Rockwell Automation, Inc. (ROK) Earnings Call Transcript & Summary

Good morning and welcome to day 2 of Morgan Stanley's Laguna Conference. I'm Josh Pokrzywinski, the firm's U.S. electrical equipment and multi-industry analyst. Joining me now for our next session is Blake Moret, Chairman and CEO of Rockwell. Before we get started, and I'll hand it over to Blake for some opening remarks, I do need to read a quick disclaimer. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please visit our research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. With that, Blake, welcome. Always a pleasure. Thanks for making the time here for us.

Josh, great to be here, and good morning, everyone. As Josh said, I am going to make a few introductory remarks and then go right into Q&A. If you would go to Slide 3 on the deck then, just a brief overview of Rockwell Automation. I'll start by saying that all of our operations are up and running, and we continue to prioritize the health and safety of our employees. And all of those employees are focused on increasing the productivity and sustainability, and I should add, the agility of industrial companies and their people. We're a pure play, and that's what we're focused on. I should also mention that you probably saw that we made some structural changes to the organization that will go into effect on October 1. We're going to be -- going to market with 3 segments going forward. We think that it simplifies the way that we streamline internal operations as well as, for you, make it easy to understand what happens in each of those segments. So with Intelligent Devices, which is still the majority of our business, that group is focused on increasing share in our core products. Lifecycle Services complements the technology, the services and the engineering to make sure that customers are getting the positive business outcomes that they're making their investment in automation in, in the first place, and it also increases recurring revenue by increasing the attachment of those services to the projects that we sell. And then finally, Software & Control is going to elevate the importance of software in the organization. We know that software increasingly is differentiation for the core automation and allows a whole new level of productivity by simplifying the integration effort, the ability to design and operate and maintain those automation solutions. One of the other things, and you can turn to the next slide, Slide 4, is about the resilience that we have in our own operations as well as, as we're helping customers. I'm very optimistic about Rockwell's position and ability to be resilient ourselves and as well as to help customers as they're increasing their resilience. And resilience can take a lot of forms based on what particular industry a customer is in. Certainly reshoring is a part of that, and we've seen some very tangible examples of that in industries such as life science biz, and there have been a few public announcements regarding semiconductor as well, but it's also about decreasing single-point failure or potential failure in the supply chain and in a customer's own manufacturing footprint. It's about remote operations. It's about the agility to be able to manage changes in SKUs to meet customer demand. It's about simulating new pieces of equipment and being able to commission them using those simulation tools, augmented reality, so that you don't have to bring people across distance to physically congregate to get a machine up and running. And we're seeing some great examples of that as we help customers through factory acceptance tests and things like that. So I think our organic efforts are focused on helping increases productivity in this resilience. But if you turn to the next slide, you can also see an increase in inorganic activity. We're using all of our strengths, creating more ways to win, and I'm very happy with the way that we've adhered to a consistent strategic framework for what acquisitions we're looking for. And early indications are that these acquisitions are having a material effect on us being able to play a larger role in our customers' digital transformation. So with that, I'll turn it to you, Josh.

Appreciate the opening remarks there, Blake. And there are few points you touched on that I want to come back to. Maybe just to start off with what you're seeing in the macro landscape, I think you're seeing a lot of industrial companies get up and running then. So if there's something that's a cost of doing business versus discretionary that's coming online, consistent with utilization levels or kind of other production levels. Are you seeing your customers kind of get back into it as we push here into the latter part of the year and their own production levels have increased? Or is it still kind of a capital decision where hey, we got a lot of excess capacity and we don't want to spend money because the economy is still fragile.

