We have been favorably disposed toward Rockwell Automation (ROK), which has reported decent sales growth and its factory automation products appear well suited to the current need for improved manufacturing efficiency. The company is also cleaning up its balance sheet:

Baldor Electric Co agreed to acquire the power systems business and assets of Rockwell Automation Inc for $1.8 billion in cash and stock. Baldor Electric Co will pay $1.75 billion in cash and about $50 million in stock. The power systems business sells its products under the Reliance Electric and Dodge brand names. The deal is expected to close in the first quarter of 2007.

According to the recent earnings report:

Power Systems fourth quarter sales were $264.9 million, an increase of 15 percent compared to sales of $231.1 million in the 2005 fourth quarter. Segment operating earnings were $41.6 million, an increase of 87 percent compared to $22.2 million in the fourth quarter of 2005. The increase in segment operating earnings was attributed to higher volume, productivity, net price, and lower restructuring charges somewhat offset by inflation. Power Systems return on sales was 15.7 percent in the fourth quarter of 2006 compared to 9.6 percent in 2005.

Sales for the full year were $1,010.1 million, an increase of 15 percent compared to $879.6 million in 2005. Segment operating earnings were $162.6 million, an increase of 47 percent compared to $110.3 million in 2005. Power Systems return on sales for the year was 16.1 percent compared to 12.5 percent in 2005.

The unit comprised just over 18% of the company’s sales in FY06 but only 4% of segment operating income. The sale values it at 15% of the company’s enterprise value, which seems to us like a solid price.

Rockwell Automation (ROK) reported a 9% gain in sales and earnings that beat expectations. It’s guidance was slightly on the light side for both sales (up 7-8% next year) and earnings ($3.70-$3.90 vs. consensus at $3.82.) The thing is, having seen leading tech companies post sales gains of 2% (Xerox) to 4% (Keane and CDW) or 5% (IBM) that 7-8% starts to look to us like ROK is on a roll.

As we noted when we first wrote about the company, Rockwell Automation sells factory automation equipment. If ever there was an industry poised to do well in today’s economic environment, Rockwell is in it.

After reviewing the earnings release, about the only blemish we found was a decline in cash flow from operations due to higher funding requirements for the company’s pension plans. Since they aren’t the only ones in that boat (or its sister ship - the options backdating scandal) we don’t worry too much about it as long as their growth rate is so much better than those other firms mentioned. While they may not be setting the world on fire (especially after selling their stake in Rockwell Scientific, which was in the nuclear bomb design business) they are doing as best as we expect most firms to do in the current economy - and after all, one has to invest somewhere.

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.

(Source: Rockwell Automation 2005 Annual Report)

Summary: Durable goods orders for capital goods remain strong, although rising inventories and some signs of stabilization/weakness merit watching.

Residential investment is another thing altogether, as consensus has quickly built on the slowing housing market. The second-quarter GDP report had some interesting data showing just how fast builders are adjusting to the new market. While the Q1 decline to 6.1% could have been a temporary pause like that of late 2004, the second quarter data shows an actual year/year decline.
Watch List news:

The Brazilian aircraft manufacturer Embraer (ERJ) has sold 30 E-175 regional jets to Republic Airlines Inc., its first sale of the jet to the US market, Embraer said in a statement. Meanwhile their business jet backlog has increased to $1.25 billion. All the positive news makes the Motley Fool think Embraer can fly.
Other News:

We had some good things to say about Rockwell Automation.

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.