Summary
- A recent pullback has caused shares of Rockwell Automation to become undervalued by 20% compared to the target price generated by a DRAG analysis.
- Analysts forecast annualized earnings growth of more than 10% moving forward and the company has consistently generated a return on invested capital of greater than 20%.
- Furthermore, the stock pays a reasonable 2.5% dividend yield and management has a solid track record of dividend growth and maintains a conservative balance sheet.
Disappointing quarterly earnings announced by Rockwell Automation (NYSE:ROK) at the beginning of December was responsible for starting the recent sell off that has sent the shares tumbling by more than 10% in just two weeks. However, the largest pure play industrial automation company in North America trades at a reasonable forward multiple, generates strong returns on its invested capital and analysts predict consist double-digit earnings growth over the next several years. This article investigates Rockwell Automation’s fundamental attributes to determine whether this recent pullback has created a compelling investment opportunity.
Please click here to read my article which outlines the DRAG analysis framework in more detail.
To summarize, the four variables used in a DRAG (dividend and risk adjusted growth) analysis are as follows (each company is ranked from 0 to 3 in each category):
1) How cyclical is the industry in which Rockwell Automation operates?
2) How strong is Rockwell Automation’s competitive position within this industry?
3) How risky is Rockwell Automation’s balance sheet?
4) What is Rockwell Automation’s dividend yield and dividend growth history?
The premise is that a company that operates in a non-cyclical industry, with a strong competitive position and a clean balance sheet that pays an attractive dividend should trade at a higher earnings multiple than a company without these attributes, even if the lower quality company has higher projected future earnings growth. After adjusting for these variables, it becomes easier to compare companies in different sectors with different levels of future growth potential.
Rockwell Automation DRAG Analysis:
Rockwell Automation Industry Analysis | |
Industry Beta | 1.14 |
Stock Beta | 1.42 |
10 Year EPS Std Dev | 74.7% |
Industry Score | 1/3 |
By each of the above measures, Rockwell Automation appears to exhibit an above average level of cyclicality. This academic research website categorizes Rockwell Automation as part of the electrical equipment industry; stocks within this industry have an average beta of 1.14 over the last 12 months. Rockwell Automation’s share price has consistently demonstrated an even higher level of volatility and although its beta has declined in recent years, it still sits significantly above 1:
The firm’s annual earnings have declined twice over the past decade (in both 2008 and 2009), demonstrating that the business is somewhat economically sensitive. For all of these reasons, Rockwell Automation is likely more cyclical than the average stock and possesses more economic risk, causing it to earn a below average score in this portion of the framework.
Rockwell Automation Competitive Position Analysis | |
Gross Margin | 41.6% |
Operating Margin | 17.9% |
Return on Assets | 13.7% |
Return on Invested Capital | 23.0% |
Competitive Position Score | 2/3 |
Rockwell Automation is a leader in its field and its margins and efficiency rations demonstrate its imposing competitive position. Its operating margin has widened slightly in recent years and its return on assets has remained consistently strong during this period. The firm’s competitive strengths are easily observable via its above average return on invested capital. Over the last decade, Rockwell Automation has achieved an average ROIC of more than 26%. Based on the above figures, the company’s competitive position is stable and worthy of an above average score in the DRAG analysis.
Rockwell Automation Balance Sheet Analysis | |
Debt to Equity Ratio | 0.46 |
Current Ratio | 2.28 |
Interest Coverage | 20.1 |
Balance Sheet Score | 2/3 |
Rockwell Automation maintains a conservative balance sheet with more cash and short term investments ($1.8 billion) than total debt outstanding ($1.2 billion). The firm also achieves an impressive level of interest coverage and has maintained a promising current ratio for more than a decade. Although the company has not been highly levered at any point in recent history, it has consistently reduced its debt levels over the last five years:
The firm’s balance sheet accounts for approximately $1 billion of goodwill, which significantly reduces its value of net tangible assets. However, Rockwell Automation sits in a solid financial position and shareholders can feel confident that its balance sheet does not add a significant level of risk to their investment.
Rockwell Automation Dividend Analysis | |
Current Yield | 2.5% |
Payout Ratio | 39.2% |
1 Year Dividend Growth | 10.8% |
3 Year Dividend Growth | 52.9% |
Dividend Score | 1.5/3 |
After a recently announced 10.8% dividend increase, shares of Rockwell Automation now yield a comfortable 2.5%. The company has more than doubled this payout during the last three years, but its payout ratio remains around 40%. Furthermore, the company has generated more in the way of free cash flow than net income in each of the last two years. The company has used these funds for both dividend payments and share buybacks in similar amounts. Although the firm kept its dividend stable from 2007 through 2009, management’s long term dividend growth track record is impressive. Investors focused on dividend growth should feel comfortable considering adding shares of Rockwell Automation as an industrial component to their portfolios.
Rockwell Automation DRAG Analysis | |
Total DRAG Score | 6.5 |
/4 = Average DRAG Score | 1.625 |
x Projected LT EPS Growth Rate | 10.45% |
x Projected 2015 EPS | $7.38 |
= Rockwell Automation Target Price | $125.32 |
With its stock price currently sitting at approximately $103, this DRAG analysis suggests that Rockwell Automation is undervalued by approximately 20%. In fact, its shares were trading at this price less than six months ago. Analysts anticipate that the company’s earnings will grow consistently over the next several years:
From a historical perspective, the stock does not appear overvalued at its current price. The above $125 target suggests a forward price to earnings ratio of approximately 17, which does not seem unreasonable given its valuation range over the last five years:
Rockwell Automation offers shareholders a number of enviable attributes: double digit earnings growth potential, a conservative balance sheet, an above average return on invested capital and a solid 2.5% dividend yield. While other industrial companies might possess more exciting growth potential, Rockwell Automation deserves serious consideration for all income and dividend growth portfolios.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. (More…)
Plenty To Like About Rockwell Automation (ROK) - Seeking Alpha
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