Sometimes it takes a little time before investors reconsider a company following restructuring. At least, that's how it looks at Emerson Electric (EMR 0.86%). Management's restructuring in recent years has created an automation company that deserves a valuation close to, if not more than, its U.S. peer Rockwell Automation (ROK 0.17%). For that reason, I think Emerson will outperform Rockwell Automation next year. Here's the lowdown.

Automation and industrial software

There's no doubt that automation is an attractive market to be in right now, which is why Emerson Electric's management has focused the company on it. Demand for automation is driven by its long-term cost-saving properties, allowing companies to reshore manufacturing from low-labor-cost countries. That's a key consideration as many companies faced significant supply chain difficulties in recent years as lockdowns shut down plants in various parts of the world. The other, often underappreciated, driver is the incredible productivity gains to be made from the use of digital technology in automation. 

In short, the explosion of web-enabled digital technologies and analytical capability creates significant efficiency gains for manufacturers. For example, consider a manufacturing plant that's been digitally modeled in a so-called "digital twin." Data from the physical plant can be used to render a digital twin of the plant and then simulated to predict servicing requirements better, reducing valuable downtime. 

From this, it's clear that industrial software is a key part of the automation offering. Indeed, Rockwell has a strategic partnership with industrial software company PTC, ABB has a partnership with Dassault Systemes, and Siemens has its own industry-leading software business.

Emerson Electric is now focused on automation and industrial software

Over the last few years, Emerson has divested non-core businesses (such as InSinkErator) and recently announced a deal to sell a 55% stake in its climate technologies business to Blackstone.

The desire to do so was evident as far back as 2017 when its management launched an audacious takeover bid for Rockwell. The idea is to create a company capable of competing with automation giants like Siemens and ABB. For reference, Siemens' digital industries segment (factory automation, process automation, motion control, and industrial software) generated revenue of 25.3 billion euros in its financial 2022 compared to $11.8 billion for Emerson's automation solutions segment and $7.8 billion overall for Rockwell Automation. 

The bid was rebuffed, but since then, Emerson has built up its automation business while seeking to divest its non-core upstream oil and gas-focused businesses. 

As for its software exposure, management bought software businesses (such as the $1.6 billion acquisition of Open Systems International in 2020) and then contributed them and $6 billion in cash for a 55% stake in industrial software company Aspen Technology.

Why Emerson stock can outperform Rockwell Automation 

Emerson's restructuring toward automation means it should command a valuation similar to that of its rival. In summary, Emerson is now an automation company with a 55% stake in an industrial software company and a 45% remaining stake in its climate technologies business. 

To illustrate the point about valuation, here's a look at what Wall Street analysts are forecasting for earnings before interest, taxation, depreciation, and amortization (EBITDA) for the two companies and what it means for their enterprise value (market cap plus net debt)-to-EBITDA valuations. As you can see below, Emerson Electric's valuations look attractive relative to Rockwell's -- one reason Emerson can outperform. 

Company/Metric

2022

2023 Est.

2024 Est.

Emerson Electric EBITDA

$4.378 million

$3.907 million

$4.274 million

Emerson Electric EV/EBITDA

11.8x

14x

12.7x

Rockwell Automation EBITDA

$1.573 million

$1.805 million

$1.970 million

Rockwell Automation EV/EBITDA

17.9x

17.8x

16.1x

Data source: Wall Street consensus from marketscreener.com. 

Looking ahead to 2023

Investors will likely reward Emerson's gradual transition toward becoming a pure-play automation company. While this argument relies on relative valuation, and Rockwell's valuation may be a little rich, Emerson is an attractive stock in its own right.