I think you have to look at the individual verticals. And so we certainly saw a couple of months ago where the automotives were shut down, right? There was not MRO being spent. There wasn't capital being spent in new capacity. Projects have not been canceled, but they had been pushed back because units weren't running off the line. Then you saw it back in May and June, those facilities were coming back online. We've seen some anecdotal information here over the last couple of weeks, some of those brand owners have talked about maybe a little bit sharper recovery. China, a little sharper recovery than expected. If you're life sciences, particularly if you're producing therapeutics that are combating the effects of the coronavirus or your trying to ready vaccine candidates for market, you're pretty busy, and you're bringing on new production, either your own or with partners, so they've been running full out. And in fact, what we have seen in life sciences and food and beverage is that they're so busy, it's about maximizing existing production, in a lot of cases. You're talking about digital transformation plans at a higher level than maybe we've ever seen, but they have, in turn, loosed that capital for things other than just making sure that they can produce what's in such high demand now.

And then I guess as much as general industrial looks nice on the pie chart, and most of the investment community thinks of that as a space, it doesn't really exist, right? So in more of the, I'll call it, diverse industrial end markets, are those folks getting back to work or is it still in kind of the pockets where sharper decline, sharper recovery or just kind of outside factors?

Well, I think, again, as you said, these industries, if you're in it, they don't think of themselves as general, right? They have a very secretive area, and so if you're Stanley Black & Decker, for instance, you're in the tools business, and there is a specific characteristic of it. For some of those that are and above a certain level of our overall businesses, we put them into that basket. But they are seeing a demand, in that particular case. Do-it-yourself has really increased. And so demand is quite high as people are at home and looking for things to fix up there. So we're happy to participate in that case. And then there are certain other examples of that as well.

And then I guess you touched on it in the opening comments, and then I think we'd be remiss to ignore the Stanley Black & Decker comment without bringing up nearshoring. Clearly, a big focus for them, and I think kind of a banner customer in that regard. We are starting to enter the 2021 planning cycle, so folks who are going to pull the trigger next year need to at least start spilling some ink over the phenomenon. Are those conversations happening? Is this more of a 2022 story in your mind? How has that unfolded?

Again, it varies by industry. Let me start by saying all of our customers are talking about how they increase their resilience and how they make sure that they're as close as possible to their customers. So I'm hearing it from my peers, our operations leader is hearing it from all of his peers, so that resilience theme, across the board, across industries, people are looking at how they do that. Specifically about reshoring. I think you're hearing most of the conversation in customers who have discrete and hybrid applications. So you probably don't hear that as much in process because you need to be close to the commodity. You need to be close to the crude or the bitumen or the iron ore or the copper deposits, so in the possible -- with the possible exception of rare earth, that [indiscernible] people are looking to diversify away from having the supply come exclusively from China. Most of the reshoring activity is really about discrete and hybrid applications. Life sciences, we've certainly seen that as people realize how little of some of those medicines were actually being produced here and how reliant we were in some other parts of the world than we've definitely seen investment in the U.S. Protective equipment, masks, we've certainly seen that, and 3M is another that's publicly talked about some of their investments, and we're proud to be a part of that. It will remain to be seen in certain other industries how much of that happens. Semiconductor is another one that's made some specific announcements, but in that particular industry, it's not just the tooling provider. It's the whole ecosystem really that has to move, in certain cases, when a company is making a decision to try to create another manufacture sector. They have other manufacturing partners that have to be prepared to move as well.

Right. And I guess in terms of where you're seeing some of that investment maybe categorically. We did a bunch of work on this, I think, back in the May, June time frame, and it seemed like components were a big area of opportunity. We moved a lot of that stuff outside the U.S. and have now discovered that supply chain got too long or maybe we can harmonize that landed cost when all is said and done. Is that, in your mind, kind of the biggest area of opportunity? Is that it's not necessarily the big splashy stuff, but some little widget that people generally forget about, but realize, oh my gosh, I get 80% of this from some place on the other side of the world?

