A look at the price chart of Rockwell Automation (ROK +5.37%) almost suggests the COVID-19 pandemic never really happened. At the time of writing, the stock is up nearly 15% in 2020. What's going on, and can the stock's recent strong run continue?
The long-term case for Rockwell Automation
The market seems to be in generous mode when it comes to Rockwell. After a 92% rise since its low point in March, the stock now trades on some pretty rich-looking valuations. In a nutshell, investors are buying into the idea that the company is set for an extended recovery in its end markets.
Weakness in heavy industries capital spending is hurting Rockwell Automation's process automation sales. Image source: Getty Images.
In addition, there's a strong case for arguing that Rockwell's long-term growth prospects have received a boost thanks to events in 2020. First, as CEO Blake Moret argued on the earnings call, the pandemic "is also accelerating the need for industrial automation and digital transformation solutions, that address manufacturing safety as well as operational flexibility and resiliency."
Second, a combination of the ongoing trade conflict with China and the shock to many companies' supply systems due to the pandemic means that myriad companies are looking at reshoring from China. And if reshoring happens in a big way, you can bet that automation will be a big part of it as manufacturing is moved back to higher-labor-cost countries.
As you can see below, there's been no shortage of buyers for Rockwell stock in recent months, and its valuations appear to be fully caught up with events.
Data by YCharts
The glass half full
There's little doubt that Rockwell's best days are yet to come, and the "recovery thesis" is backed by management's disclosure that monthly order trends had made sequential improvement (relatively and absolutely) every month since the low point in April. Indeed, analysts have the industrial stock growing revenue and earnings by mid-single digits in its fiscal 2021 as the company recovers from a pandemic hit in 2020 -- Rockwell's management expects organic sales to decline 8% in 2020.
Data source: Rockwell Automation presentations.
Moreover, anecdotal evidence from companies exposed to the industrial economy, such as railroads Union Pacific and Kansas City Southern, suggests companies are seriously looking at reshoring manufacturing operations -- great news for Rockwell in its home U.S. market.
The glass half empty
That said, it's worth noting the following points:
- While the movement toward greater usage of automation appears to be a favorable secular trend, it's unlikely to fully offset cyclical weakness in capital spending caused by a slow economy.
- Rockwell has heavy exposure to some end markets, such as automotive and process industries, that are likely to remain weak for some time.
- The company's revenue is its customers' capital spending -- something that companies are looking to cut in slowdowns, and reluctant to expand unless the economy is doing well.
Putting these points together, it's clear that Rockwell isn't a stock you should be buying unless you are positive on long-term growth in the economy.
The following table, gleaned from the third-quarter earnings presentations, shows just how much exposure the industrial stock has to heavy industries through its process automation sales. They are likely to remain weak while the oil and gas industry recovers financially from the decline in the price of oil.
Rockwell's hybrid automation sales probably don't have the strongest potential to bounce back in the next few quarters, but it could be well into 2021 before automotive-related (discrete automation) sales improve.
| Activity |
Percentage of Third Quarter Sales |
Year Over Year Sales Growth in Third Quarter |
Key Industries' Sales Growth in Third Quarter |
|---|---|---|---|
|
Discrete automation |
22% |
(20%) |
Automotive down 25%, semiconductor up mid-single-digits |
|
Hybrid automation |
44% |
(10%) |
Food and beverage down 10%, life sciences down 10%, tire down double-digits |
|
Process automation |
34% |
(25%) |
Oil and gas down 30%, mining/aggregate/cement down double-digits, chemicals down double-digits |
Data source: Rockwell Automation presentations.
Is Rockwell a buy?
As attractive as the company is for the long-term, it's hard to make a case that there's sufficient margin of safety built into the valuation to cover for any errors. Simply put, the stock looks priced for perfection, and on a risk/reward basis that means the stock is worth avoiding for now.
Investors are going to have to see either a dip in the share price and/or an improvement in Rockwell's end markets for the stock to look like a good value in the near term.
