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Thursday, July 27, 2006

Rockwell Automation: Will Investors Ever Learn?

By William Trent, CFA of Stock Market Beat

Rockwell Automation (ROK) sells factory automation equipment. If ever there was an industry poised to do well in today’s economic environment, Rockwell is in it. Productivity growth is the only way manufacturing companies can keep up with low-cost providers.
Rockwell just posted an outstanding quarter.

According to Reuters:
Net income increased to $149 million, or 83 cents per share, from $127.3 million, or 68 cents per share, a year ago. Wall Street analysts expected net income of 81 cents per share, according to Reuters Estimates.

Sales of its products, which help factories run more smoothly, came in at $1.4284 billion, up 13.5 percent from $1.2647 billion a year ago. Analysts expected third-quarter sales of $1.3989 billion.
Rockwell expects full-year 2006 results to “modestly exceed” its prior forecast of earnings per share from continuing operations of $3.25 on 11 percent revenue growth.

Not the kind of news one expects to send a stock down more than 10 percent for the day. In part, Wall Street was disappointed that after beating estimates the full-year guidance wasn’t really raised. In fact, some analysts consider the company to have reduced guidance:
Deutsche Bank analyst Nigel Coe wrote in a research note that the profit beat Wall Street expectations largely due to a lower-than-expected tax rate. The lower tax rate, he said, means that “the quality of this (full year profit forecast) number has been lowered.”

Whatever. Management reiterated on the call their past comments that the tax rate can jump around from quarter to quarter due to the timing of various items.This all brings us back to April, 2005. The stock sold off sharply because the company “missed” its earnings target for the quarter. Problem is, Rockwell doesn’t give quarterly guidance. The high ticket prices of their equipment means there is too much volatility in quarterly numbers just because a sale occurs a few days earlier or later than the quarter end. No matter. Wall Street came up with their estimates and punished the stock for failing to meet them.

Of course, the company went on to exceed the annual guidance it had provided, the selloff marked the low of the year and by the following April the share price had nearly doubled.

Can the same thing happen again? Possibly. The stock is now trading at about 16x the consensus estimate for fiscal year ending in September 2007. That is not dirt-cheap in today’s market, but not outrageous either. Now consider some of management’s comments on the conference call:
We are currently in the teeth of a major correction in demand from our Detroit automotive market. Sales from the Detroit region were down almost 50% this quarter, which in turn reduced total company growth by more than a point, Logix growth by about two points, and control systems’ conversion margin by about five points. In the past, a correction of this magnitude would have had significant consequences for Rockwell Automation. Our ability to deliver double-digit growth during such a correction would have been unimaginable 10 years ago. Quarter four will see a similar 50% year-over-year sales decline in Detroit – and we expect to again deliver double-digit revenue growth.

Currently, we still believe we’re in the 11th quarter of the expansion (of industrial capital spending), and if you look at the historical definition of those expansions, it would last anywhere between 25 and 35 quarters, and I think what we’re continuing to see is disciplined spending by our customers.

This is a solid company that backs up its promises. While it had gotten expensive for today’s market, there was no need for the panic selling following its earnings report.

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