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Rockwell Automation Remains Neutral

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On Jun 26, we maintained our Neutral recommendation on leading global provider of industrial automation power, control, and information solutions, Rockwell Automation Inc. (ROK - Free Report) . Our reiteration was on the basis of expected benefits from investment in Logix, recent acquisition of China-based medium voltage drives business, restructuring activities and a strong operating margin performance, offset by concerns regarding the uncertain global economic scenario, further deterioration in the Chinese economy and margin headwinds in the form of increased growth spending.

Why Reiterated?
Rockwell Automation reported EPS of $1.33 in the second quarter of fiscal 2013, up 11% year over year and ahead of the Zacks Consensus Estimate. Sales dipped 2% to $1.53 billion in the quarter, short of the Zacks Consensus Estimate.

Despite decline in revenues, margins were strong in the second quarter. Total segment operating margin was 18.7% as strong productivity, favorable mix and lower variable compensation expense offset the impact of lower sales. The productivity result was a combination of restructuring savings that the company has not yet redeployed due to sluggish market conditions. Management expects margin for the full year to be around 18.9%, up from its previous guidance of 18.7%, aided by restructuring benefits and strong operating performance momentum.

In a bid to expand its business in the Asia-Pacific region, Rockwell Automation acquired the medium voltage drives business of China-based Harbin Jiuzhou Electric. The ever-expanding customer base in the Asia-Pacific region has resulted in higher demand for efficient medium voltage drives. Given the higher demand for Rockwell’s medium voltage drives, the business is growing significantly.
Logix is the technology foundation that enabled Rockwell Automation to become an industry leader for batch process applications and attain a competitive edge over traditional Distributed Control Systems (DCS) providers for continuous process applications. Even though Logix sales were flat year over year in the second quarter, it is expected to rebound and grow in the mid single digits in the second half of fiscal 2013. Rockwell Automation has plans to invest in Logix and expand the served market.  
On the flipside, moderating global economic growth and uncertainty in the global economic scenario can lead to cautious capital spending, limiting Rockwell Automation’s near-term revenue visibility. Rockwell Automation’s performance in Asia Pacific (12% of sales) continued to be weak in the second quarter with organic sales dropping 16%, worse than first quarter’s decline of 9%. The company expects its China sales to decline slightly for the full year; a downward revision from the previous expectation of 5% annual growth.

Furthermore, Rockwell Automation needs to consistently develop advanced technologies for new products and product enhancements to withstand competition. Developing new products requires high levels of innovation, and the development process is often lengthy and costly. The company’s increased spending to support growth will continue to put pressure on margins in the near term.
Other Stocks to Consider
Rockwell Automation currently retains a Zacks Rank #3 (Hold). Other stocks in the industrial products sector with favorable Zacks ranks are Edwards Group Limited , with a Zacks Rank # 1 (Strong Buy) and Broadwind Energy, Inc. (BWEN - Free Report) and Plug Power Inc. (PLUG - Free Report) , both carrying a Zacks Rank #2 (Buy).

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