Is Rockwell Automation Undervalued Now?

Rockwell Automation (ROK 1.05%) is one of the most exciting stocks in the industrial sector. It's the leading U.S. player in automation, and it's at the vanguard of the movement toward improving manufacturing productivity in America via introducing automated processes.

Its long-term growth prospects look excellent, but the company is being hit with ongoing supply chain difficulties in the near term, and investors recently dumped the stock. Is now the time to buy in with a long-term view, or should investors continue to shy away from the stock? Here's the lowdown.

Image source: Getty Images.

What happened in Rockwell Automation's second quarter

In a nutshell, Q2 earnings came in lower than expected, and management lowered its full-year guidance. The main issue is the well-documented supply chain issues and cost inflation bedeviling the global economy right now. Rockwell is being acutely hit in its automotive and e-commerce (warehouse automation) markets, where semiconductors and other components are negatively impacting its ability to ship into those end markets.

As such, management made significant reductions to its full-year guidance. As you can see below, it's a question of lower sales and lower margins. 

Data source: Rockwell presentations. *Notes by the author based on earnings presentations.

The case for buying Rockwell stock 

It doesn't make happy reading for investors; then again, investing isn't a beauty contest. It's about finding good value investments. There is a case for buying the stock right now in this context. The crux of the bulls' case is that Rockwell's orders growth remains robust (up 37% on a year-over-year basis in the second quarter) and the supply chain problems, although significant, are temporary. Moreover, Rockwell could see a margin boost in connection with sales improvements when semiconductors and other components become more available. 

Meanwhile, no one doubts the importance of capital investment in automation. There's an obvious need for the semiconductor industry to invest, and underlying demand for cars (in particular electric vehicles) remains strong, so automotive companies will increase investment over time. Across all of Rockwell's end markets, pent-up demand will likely release at some point, and the company will convert its growing backlog into sales in the future. 

Image source: Getty Images.

It's a compelling case, and if taken to its fruition, it implies a strong recovery in Rockwell's fiscal 2023. Indeed, CFO Nick Gangestad said on the earnings call that he expects "margins to improve sequentially" through the third and fourth quarters as pricing actions take hold to counteract cost increases. 

There is a downside risk

That said, there's no shortage of downside risk to the bulls' outlook. Rockwell is a company whose revenue relies highly on its customers' capital spending plans. Unlike operating spending, capital spending plans can be quickly shelved or delayed in an economic slowdown. Consequently, if the global economy hits a rough patch due to the persistent supply chain difficulties -- the fallout from the war in Ukraine, rising rates, the unwinding of quantitative easing, extended lockdowns in China, or any other event you can think of -- Rockwell will feel the pain first. 

Buy or sell?

Ultimately, it boils down to a risk/reward calculation -- and frankly, the stock price reduction isn't enough to make the stock a good value right now. Based on the midpoint of the reduced guidance, i.e., $9.60, and Rockwell's current stock price of $200, the stock trades at nearly 21 times its estimated fiscal 2022 earnings. That's probably close to a fair value for the risk involved. Still, plenty of other stocks offer a better value for carrying the risk of a slowdown in the economy in the current environment. As such, Rockwell is still one for the watch list.