Better Buy: Emerson Electric vs. Rockwell Automation

These two automation-focused stocks have had contrasting times of it in recent years. Over the last five years, Rockwell Automation (ROK 1.30%) stock is up 154%, with Emerson Electric (EMR 0.05%) up only 83%, as compared to the S&P 500 index's 111% increase over the same period. What's going on, and which stock is better placed for 2021?

The difference between Emerson Electric and Rockwell Automation

The two companies will also be inextricably linked due to Emerson Electric's failed attempt to buy Rockwell in 2017. Back then, Emerson's CEO David Farr was hoping to create a U.S. powerhouse in automation by marrying Emerson's expertise in process automation (managing the flow of raw material into products, such as in petrochemical refining) with Rockwell's factory automation (automated processes in manufacturing).

Image source: Getty Images.

Farr's idea was a good one, and it helps to highlight the key difference between the two companies. Specifically, Emerson is more of a process automation company, and Rockwell is more of a factory automation play. Around 35% of Rockwell's sales go to the process automation markets, with 25% coming from discrete automation (automotive, semiconductor, and general industrial) and 40% coming from hybrid automation (food and beverage, life sciences, etc.)

In addition to automation, Emerson has a commercial and residential solutions (tools, home products, and climate technologies) segment that contributed almost 40% of segment earnings in 2020.

Outlook for 2021

The difference helps explain why the market is willing to pay a valuation premium for Rockwell over Emerson right now. Simply put, the market, rightly or wrongly, is nervous about Emerson's exposure to energy spending. The chart below shows forward estimates for enterprise value (market cap plus net debt) divided by earnings before interest, taxation, depreciation, and amortization, or EBITDA, a commonly used valuation method.

Data by YCharts

The reason? It comes down to the reluctance of process automation companies to release budgets for spending on projects when energy prices, and specifically the price of oil, are in decline. It's a frustrating situation, and process companies can't hold off spending on these kinds of projects forever, but the evidence is that it happens.

Process automation is still weak

For example, both companies gave earnings recently and upgraded their full-year 2021 sales and earnings guidance, but they both gave disappointing guidance for their process automation sales.

Emerson's full-year 2021 sales growth guidance now calls for underlying sales growth of 0% to 4%, compared to previous expectations for a 1% decline to a gain of 2%. However, the increase largely comes down to an upgrade in sales expectations for the commercial and residential solutions business. There, management is guiding

for 8% to 10% growth instead of the previous guidance for 4% to 7%. There was only a slight improvement in the automation solutions segment sales growth expectations. The midpoint of guidance now calls for a 1% decline instead of a 2.5% decline previously.

Rockwell now expects its full-year 2021 organic sales to grow at a 4.5% to 7.5% rate, compared to previous guidance of 3.5% to 6.5%. But as you can see below, management actually lowered its full-year expectations for process automation sales, largely on the back of weaker oil- and gas-related sales.

Whichever way you look at it, it's process automation that's the weak area in 2021.

Data source: Rockwell Automation presentations. Chart by author. Author's analysis.

Putting all of this together, it appears that Rockwell is the better buy due to its exposure to the fast-recovering factory (discrete and hybrid) automation markets. Open and shut case? It's not that simple.

Three reasons why Emerson Electric is the better buy

First, Emerson is more than just a process automation company. The commercial and residential solutions segment contributed 46% of segment earnings in the first quarter. Moreover, around 24% of Emerson's sales go to the discrete and hybrid automation end markets. Meanwhile, upstream and midstream oil and gas only constitutes around a third of automation sales.

Image source: Getty Images.

Second, in any case, the price of oil has recovered to above $50 -- and if it stays that way, then capital spending will surely come back, even if it won't be until fiscal 2022. As Honeywell (HON 0.68%) CEO Darius Adamczyk said when discussing Honeywell's process automation business: "There is definitely a pent-up demand because you can't underfund this marketplace for too long. So, whether that happens in the second half of this year or 2022, that story is yet to be told." 

Third, based on Wall Street analyst estimates, Emerson trades on a clear valuation discount to Rockwell.

Data source: Company presentations.marketscreener.com.

Emerson or Rockwell Automation?

Rockwell is a great company, and industrial automation is a very good market to be positioned in, but don't count out the potential for Emerson's process automation sales to come back if the price of oil stays above $50. In addition, given the valuation discount, Emerson is the better buy in my view.