This Automation Company is a Good Long Term Buy
Sandeep is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When capacity utilization bottomed at 67% in June 2009 during the last recession, there was easier money to be made. Now that the U.S. rate is 78-80%, it appears that we are in that mid-cycle period where the rate goes through a nominal flattening with some short-term cyclical behavior. With capacity utilization at these levels, customers typically look to invest for further productivity improvements in existing facilities.
For long-term investors, I believe Rockwell Automation (NYSE: ROK) will continue to add meaningful improvements to growth, leverage, and Return on Invested Capital (ROIC). Rockwell is a leading global provider of industrial automation solutions. The company operates in two segments: Architecture & Software and Control Products & Solutions. I believe Rockwell is well positioned to help companies enhance manufacturing and operating efficiencies. Further, the company should benefit from capacity expansion in the emerging markets and a Cap-ex recovery in developed markets. I believe the shares offer attractive upside potential from current levels.
Current Positioning in The Market
Since Rockwell updated guidance in July, no geographies have seen a major downturn. Brazil has stabilized following a fall-off earlier in the year, and growth in China has been resilient. The EMEA region has held up well given the industrial backdrop in Western Europe. Current signs are that the Oil & Gas and Auto segments should remain solid into 2013. Longer-term, I believe the company will continue to take share in Process. Also, Rockwell has excellent visibility into distributor inventory levels as it receives POS data for 95% of its network. Currently, channel inventories are tracking in line with demand.
Shareholder-Friendly Cash Allocation
Rockwell has paid $300 million of discretionary cash into its pension fund this year. I believe that further contributions are unlikely in FY13 which allows increased returns to shareholders next year. I estimate that deploying half of this to the buyback for instance would add another ~$0.05 to EPS, while a slight acceleration in dividend payout growth in 2013 (vs. 2012) would imply a yield of 3%. Management has also indicated that it is likely to be more acquisitive in FY13 vs. FY12. Rockwell still expects to repurchase at least ~ 3 million shares in ’12 (2.3 million repurchased 1Q-3Q)
The Company Seems Undervalued
The company has several competitors include ABB LTD (NYSE: ABB), Emerson Electric (NYSE: EMR) and HollySys Automation (NASDAQ: HOLI). The following table summarizes the Expected annual growth for the next several years, Dividend yield, ROIC and forward PE of Rockwell and its peers in automation control systems:
|
Company |
Expected EPS growth for next 5 years |
Dividend Yield |
ROIC |
Forward PE |
|
ABB |
11.60% |
3.60% |
12.61% |
12.20 |
|
Emerson Electric |
9.46% |
3.30% |
14.36% |
13.00 |
|
HollySys |
14.54% |
NA |
17.16% |
9.39 |
|
Rockwell |
11.13% |
2.70% |
19.03% |
12.67 |
We can see that Rockwell is trading mostly in-line with ABB and Emerson Electric and at a premium to HollySys. The company’s valuation at a premium to HollySys seems justified due to its impressive dividend yield. Although Rockwell provides lesser yield as compared to ABB and Emerson, it also has the lowest payout ratio (payout ratio of just 33% as compared to Emerson’s 47% and ABB’s 55%) and thus, there is good scope for dividend hikes in the future. Rockwell’s expected growth rate is in-line with ABB and better than Emerson. Moreover, Rockwell also seems a bit undervalued given the “best-in-class” return on invested capital.
On a long-term secular basis, I estimate Rockwell’s demand is driven by an increased or sustained high level of production capacity utilization and corresponding capacity expansion leveraged across new markets and geographies. As utilization increases, I expect a corresponding increase in the repair and replacement business and potentially new plant construction, both of which would supplement demand driven by utilization rates. For long-term investors, I believe Rockwell will continue to add meaningful improvements to growth, leverage, and ROIC, but I suggest investors to approach the current environment more cautiously. Thus, I recommend it as a good long term investment.
sandeep2gupta has no positions in the stocks mentioned above. The Motley Fool owns shares of ABB. Motley Fool newsletter services recommend Emerson Electric Co.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
