Rockwells Third-Quarter Guidance Raises Wider Questions
Ever since the economic storm clouds started gathering some 12 months ago, the worlds automation vendors have been seeking to reassure shareholders and analysts that their sector would be largely unaffected by any forthcoming downturn. Automation would be just what manufacturers needed to weather the forthcoming economic turmoil; hence, continued investment in automation could be expected as the tough times ahead got tougher. Whether the said analysts, not to mention shareholders, actually believed any of this is another matter, given that automation stocks have fallen by an average of some 22% over the past 12 months.
Now any residual complacency has been rudely shattered with the release by Rockwell Automation in the last week of June of what it euphemistically called third-quarter guidance, but what in common parlance would be called a profit warning.
The company, said its press release, now expects to report third-quarter diluted earnings per share (EPS) of $0.93 - $1.00. What that meant, it explained, was that Given the expected third-quarter earnings, and what appear to be less favorable market conditions in the U.S. and Europe, the company no longer believes that full-year EPS will fall within the previous annual guidance range of $4.25 - $4.45.
Its worth going back and looking at what chairman and CEO Keith Nosbusch said just two months earlier when announcing the groups second quarter results: Looking forward, we expect continued strength in emerging economies, steady demand in the United States and improved performance in Europe. While we continue to acknowledge that there is significant uncertainty in the economic environment, particularly in the United States, we have not seen a fundamental change in customer demand for our products, services or solutions. It was that observation which led Nick Heymann, an analyst at Sterne Agee, to comment that these guys are flying magic carpets. Not any more, theyre not, Nick.
Revenue for the month of April was consistent with original expectations, the recent statement continued. However, for the past several weeks, the company has experienced slower than expected growth in the U.S. and Europe, primarily in its product businesses. The third-quarter organic growth rates in the U.S. and Europe are expected to be in the low single digits versus the year ago period.
Nor is that the end of its problems. In the third quarter, the company has seen continued strong revenue growth in its solutions and services businesses within the Control Products & Solutions segment. However, in the higher-margin Architecture & Software segment, the expected revenue growth has not occurred. Given that it is to precisely to that segment that Rockwell has been looking for future growth and improved margins, that cannot be regarded as anything other than a huge disappointment.
Steadying the ship
Nosbusch, however, saw it as his duty to steady the ship. I continue to have confidence in the long-term growth prospects for this business, he said. It appears that market growth is slowing in two key regions, and we will deal with that reality. We remain committed to delivering appropriate profitability while preserving our investments in future growth opportunities and maintaining our technology leadership.
Immediate market reaction was to mark Rockwells stock down sharply, making it even more attractive to a potential predator. The question for investors, analysts and, not least, those who work in the industry, however, is whether these problems are specific to Rockwell, or whether they signify a more general malaise. That certainly seems to be how investors see it. Indeed, despite the sudden drop precipitated by the guidance, the fall in the Rockwell stock price over the past 12 months at some 38% is not significantly out of line with competitors such as Schneider at 36%, Siemens at 34% or GE at 31%.
Problems at Siemens?
Siemens automation business is, arguably, closest in profile to Rockwells. A recent report in The New York Times (thanks to Gary Mintchell for pointing this one out) has an unnamed Siemens insider saying that the company is on the point of announcing no less than 17,000 job losses worldwide, which is expected to reduce overheads by as much as 1.2 billion as part of CEO Peter Löschers ongoing restructuring. The move follows the earlier announcement of first quarter profits down 67% on the same period in 2007 on revenues up just 1%.
Despite its process automation ambitions, it could be argued that Rockwell remains primarily a supplier of automation solutions to the discrete sector, as do Schneider, Siemens and GE Fanuc. So are things likely to be any better among mainstream process automation vendors? Here, the argument goes, ongoing investment in the oil and gas sector driven by the soaring oil price will mask any recessionary tendencies in the economy as a whole. Process automation vendors are therefore, so the argument goes, pretty much bulletproof.
If thats the case, one might expect their stock prices to have bucked the trend elsewhere in the automation sector, but in fact, the messages are mixed. True, Emerson and ABB are the only automation stocks which are actually worth more at the time of writing than they were 12 months ago, Emerson up some 5% on its value a year ago, and ABB up 23%, the latter perhaps reflecting its green power as much as its process automation credentials, and Honeywell is down by only 11%, or less than a third of the falls among the discrete vendors. On the other hand, Invensys stock, despite all the talk of recovery, was actually worth 33% less at the end of June than it was 12 months earlier, and Yokogawa stock is the biggest faller in the entire sector, down nearly 42% over the past 12 months.
So whats going on? Well, analysts and investors, while initially no doubt impressed by how various process automation CEOs have stressed the strength of their oil-and- gas-related business, may also have noted that not all vendors sell exclusively into oil and gas. Moreover, they may also have appreciated that, outside that particular sector, the process industries are huge net consumers of energy, and thus, if anything, more vulnerable to the impact of high energy costs than the economy as whole. And they may also have a sneaking suspicion that, like the British army in the past, the vendors themselves are making detailed preparations to fight the last war rather than the next one.
The effects of an oil price at $143 a barrel, as at the time of writing, cannot necessarily be determined simply by extrapolating from previous price hikes. Unleaded gasoline (what we call petrol) at 119 pence per liter―thats $8.97 a US gallon―and diesel at 133 pence a liter―$10.04 a US Gallon―the prices up the road this morning converted at todays exchange rate, are taking us into entirely uncharted territory and really are changing consumer habits. Witness the reduced traffic on our local commuter routes and the cheerful fellow who came to quote for installing a wood-burning stove who is booked until the end of August.
Less anecdotally but equally important, the oil products supply chain, at least in Europe, is very different from even a few years ago. Majors such as BP have been disaggregating; indeed BP―British Petroleum, in case youd forgotten―no longer actually owns a single refinery in Britain and has largely divested itself of its petrochemical interests as well. As a resul,t it no longer has to take into account the needs of downstream businesses in its investment plans. Their new owners, by contrast, are caught in a classic feedstock squeeze and cant necessarily be expected to come riding to the rescue of a hard-pressed automation sector.
The R Word
Are we in a recession and, if we are, will the automation industry prove to be immune to its worst effects? The jury among the pundits is still out but, while we await their verdict, we could do worse than adopt the same approach as we would to conflicting weather forecasts―look out of the window and form our own judgement.