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Thursday, August 31, 2006

Rockwell Automation Downgrade Too Late for Investors

By William Trent, CFA of Stock Market Beat

We recently discussed the selloff in Rockwell Automation (ROK) asking “will investors ever learn?” The answer appears to be no.

Rockwell Automation Downgraded: Financial News - Yahoo! Finance

A Credit Suisse analyst downgraded shares of Rockwell Automation Inc. Wednesday, saying the factory automation equipment maker’s stock has few reasons to grow.Credit Suisse analyst Nicole Parent reduced her rating to “Underperform” from “Neutral” and lowered her target price to $58 from $64.

Shares have increased about 60 percent due to good news over the past couple years, as the company refocused on efficiency, end market diversity, global expansion, and spinoffs of segments, wrote Parent.

But while the stock is down about 28 percent from its 52-week high of $79.47 on April 24, shares are unlikely to rise, Parent said, because she believes investors have already priced the good news into the stock, and that margins are likely to come under pressure down the road.

A 28% decline means investors are pricing in good news? I’d hate to see what happens when they price in bad news - or perhaps in the Sell Side’s alternate universe it would take a 50% rally for the bad news to be priced in. Here is what we had to say in our previous post, which we continue to believe:

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.
We can understand the analyst’s embarassment as the shares have fallen this year. It has happened to everyone. We would also be willing to listen to reasonable arguments as to what has changed in the fundamental story for Rockwell. But the reasons listed by Credit Suisse were much more valid at $79 than they are today at $56.

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