Stocks to plug into the rise of automation

While automation is integral to what the World Economic Forum refers to as the Fourth Industrial Revolution, it's still in its infancy and represents an untapped investment opportunity. Investors may want to take a close look at select companies that are well positioned to profit from the rise of automation.

A sprawling conglomerate,  Honeywell (HON) operates through four business segments -- Aerospace, Home and Building Technologies, Performance Materials and Technologies, and Safety and Productivity Solutions. A leading name in process and warehouse automation, the company is increasingly transforming itself into a software-industrial company serving diverse markets that include the U.S. defense, e-commerce and oil & gas industries.

In a bid to bulk up its warehouse automation business, Honeywell acquired top robotics company Intelligrated and, more recently, scooped up German warehouse automation firm Transnorm. "We are bullish on some of its recent acquisitions, which we believe will help propel the firm's productivity solutions business toward a 9% CAGR over the next five years," says a Morningstar report, noting that "only about 5% of warehouses are automated in the United States" and that as the market increasingly consolidates, "Honeywell will remain on top."

Warehouse automation is one of the last frontiers where companies can significantly reduce their long-term manufacturing costs, the report says.

Honeywell's wide moat, or sustainable competitive advantage, stems from its ability to leverage its software technology across its massive industrial installed base. "This software technology is integrated into both mission-critical operations, as in cockpit control during commercial aircraft flights, and in customer operations, through diverse offerings like warehouse automation in factories or connected solutions in buildings," says Morningstar equity analyst, Joshua Aguilar, who recently raised the stock's fair value from US$156 to US$168, prompted by "more optimistic organic growth assumptions."

The automation giant also boasts strong competitive edge in its Performance Materials and Technologies (PMT) segment with a significant exposure (nearly 50% of revenue) to the oil and gas industry, where switching costs enable it "turn a profit even during large drops in the price of oil," says Aguilar.

German industrial giant  Siemens (SIEGY) has global leadership position in electrification, automation and digitization. The firm operates in eight sectors: power and gas (18% of 2017 sales); wind power and renewables (9%), energy management (15%), building technologies (8%), mobility (10%), digital factory (13%), process industries and drives (11%) and Siemens Healthineers (16%).

Siemens, which has diverse businesses serving multiple end markets, is currently rejigging its portfolio with greater focus on achieving growth in electrification, automation and digitisation, says a Morningstar report.

Although the company has been assigned a narrow moat rating, built on switching costs, intangible assets and technology leadership, it enjoys strong competitive positions in some of its individual segments, including industry automation, which "should result in returns on invested capital exceeding costs," the report notes.

The digital factory division, which generated 13% of sales and 23% of EBIT in 2017, has carved a wide moat and benefits from very high switching costs. "By helping industrial companies automate factory floors, Siemens provides cost savings to customers and develops sticky relationships through maintenance support services," says Morningstar equity analyst Jeffrey Vonk. The automation products, he adds, are well embedded in the production process, which makes "companies elect to stay with the incumbent product for several years."

The company also enjoys a position of strength in the renewables and oil & gas markets. "The firm has strengthened its oil and gas portfolio through several acquisitions and mergers," says Vonk, whose US$77.50 fair value estimate for the stock incorporates 2.5% annual earnings growth, spurred by strong activity in wind power, digital factory, building technologies and mobility.

A pure-play automation name,  Rockwell (ROK) provides industrial automation and information solutions through two segments: Architecture & Software and Control Products & Solutions. The former division houses its Logix architecture that runs with third-party applications and contains all its hardware, software and communication components, whereas the latter segment sells industrial control products and offers technical automation services.

"Rockwell is one of a few industrial players and one of the only remaining pure-play automation competitors focusing on creating a single, common software platform that combines a customer's traditional manufacturing plant floor operations with its information technology functions," says a Morningstar report.

By integrating plant assets with the rest of the enterprise value chain, customers can reduce their time to market, cut cost of ownership and manage risks. "While the firm does not build robots, it helps customers achieve these objectives by marrying differentiated technology, including routers, switches and sensors, with deep technical know-how to remotely monitor assembly lines, reduce energy costs, forecast outages and strive toward continuous production," says Aguilar.

The wide-moat company is also seeking to gain a stronger foothold in hybrid manufacturing and is attempting to marry traditional operating plant assets with software data analytics. Rockwell is achieving that with its signature platform Logix, which can "perform multiple automation applications, like discrete manufacturing (e.g. automotive), process manufacturing (e.g. chemicals), and hybrid manufacturing (e.g. pharmaceuticals) on a single platform," notes Aguilar, who recently raised the stock's fair value estimate to US$160 from US$154, prompted by a more sanguine outlook for the firm's earning power. "Ultimately, we believe the value offered by its solutions should allow the firm to remain a top player in the growing automation industry."