Rockwell Automation

Rockwell reported third-quarter organic sales growth of 10% year over year. Results were driven by strength in its software and control segment. Management raised its full-year guidance, but shares fell significantly the morning of Aug. 4.

Why it matters: Rockwell is firing on all cylinders amid unprecedented US construction activity. The company is experiencing the most rapid sales growth within the data center, semiconductor, and warehouse automation end markets, but it is robustly growing in all areas except the mining end market. Geographically, North America is Rockwell's highest-growth region, but its EMEA and APAC businesses grew in the mid-single digits year over year. Latin America is its sole declining region.

The bottom line: We maintain our $282 fair value estimate for wide-moat Rockwell. We consider the shares significantly overvalued. We reiterate that we believe Rockwell benefits from multiyear trends such as the energy transition, reshoring, and AI-focused data center spending. Hence, our model incorporates growth expectations significantly above what Rockwell has delivered in its past. Even after the Aug. 4 selloff, we greatly struggle to justify Rockwell's share price. The market seems to be extrapolating current US construction spending far into the 2030s.

Between the lines: Rockwell's share buyback pace decelerated significantly this quarter; repurchases were just 0.3 million shares for $145 million, versus 1.2 million shares for $454 million last quarter. Some $1.2 billion is still authorized for buybacks, so management may see the stock as expensive. Regardless of Rockwell's reason, we believe capital is better spent elsewhere until its share price converges closer to our fair value estimate.

We assign wide-moat Rockwell a $282 per share fair value estimate, which translates to around 22 times our estimate of 2026 earnings. Rockwell's value is underpinned by its wide economic moat through which we believe it can outearn its cost of capital over the next 20 years.

We model mid-single-digit organic sales growth as we expect demand for Rockwell’s automation products to benefit from secular trends such as the growing skilled labor shortage, rising product quality standards, labor efficiency and safety initiatives, and continued industrialization in developing nations. A 2024 survey of manufacturing facilities conducted by the Manufacturing Leadership Council determined that only around 7% of factories are fully digitized, which we believe gives Rockwell a long runway for continued growth. In recent years, process industries such as chemicals and food and beverage, where safety risks for humans make automation more attractive, have moved up the adoption curve for industrial automation. Many of Rockwell’s end markets such as the pharmaceutical and semiconductor industries are also suited to automation due to the uniformity of processes, need for precision, and often sterile production environments. Rockwell's organic revenue growth does, however, depend on global industrial capital spending cycles; even in healthy economic environments, it is difficult to predict when manufacturers will earmark capital for significant manufacturing capacity expansion or upgrades.

Over the short term, we see demand tailwinds from the aging US industrial equipment fleet needing replacement and the reshoring of supply chains back to the US where Rockwell has the strongest market share. We believe that organic revenue growth will drive strong margin conversion, producing average segment operating margins in the high teens to low 20s throughout our five-year forecast period, slightly greater than the average margin achieved over the past 10 years. After a muted 2025 stemming from slowing greenfield construction and inventory destocking, we model margin expansion from operating leverage and ongoing efforts to improve sourcing and labor utilization.

A significant proportion of physical equipment installed in factories is still from the 1970s and 1980s, because unlike consumer electronics, industrial equipment is built for durability and customized to fit each individual manufacturing customer, and as such has much stronger switching costs. We therefore expect Rockwell to experience GDP-plus growth over the long term due to the structural driver of technology adoption, but lower than a software or tech sector due to entrenched legacy installations moderating the adoption pace. We think automation trends will remain strong and model Rockwell to grow its earnings in the low double digits.

We assign Rockwell a wide economic moat rating carved through switching costs and intangible assets. Rockwell has maintained the highest returns on invested capital in its peer group for many years. Although returns have been muted in recent years due to the expensive acquisition of Plex Systems in 2021, we model returns well above Rockwell’s cost of capital. Notably, during the depths of the global financial crisis in 2009, Rockwell’s ROIC, including goodwill, did not fall below 16%, over 700 basis points above our estimated cost of capital, even though its performance is highly correlated to global industrial production, which was severely hampered by the crisis. We think the company has since grown stronger, and as such, we believe it’s more likely than not that Rockwell can continue to outearn its cost of capital over the next 20 years.

