Investors in Rockwell Automation (NYSE: ROK) can hardly be surprised by management lowering the range of full-year sales and earnings guidance. There's no way to get around it: Rockwell is a cyclical company whose revenue is other companies' capital spending -- great when the economy is growing strongly, but not so good in a slow-growth environment.
Given that global growth is slowing in 2019 and global automotive production -- a key end market for Rockwell -- is in decline, there was always a possibility that the company would have to take down guidance. But does it mean the stock can't continue to do well this year? Let's take a closer look.
The bears and bulls continue to do battle over Rockwell Automation. Image source: Getty Images.
Rockwell Automation cuts full-year guidance
The table below shows how management cut guidance on the recent second-quarter earnings call. The previous guidance range was pretty wide, and management took down the high end of sales and earnings guidance. But what does it mean for valuation?
Based on the current stock price of around $178, the midpoint of current guidance puts the stock on a 2019 fiscal year P/E multiple of slightly less than 20 times earnings. Moreover, given that free cash flow conversion from net income is expected at a 100% rate, the 2019 price to free-cash-flow multiple is a similar figure. Those aren't bad multiples for a company with long-term exposure to the Internet of Things (IoT) -- it's one reason Rockwell has traditionally traded at a premium to its sector.
Organic growth range
Segment operating margin
Adjusted EPS range
Data source: Rockwell Automation.
The questions now turn to whether the reasons for Rockwell's guidance cut will lead to more reductions in the future, and what is the likelihood of Rockwell meeting its current guidance for 2019?
All about automotive
According to CEO Blake Moret, so far this year, the problems are isolated to the automotive sector. It's no secret that global automotive production is set to decline in 2019, and vehicle technology companies like BorgWarner (NYSE: BWA) have seen low-single-digit sales declines in recent quarters.
Unfortunately, production declines are feeding through into spending decisions in automotive automation -- not good news for Rockwell. Going back to the first-quarter earnings call in January, Moret maintained the company's headline guidance, but told investors that he was no longer predicting flat sales to the automotive sector in 2018; instead, he saw a mid-single-digit decline coming for the full year.
Fast forward to the recent second-quarter earnings, and a sales decline of 20% in the automotive sector encouraged Moret to cut his expectations for automotive sales in 2019 -- it's now expected to decline by 10%. Quoting Moret on the earnings call, "given the weakness in automotive, we are reducing the high end of our guidance range for organic sales growth and adjusted EPS."
All told, it really is all about the automotive sector. One indication of this comes from contrasting Rockwell's architecture and software sales with its control products and solutions sales. CFO Patrick Goris said, "our automotive business would be overweight in architecture and software, versus control products and solutions," and as you can see below, it's the automotive-heavy segment that took the hit in the quarter.
Data source: Rockwell Automation.
Reasons to be cheerful
There's no guarantee that the automotive sector won't decline further in 2019, and a stock like Rockwell always carries cyclical risk from a broad-based slowdown in the economy. But there's a reason to be positive about the company's prospects in 2019 and beyond.
So far, Rockwell's problems appear to be mainly limited to the automotive sector in 2019. It's true that other industrial companies -- such as 3M -- have reported weakness in other sectors of the economy, but Moret also said heavy industries grew high-single-digits in the quarter, with consumer up mid-single-digits. The strength in heavy industries -- within which oil and gas sales were up double digits -- will be music to the ears of investors in process automation company Emerson Electric (NYSE: EMR) ahead of its earnings report.
During the earnings call, Wells Fargo analyst Deepa Raghavan asked Moret which industries "could get you to that high end of organic growth guide?" Moret replied that "it would be the continued strong growth in heavy industries through the year," as well as automotive meeting current expectations. Capital spending in heavy industries could receive a boost from the recovery in the price of oil to around $65 a barrel, from around $45 at the start of 2019.
Meanwhile, companies like BorgWarner and Rockwell are expecting a relatively better second half of calendar 2019 for automotive, and spending on electric vehicles is likely to provide growth opportunities beyond the near term.
Even with the recent post-results sell-off, Rockwell's stock isn't screamingly cheap. But if you believe in the company's long-term growth trajectory, then the current weakness in the stock price could be seen as a decent entry point into a long-term growth story.
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