Industrial software company PTC(NASDAQ: PTC) and Rockwell Automation(NYSE: ROK) are strategic partners and share many of the same end-market drivers. When the industrials sector wants to invest in automation and the digital technology that drives it, both companies benefit, and when it pulls back, both companies suffer. Yet right now, PTC is a stock worth buying, while Rockwell is one to be avoided. Let's delve deeper and see why that's the case.
Two complimentary businesses
Rockwell Automation offers industrial automation, the software and controls that drive it, and consulting and services to help implement it. It's a complementary technology to the digital software solutions offered by PTC.
The latter's solutions help customers digitally design, control, and monitor a product's life cycle, from its inception to its servicing and disposal, within a so-called "digital loop."
As such, similar factors drive their end markets, and Rockwell formerly had equity investment in PTC.
However, there are two crucial differences between the companies right now.
PTC is doing a better job of providing investors with guidance, and it's on track to meet its initial 2024 forecast, while Rockwell Automation is not. However, both companies are facing challenging conditions in 2024. CEO Neil Barua of PTC described the sales environment as "tough going for at least six quarters now here at PTC" on an earnings call in May.
Meanwhile, Rockwell's management acknowledges that its customers had more excess inventory than it (Rockwell) had previously expected.
Image source: Getty Images.
The difference is that PTC started the year forecasting that its crucial metric -- full-year annual run rate (ARR) of subscription, cloud, and support revenue -- would be $2.22 billion at the midpoint of its guidance range, and it remained that way on the earnings presentation in May. Moreover, PTC's strong performance in its second quarter gives confidence that it will hit its targets.
The same can't be said for Rockwell Automation. The cracks began to show last year when the company lowered its full-year 2023 orders and backlog estimate in August and then missed the numbers in the full year, ending in October 2023.
Orders and backlog for FY 2023 | April 2023 estimate | August 2023 estimate | Actual FY 2023 |
|---|---|---|---|
Orders | $9 billion | $8.5 billion to $9 billion | $8.2 billion |
Backlog | $5 billion | $4.5 billion to $5 billion | $4.1 billion |
Data source: Rockwell Automation.
It gets worse. In May, the deterioration in its end markets forced the company to cut its full-year 2024 sales and earnings guidance, and chief financial officer Nick Gangestad announced he would retire. He oversaw a string of disappointing earnings announcements during his previous stint in that role at 3M.
Full-Year 2024 Guidance | In November | In January | In May |
|---|---|---|---|
Reported sales growth | 0.5% to 6.5% | 0.5% to 6.5% | (4%) to (6%) |
Organic sales growth | (2%) to 4% | (2%) to 4% | (6%) to (8%) |
Adjusted EPS | $12-$13.50 | $12-$13.50 | $10-$11 |
Data source: Rockwell Automation.
A more resilient business model
Another reason to favor PTC is its more resilient business model. For example, it's harder for Rockwell to cut costs in a downturn, meaning that its profit margin will dip when sales start to slope. And Rockwell tends to convert sales into free cash flow (FCF) at a mid-teens rate -- a good rate.
That's fine. However, PTC's focus on growing recurring revenue means Wall Street expects 30%-plus FCF margins in the coming years, a figure that reflects its asset-light business model.
In addition, as Barua noted on the last earnings call, "We have a disciplined process to manage our internal spending based on the level of ARR growth we are seeing." In other words, if PTC's key growth metric, ARR, starts to slow, the company has the financial flexibility to cut its spending to ensure it hits its targets for free cash flow.
As such, a slowdown would put the company's FCF targets less at risk than Rockwell's.
Image source: Getty Images.
PTC or Rockwell?
The greater financial flexibility and guidance track record make PTC a stock to buy. At the same time, Rockwell must steady the ship with a quarter or two of good execution and guidance maintenance before investors fall back in love with the stock.
Rockwell's position on guidance wasn't easy. After all, its dealers rushed to load up on inventory in 2022 when the supply chain crisis led to extended equipment lead times, meaning that dealers pulled forward orders to ensure they had enough inventory to meet demand. Moving into 2023, lead times normalized, and end demand slowed, and so did Rockwell's orders. Unfortunately, Rockwell's management has been far too optimistic on the timing of an order recovery. As such, it makes sense for investors to wait until a clear recovery is in place before buying in.
Overall, both companies are in excellent long-term growth markets, but one definitely needs to improve its investor guidance and demonstrate that its orders are on an upward trend again. Rockwell's management expects its order growth to turn positive in its upcoming third quarter -- something to look out for.
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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends 3M and PTC. The Motley Fool has a disclosure policy.