We think it is highly unlikely for a customer to switch suppliers once Rockwell’s equipment is installed. For a customer to rip out mission-critical equipment that represents a small percentage of its bill of materials, the savings from a different system would have to exceed the sum of the upfront capital expense, costs of operational downtime, plant redesign, employee retraining, and the risks of integrating new equipment. Downtime alone for a large-scale manufacturing plant can cost millions of dollars per hour, stemming from wasted materials, installation costs, and lost production.

Moreover, we believe incumbency is strong in the industry; a customer will likely choose the same automation provider to replace equipment at the end of its useful life. In our view, Rockwell’s switching costs enable the company to benefit from decades of high-margin maintenance, repair, and overhaul sales as some of its equipment remains installed and serviceable in customer factories for upward of 30 years. We estimate that MRO sales represent around a third of Rockwell’s revenue versus around two thirds at close peer Emerson Electric.

Automated industrial tasks can broadly be broken down into three types: discrete, process, and hybrid. In discrete manufacturing, products such as electronics, vehicles, and semiconductors tend to be made in batches or runs. The global discrete automation market is fragmented and led by the likes of Siemens, Schneider Electric, ABB, Rockwell, and Emerson Electric. Although Rockwell does not hold the majority market share as measured by overall revenue, each competitor specializes in different product types and end markets, as automation equipment tends to perform niche functions and is therefore not interchangeable. For instance, Rockwell estimates that it holds over 70% market share of controllers in the US, a niche it has dominated for decades.

In contrast, process manufacturing is typically designed for uninterrupted, continuous operation. Producing goods such as oil derivatives, chemicals, and drinking water involves processes that run 24/7. Halting a process can be costly because continuous processes are designed for steady-state operation, and interruptions can generate waste and interfere with product quality. Equipment reliability is therefore a major factor in selecting a supplier. The same discrete players plus Yokogawa and Honeywell lead the process automation market.

Hybrid processes such as the manufacturing of pharmaceuticals, food and beverages, and personal-care products involve both discrete and process automation. Rockwell’s offering becomes even more enticing with a strong presence in both categories. Although Rockwell used to have a much greater exposure to discrete automation, it diversified in recent decades and today generates around 75% of its revenue from process and hybrid automation equipment, software, and services. We believe its presence in all facets of manufacturing automation, the expert services it offers, and its history of innovation make Rockwell a convincing partner.

We expect Rockwell's software and control segment to generate returns above its cost of capital for many years. The segment has produced returns on invested capital above its peer average and Rockwell’s weighted average cost of capital even with the acquisition of Plex damping returns. We think the segment merits a wide economic moat rating as it benefits from strong switching costs and intangible assets inherent in control-level equipment. The segment generates higher operating margins than its average high-performing software peer, giving us confidence that customers are willing to pay up for Rockwell’s products.

We generally believe floor-level industrial automation devices, where Rockwell’s intelligent devices segment sits, have narrower moats than control-level products in the layer above. However, the segment has vastly outearned its cost of capital for many decades and generates higher operating margins and far greater returns than the average of its wide-moat peers. We therefore think the segment has a wide economic moat as it is reasonable to expect the segment to outearn its cost of capital over the next 20 years.

Rockwell has multidecade relationships with the industry’s largest distributors, an essential bottleneck connecting end users to equipment manufacturers. The firm generates over 70% of sales through distributors, with the remainder being sold to machine builders. All of Rockwell’s distribution sales in the US are made through a limited distribution model, which is an exclusive agreement whereby a distributor can only sell Rockwell products. These distributors are essentially the outsourced sales and servicing arms of Rockwell, highly trained on its products and unable to sell competing offerings. Rockwell’s exclusive distributors act as a one-stop shop for customers, offering bespoke services such as plant design, system integration, and maintenance. Customers tend to value such a partnership because they have highly complex operations and ongoing maintenance needs.

Rockwell dominates niche industrial automation functions and has defended its position for decades, giving us confidence it can do so in the future.

Rockwell’s automation products are well known and have formed a premium reputation, giving the company ample pricing power.

Although automation equipment mandates high capital investment, Rockwell’s equipment saves customers substantial money over time, incentivizing spending during economic downturns.

Although Rockwell generates higher margins than peers, it competes against very large firms that can easily outspend it in R&D, potentially eroding its technology advantage over time.

Some of Rockwell’s customers have indicated the firm’s products have become too expensive. Raising prices above inflation can result in sales volume declines and unhappy customers.

Rockwell’s recent executive hires are from 3M, a company that has declined in quality in recent years. Outsiders from underperforming companies could bring with them questionable decision-making.