Why Rockwell Automation's Results Are Better Than they Look

Rockwell Automation's earnings weren't as bad as the market treated them, and they spelled out good news for Emerson Electric and General Electric.

May 12, 2014 at 2:00PM

There wasn't an awful lot wrong with Rockwell Automation's (NYSE:ROK) recent second-quarter results, but when a stock is priced to perfection, any hiccup will cause a negative overreaction. In truth, its earnings and commentary were slightly more bullish concerning the underlying trading conditions, and investors in companies like Emerson Electric (NYSE:EMR) and General Electric (NYSE:GE) have reason to look more favorably upon future prospects. Rockwell's numbers were better than they looked.

Rockwell Automation's reports another unusual quarter
Last time around, Rockwell reported an "unusual quarter" in that it was seeing relative strength in areas where other industrial companies were weak, and vice versa. This time, its earnings report was unusual, but for a different reason: namely, because underlying conditions got better, but a combination of foreign exchange effects and tax increases meant that its full-year guidance was left unchanged.

The following table explains the subtleties of its full-year guidance change

  Previous Guidance Updated Guidance
Sales 3%-6% 3.0%-6.0%
Organic growth 3%-6% 3.5%-6.5%
Currency and acquisition ~0% ~1.0%
Tax rate 26%-27% ~27.0%
Adjusted EPS $6.00-$6.35 $6.00-$6.35

Source: Rockwell Automation presentations

Although sales and EPS guidance was unchanged, management upgraded its expectations for underlying growth -- a good sign that industrial conditions are strengthening. However, lower expected sales from acquisitions and negative currency effects are likely to offset the organic strength. In a similar manner, the expectation that the tax rate will come in toward the top of its guidance, means that the unchanged EPS guidance actually implies better underlying profitability. No matter, the market still sold the stock off aggressively.

However, even with the recent price reduction, Rockwell Automation still doesn't look cheap compared to industry peers like General Electric and Emerson Electric. Incidentally, the latter companies are sometimes seen as potential suitors for Rockwell -- something which may explain the valuation premium.

ROK PE Ratio (Forward) Chart

ROK P/E Ratio (Forward) data by YCharts

Considerations like tax rates and the performance of acquisitions are not things that most investors can predict with any worthwhile degree of certainty, and who knows where currencies will move from quarter to quarter? The most important thing for Fools to really think about is from where can Rockwell beat expectations going forward?  Moreover, does its forecast for stronger organic sales imply better conditions for other companies like General Electric and Emerson Electric?

Rockwell Automation reports a good quarter, others take note
In a way, it was a better report for Emerson Electric than it was for Rockwell Automation! The reason being that the key takeaway from Rockwell's results was the improvement in prospects in the process controls industry -- a key industry vertical for Emerson Electric. As this article indicates, Emerson Electric's end markets are quite diversified, but its most important segment is process management (42.5% of 2013 segmental earnings) with oil & gas and chemicals being the most important end markets within the segment.

Fortunately, Rockwell Automation's management had good things to say about these sectors. Although, process sales grew only 3% in the second quarter, they were up 5% in the first half, and speaking on the conference call, Rockwell's CEO, Keith Rosbusch, affirmed that the second half would be stronger: "Well, we do expect the second half process to be higher than the first half and the first half as you've said was 5%. So we are expecting it to go up and we see the best opportunity there continue to be in oil and gas."

Moreover, he also outlined that he saw "increased activity" in chemicals. Essentially, the renaissance in North American energy production (upstream activity) is now creating opportunities for downstream investments in petrochemicals, coatings and chemicals.

In fact, Emerson Electric reported a pretty similar story in its second-quarter results. Although, its underlying sales growth in process management was only up 1% in the quarter, its orders increased 12% -- a sure indication of future growth.

This is obviously good news for Emerson and Rockwell, and also for General Electric. It's also quite timely, because General Electric restructured its oil and gas division at the start of 2014 in order better focus on individual segments of the industry. A key part of the plan was the creation of a downstream technology solutions business. Shale oil and gas exploration is seen as a key driver for the kind of future downstream and transportation investment that General Electric plans to sell into.

The bottom line
All told, it wasn't a bad report from Rockwell Automation, and the raising of its organic sales forecast is obviously good news. The stock's forward P/E ratio of more than 19 times earnings leaves it looking fairly valued, but not particularly good value versus Emerson Electric and General Electric. Thinking longer term, the indications are that the downstream processing industry is a pretty good place to be invested -- especially for North America -- and Fools should start to warm to this theme.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Emerson Electric Co.. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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