectation for many businesses and end markets as it pertains to declines from the COVID-19 outbreak.
As is always the case, Rockwell’s end-market commentary was interesting.
Management pointed to high single-digit growth from its discrete markets, including 20% growth in autos and double-digit growth in semiconductors. The semiconductor growth isn’t surprising, given the strong trends reported by companies like ASML (ASML), Atlas Copco (OTCPK:ATLKY), TSMC (TSM), and VAT Group (OTCPK:VACNY), but the auto performance is surprising, with so many companies across the board highlighting pronounced weakness in auto industry demand. In Rockwell’s case, it looks like a lot of company-specific project business is driving the performance, including EV battery assembly projects in Asia.
Hybrid markets were flat overall, with modest growth in food/beverage, mid-single-digit declines in life sciences, and a high single-digit decline in tires. Here, again, I think there are idiosyncratic company-specific issues at work. Most companies with exposure to food/beverage automation, including ABB and Emerson, are seeing good results, but this is always a highly variable market on a company-by-company basis. With life sciences, most companies are reporting healthy demand, and Rockwell may have been hit harder by a tougher comp (life sciences was very strong for ROK a year ago).
That process markets were only down mid-single-digits is a win, particularly the mid-single-digit decline in oil and gas, though I suspect that was driven by projects that finished before the precipitous fall in oil prices. Mining/cement was down a similar amount, while chemicals were down at a high single-digit rate.
The Outlook
Overall, Rockwell’s end-market exposures look good for the eventual recovery, with autos and general industrial likely to see more V-shaped recoveries, semiconductors likely to continue recovering, and food/beverage and life sci staying relatively healthy. Oil/gas is definitely a worry, and I think this may be a multiyear downturn, but it’s only about 10% of overall revenue, and Rockwell could benefit from share gains through its Sensia JV with Schlumberger (SLB). I do also wonder if Rockwell’s comparative outperformance in the auto sector could create some downside risk in the recovery (a timing issue).
Longer term, Rockwell is poised to be a strong beneficiary if there is a significant reshoring of businesses to the United States. The COVID-19 crisis has highlighted the downside of having offshored so much capacity in areas like pharmaceuticals, medical devices, and certain consumer and industrial goods (including safety/protection equipment).
Reshoring of some pharmaceutical intermediaries and other essential goods seems likely, but it also seems premature to expect a wholesale change in how manufacturing companies operate their manufacturing and supply chains. If it does happen, though, Rockwell’s strong market share in U.S. factory automation (around 20%) will give the company significant potential leverage, but I expect its competitors to try to leverage their existing relationships with companies operating overseas to gain share in the U.S. at Rockwell’s expense.
The adjustments I’ve made to my model for Rockwell are broadly similar to the adjustments I’ve made for peer companies, though Rockwell’s leverage to controls, sensors, and software versus instrumentation is a meaningful advantage, and I expect a shallower revenue trough for Rockwell. I still expect mid-single-digit long-term revenue growth, as well as modest operating margin and asset efficiency improvements driving FCF margins into the high teens.
The Bottom Line
On discounted cash flow, Rockwell’s prospective return is back down to the mid-single-digits, and the shares likewise don’t look cheap on a margin/return EV/EBITDA basis. That’s not atypical for Rockwell, but I do see some elevated risk now, given how the Street is assuming a relatively early and sharp rebound for Rockwell and near-term benefits from reshoring. While it’s a stock worth buying opportunistically, I’m not going to chase it.
Disclosure:I am/we are long ABB.I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
