Why This Red-Hot Industry Will Outlast Any Recession

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If you buy stocks in a slowdown, it’s a good idea to ensure they will have good growth prospects coming out of recession. In that context, it’s a great idea to look at the industrial automation and software companies that power industrial automation. They represent a growth industry whose best days are yet to come. 

Industrial automation, industrial software, and Industry 4.0 

To understand the full benefit of automation, it’s essential to be aware of “Industry 4.0,” also known as the “fourth industrial revolution.” Simply put, it refers to the confluence of the digital and physical worlds. One example comes from creating a so-called “digital twin” of a physical asset. Say a gas turbine or a bottling plant is digitally twinned. The Internet-of-Things technology generates a mass of data from the physical asset, which is then analyzed digitally and modeled using the twin. In this way, artificial intelligence can better model, guide, and predict the behavior of the physical asset. For example, data from the bottling plant line could be digitally modeled and simulated to predict better when the equipment needed servicing — doing so would reduce costly downtime and improve productivity.

The benefits of automation

It’s always tricky to succinctly articulate these concepts. Hence, I thought it would be interesting to refer to what the management of one leading industrial company, Stanley Black & Decker (SWK -4.37%), said recently about its Industry 4.0 opportunity. The tools and hardware company is trying to reduce its manufacturing and supply chain costs, and using automation is one way it can do this.

Speaking at a conference recently, CEO Don Allan said, “If you did a power tool assembly in China or Mexico, you might have 50 to 75 people on the line,” whereas the automated solution the company is running in North Carolina has 10-12 people operating it. He noted that an updated version of the automated plant could get that figure down to 2-3. While the cost of doing the latter “is almost equivalent to the cost” of doing the line in China or Mexico, the benefit is Stanley can run an automated line “24/7,” as Allan puts it. 

In addition to the productivity benefits at a plant level, the ability to create cost-effective facilities enables companies to reduce the complexity of their supply chains and reshore production. That’s a massive plus for a company like Stanley, which alongside much of the industrial sector, suffered from significant supply chain issues in 2022. Unfortunately, the pandemic and its associated lockdowns created tremendous stress on supply chains and shortages of products like semiconductors and other components. Automating and digitizing production helps to improve supply chain efficiency and should allow companies to better manage inventory and the supply of critical components. It also gives greater flexibility in locating a production plant so that management can reduce the complexity of its global supply chain.  As such, it’s a pretty safe bet that companies will continue to look at investing in Industry 4.0 solutions through any recession. 

How to invest in the sector 

A few ways to invest in this trend include automation company Rockwell Automation (ROK -3.31%) or its industrial software partner PTC (PTC -1.78%). One of the most prominent players in automation, Rockwell manufactures control products, sensors, controllers, and systems and sells across all three major end markets for automation. Namely, discrete automation (semiconductor manufacturing, automotive production, etc.), process automation (continuous processing of raw materials such as oil & gas and chemicals), and hybrid automation (food & beverage, life sciences, etc.).

Although management has had to lower its full-year organic sales growth this year (from 10%-14% to 10%-12%) on the back of supply chain volatility (a familiar refrain this year), it’s still set for double-digit growth.

The company is highly profitable and traditionally is a good cash generator, generating high mid-teens margins. However, despite the stock’s decline this year (nearly 38%, as I write), the stock still doesn’t look like a raging buy. Based on its ratio of enterprise value (market cap plus net debt) to earnings before interest, taxation, depreciation, and amortization (EBITDA), it’s hard to make a case for the stock being a great value. 

ROK EV to EBITDA data by YCharts

Rockwell has a strategic alliance with PTC and has also invested heavily in the company, and the latter does look like a good value. The company has upgraded its growth expectations for 2022 and is achieving impressive growth in its core computer-aided design and product lifecycle management (PLM) software solutions. Meanwhile, its growth products (Internet of Things, or IoT and augmented reality, or AR; Industry 4.0 specific solutions) are set for long-term growth. PTC’s IoT solutions connect the physical world to the digital world, while its AR solutions help visually represent data in the physical world — think of service engineer looking at a complex network through a tablet running a digital overlay of the network in front of him. Based on its excellent long-term growth prospects and Wall Street analyst projections of $700 million in free cash flow in 2024 (putting it on less than 18 times 2024 free cash flow), PTC is a good value for a high-growth stock.

There’s no denying Rockwell and PTC will come under pressure if the economy turns down and near-term orders dry up. But on the other hand, the productivity gains from implementing Industry 4.0 solutions (as seen with the Stanley Black & Decker example above) will ensure that they emerge strongly out of any recession and beyond. As such, a stock like PTC is very attractive to buy on a dip.

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