The best is yet to come for Rockwell Automation (ROK -0.28%), but unfortunately, so is the worst. The company's revenue is other industrial companies' capital spending, and when the economy turns, the first thing businesses do is cut back on expansionary spending. That's the bad news, but the good news is that Rockwell's underlying long-term growth drivers are still intact, even if 2020 is shaping up to be a very bad year. Let's take a closer look at what's going on and whether the stock is a good value.
Rockwell Automation
As the name suggests, Rockwell is a leader in industrial automation. It services a broad range of customers, but its most important end markets tend to be industries like automotives, food and beverage, and process industries -- in other words, the early adopters of automated manufacturing or processing.
Clearly, the company has three main problems in 2020:
- The industrial automation market was already weak entering the calendar year.
- The COVID-19 pandemic and the measures taken to contain it are causing extensive manufacturing shutdowns and the threat of an extended recession.
- Many of the areas of particular weakness in the economy are key end markets for Rockwell.
The first point can be illustrated by the following chart of its year-over-year organic sales growth. As you can see below, Rockwell started its fiscal 2020 with a 1% decline in sales growth. Moreover, even before the COVID-19 outbreak in China turned into a global pandemic, the company was only forecasting organic sales growth in 2020 to range from a 1.5% decline to a 1.5% increase.
Data source: Rockwell Automation.
Manufacturing shutdowns and Rockwell's end-market exposure
The second point was highlighted recently when Rockwell's management came out and said its second-quarter sales "held up well," but "we expect that as COVID-19 impacts more countries and economies, we will face lower demand in many of our served industries for a period of time. As a result, we are taking pre-emptive actions to align the company's cost structure with this environment."
The update was hardly surprising given the kind of end market exposure Rockwell has. For example, the automotive end market generates 10% of its sales, with oil and gas also responsible for 10% and a host of other process industries (mining, metals, chemicals, etc.) responsible for 25%.
There's no prize for guessing that the automotive market is very weak now; the latest Association of American Railroads weekly rail traffic data shows carloads of motor vehicles and parts down 82% year over year in the week ending April 4. Moreover, with the price of oil at around $23 a barrel, it's highly likely that oil and gas capital spending will continue to be cut.
Unfortunately, Rockwell is in the wrong end markets at the wrong time.
Rockwell remains a long-term growth story
Clearly, it's not going to be a great year for the company, and investors should brace themselves for a horrible third quarter. Furthermore, until the COVID-19 pandemic is contained and the global economy starts to recover, there's likely to be pressure on Rockwell's sales.
It obviously matters in the near term, but the reality is that the economy will recover at some point, and Rockwell is surely going to be a beneficiary of it. The key attraction of the company is due to the importance of industrial automation at the heart of the so-called fourth industrial revolution: the use of the Internet of Things (IoT) in order to improve the performance of physical assets.
Food and beverage spending on industrial automation will help offset weakness elsewhere for Rockwell Automation. Image source: Getty Images.
Simply put, the use of web-enabled devices, analytics, and the overlaying of digitally created insights (augmented reality) is helping industrial companies to better monitor, guide, and manage their physical assets. It's a trend that's not going away anytime soon, and Rockwell's architecture and software are at the heart of it.
Moreover, as the benefits of digitizing factories become ever more apparent, more companies will be encouraged to invest in automation. Such arguments still hold over the long term, even if Rockwell is set for a period of very weak earnings.
Is Rockwell a good value stock?
The tricky bit is deciding whether the stock is at a suitable entry point. The following chart shows some commonly used valuation methods. I'll let you take a look at them while comparing current valuations with what they were just before the previous slowdown (see first chart above) in 2016.
Data by YCharts.
Frankly, Rockwell's current valuation hasn't hit the lows it did at the start of 2016, and on that basis, it's hard to argue it's a great value for the risk involved right now. On a more positive note, it's definitely a stock worth watching with a view to buying in on some significant weakness, because its best days are still ahead of it.