Well, I think that's an attractive category. And I will tell you, I'm not sure you've seen it yet, but we started up a line in Milwaukee making our motor contactors, and it's highly automated. But it's a good way to demonstrate how even in the high labor cost location, we can make a competitively-priced product. It's not one of our more complex products. But you also see, I think, some opportunities for reshoring based on bringing production of products that represent a large part of a customer's IP that they want to have in a location that they recognize that local governments will respect that IP, and I think that's another reason that you might bring a product back that may not necessarily be very simple or basic, but represents some really important IP. Again, Rockwell is looking at making sure that we're decreasing the number of high-value products that are only made in 1 location. We make a certain product, for instance, in Singapore, that we're going to make sure that we can make in Twinsburg, Ohio as well to be able to move as needed if a part of the world goes off line for some previously unforeseen reason to be able to balance supply. I want to reduce those single points of failure, either in our own manufacturing footprint or in the part of our suppliers. And to your point, those components may very well be that link that we have to pay attention to.

Understood. So I'll take a little bit of an indirect jump. You mentioned governmental considerations in respect for IP. But maybe taking the other side of governmental. U.S. elections coming up. Are you seeing any reluctance from customers to kind of make a bet not having perfect clarity into the outcome? I think some industries saw a version of this in 2016, not for a prolonged period of time, but has that been a source of discussion with your customers?

I really have not seen that. I have not seen people who would delay CapEx expenditures or addressing maintenance issues or what have you because they're just going to wait for the election. I think particularly in the U.S., it's comforting to see that both candidates have prioritized U.S. manufacturing. And quite simply, Rockwell, as the market share leader in the U.S., it's our home market, has the most benefit from those increases in domestic manufacturing.

Got it. And then I guess just digging into 2 end markets specifically that I think come up a lot for Rockwell. First, right or wrong, I would guess, is automotive. Clearly, with what's happening with Tesla, it would imply that capital was nearly free in the electric vehicle community and maybe not as much in the combustion market. I know that there's some rich content opportunities. You guys don't do much in powertrain for combustion. But how does that phenomenon impact you with new entrants into the marketplace, maybe the legacy folks being a little less reluctant where your installed base is biggest? Maybe just kind of walk through what's a pretty dynamic environment these days.

Right. It's exciting. I mean, we're tracking dozens of companies, brand owners or prospective brand owners who are bringing vehicles to market. Certainly, all of the traditional customers are either partnering or rolling out their own plants, but then you have all these other smaller companies as well. As you said, our readiness to serve an electric vehicle manufacturer is very high because there's all the traditional strengths that we have for body and assembly and stamping and painting, final assembly and so on. But then in the drivetrain, the battery assembly is a great application for us, one that we're even better positioned to address with our Independent Cart Technology, which a lot of our competitors don't have. And when we look at that compared to power transmission, boring out engine cylinders and finishing metal services, that requires a lot of CNC that we were growing in that area with partnerships with FANUC and others, but we didn't have the direct readiness to serve that we do for electric vehicles. So I'm happy to see those trends, I think they will continue. Our win rate is higher there than it even has been traditionally. And as you know, automotive is a strong general vertical for us. But from a long time Rockwell watcher, it's interesting to know that this year, we expect automotive to be actually a little less than 10% of our total business, and that's a surprise. It was certainly much, much higher when I got into this business years ago.

Right. And then I guess on the -- maybe another big end market that gets a lot of discussion, although maybe not as much these days is on the oil and gas side. You have the Sensia partnership or Sensia JV in place. Clearly, as much as we've seen some inflation in some other commodity groups, oil, not as much. I think, historically, you've characterized this well. These are productivity tools, so where is your breakeven cost? Is that still the way customers are thinking about it today or have they just been starved for long enough where they're saying, "Look, like, I'm turning out my pockets. I've got nothing to give you."

No. It's -- make no mistake, oil and gas is a tough business to be in right now. But as you said, I like our positioning. It's focused on OpEx, focused on safety and those are things that, if these operators are going to stay in business, they have to reduce the breakeven point to produce a barrel of oil from an existing well. They have to address safety, and so we are not as tied to drilling new holes in the ground, and that's a good place to be at this point. So the world is still consuming somewhere in the neighborhood of 90 million barrels of oil a day, and that's still a lot of opportunity to increase efficiency, and that's exactly where Sensia is focused.