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4 automation firms headed into 'buy' territory

Glenn Freeman  |  27 May 2020Text size  Decrease  Increase  |  
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During an economic downturn, companies that produce capital goods — tangible assets sold to other businesses that produce goods or services such as office buildings, equipment and machinery — see a drop in demand for orders.

"If you're a company that's uncertain about your cash flow outlook, you're going to cut capital expenditure, and within that CapEx budget, it's going to be all those capital goods products," says Denise Molina, director of equity research for Morningstar Europe, Middle East and Africa.

Molina anticipates a sharp drop in earnings for capital goods companies in the second quarter of 2020, describing the current environment as one where "the tap has literally been turned off."

The shut down of plants means supply has been severely disrupted, with orders not getting through and in many cases not even produced.

With the caveat that earnings volatility will likely continue and share prices may decline further still, Molina says: "we see some really nice companies that haven't been cheap for a while potentially coming on sale."

"There's going to be probably some pretty dramatic earnings declines from these shutdowns and that's maybe not fully appreciated yet by the market, especially when the US starts to put out their numbers."

Share price history of moated automation stocks

automation

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ABB

Analyst Rating: 4-star | Economic Moat: Wide | Price-to-Fair Value: 0.92

ABB is a Swiss-Swedish multinational corporation headquartered in Zurich, Switzerland, operating in robotics, power, heavy electrical equipment and automation technology.

Morningstar's Molina views ABB as one of the best-placed companies to benefit from rising levels of industrial automation, which accounts for more than half of its revenue.

Molina recently reduced her fair value estimate slightly, to CHF21 from CHF25 in response to the short-term revenue impact from global measures to curb the spread of coronavirus.

"But long-term, we think the company has an excellent portfolio of products for industrial automation and a leading position in robotics," she says.

"Lessons from the pandemic could include seeing the benefits of industry 4.0 [the Internet of Things] software for remote plant management and the deployment of robotics to improve manufacturing capacity flexibility."

Molina expects a lower volume of sales and supply chain disruptions to weigh on margins this year – predicting 5 per cent revenue decline. But this should return to positive figures from 2021, when she predicts growth of 9 per cent.

The company's current share price of US$19.42 sees it trade 8 per cent below the latest fair value estimate.

Schneider Electric

Analyst Rating: 3-star | Economic Moat: Wide | Price-to-Fair Value: 0.96

Molina likes this French multinational for similar reasons. Schneider Electric provides electrical components, power distribution equipment and automation components to industrial and energy companies.

The company's first quarter 2020 revenue decline in Asia was "ugly" says Molina, who expects the second quarter to be worse still. But this was expected and is already priced-in to her fair value estimate.

Schneider's energy management and industrial automation divisions led the losses, which reported revenue declines of between 16 per cent and 20 per cent in Asia. But Morningstar expects growth to return in line with Schneider management's reports that activity in China has already picked up after the lifting of coronavirus-related restrictions.

"For the full year, we forecast a 5 per cent revenue and 9 per cent EBIT decline, including expected cost adjustments such as lower pay for lower hours," Molina says.

"Our EUR 90 fair value remains intact and is most influenced by our long-term assumptions for revenue, profitability and the pace of investment in the business."

Molina believes the company will recover most of its revenue declines over the next few years, noting that new orders typically take between six and eight quarters to bounce back.
"In addition, lessons learned from the COVID-19 experience are likely to speed up investments in automation and remote plant management software," she says.

Other structural shifts in the areas of climate change, electrification and growing rates of data collection also heavily favour Schneider.

Schneider's latest closing share price of EUR84.20 sees it trade 4 per cent below what Molina believes it is worth.

A few Japanese companies also rank among Morningstar's moat-rated companies within the automation space, and the following two are undervalued versus our analyst fair value estimates. But investors should be mindful the following names also have high Fair Value Uncertainty ratings, whereas ABB and Schneider are rated medium for this metric.

Fanuc (6954)

Analyst Rating: 3-star | Economic Moat: Wide | Price-to-Fair Value: 0.93

Japanese firm Fanuc is the world's largest computer numerical control and industrial robotics manufacturer. The company designs, manufactures, sells, and maintains factory automation-related products for automobile, electronic device and machine tool manufacturers.

Its Factory Automation division contributes around one-third of total sales and holds the largest market share of automated control software for machine tools. Within its dominant automotive and electronics segments, the firm supplies the likes of General Motors, Audi and Panasonic.

Robotics contributed around 40 per cent of the company's fiscal 2019 revenue.

"As factory automation continues to grow across a variety of industries, the company will be able to provide its robots to not just its current main customer base like the automotive and electronics industries, but will be able to further expand its customer base in other industries such as food and pharmaceuticals," says Morningstar equity analyst Jason Kondo.

Kondo says all three of Fanuc’s core products businesses will be hurt over the shorter-term by the global economic slowdown spurred by COVID-19. But he expects this will start to turn around from the second half of fiscal 2020.

Yaskawa Electric (6506)

Analyst Rating: 3-star | Economic Moat: Wide | Price-to-Fair Value: 0.98

A Japanese manufacturer of servos, motion controllers, AC motor drives, switches and industrial robots, Yaskawa ranks alongside Fanuc as another "big 4" robotics player.
Yaskawa's year-end results last month saw Morningstar reduce its fair value estimate to JPY4,000 from JPY4,400. This was in response to a weaker medium-term outlook for the company's motion control and robotics divisions.

But Kondo continues to regard the company as undervalued. He expects the sharpest decline of 15 per cent within the robotics business, largely because around half its customers are within the automotive industry – many of which have been hit by shutdowns during the pandemic.

On the other hand, Yaskawa's AC servo motors business should hold up better due to its more diversified customer base. Around 35 per cent of this division's revenue comes from semiconductors, electrical components, and liquid crystal-related markets.

Kondo expects most of the growth in the motion control segment that is crucial to this segment to come in the second half of this year, which he expects to be up about 6 per cent year-on-year.

But this follows an estimated decline of around 40 per cent year-on-year for March 2020: "the highest decline since October 2009, during the previous recession," says Kondo.

Yaskawa is currently trading at JPY4,000, slightly above Morningstar's fair value estimate of JPY3,630.

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is senior editor for Morningstar Australia

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