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Emerson Electric: Fair Price for 2013
Posted by: Dividend Monk (IP Logged)
Date: February 21, 2013 04:57AM
Emerson Electric Company (EMR) is a broad industrial technology company that is involved with a number of different industries worldwide. -Seven Year Revenue Growth Rate: 5%
-Seven Year EPS Growth Rate: 6.7%
-Seven Year Dividend Growth Rate: 10%
-Current Dividend Yield: 2.84%
-Balance Sheet Strength: Strong
At the current time, I view the stock as fairly valued but not with any margin of safety. Writing puts to enter the position at a lower cost basis may be lucrative, however.
OverviewEmerson Electric Company (NYSE: EMR) is a Fortune 500 industrial technology company based in Missouri. The company was founded over 120 years ago and provides a very large array of technology products and services. The company draws 45% of its revenue from the United States, 24% from Asia, 20% from Europe, and 11% from other places of the world. With over 130,000 employees, Emerson’s technologies are powering the world’s data centers, telecommunications equipment, and facilities.
Business SegmentsEmerson Electric Co. currently consists of five business segments:
Emerson’s largest business segment, Process Management, accounts for 31% of revenue. The Process Management segment provides control systems, monitoring systems, asset optimization, components, and services. Only 39% of the revenue from this segment comes from the United States, with the rest being spread out rather equally from Europe, Asia, and the rest of the world. Compared to 2011, sales and earnings for 2012 were up 13% and 14%, respectively.
Emerson’s Network Power segment accounts for 25% of revenue. In this segment, Emerson provides power products and solutions for data centers and telecommunications networks. This includes AC power systems, DC power systems, cooling systems, embedded computing and power, uninterrupted backup systems, and service (including 24-hour service). Only about 38% of the revenue from this particular segment comes from North America. Compared to 2011, sales and earnings were down 6% and 17% respectively, in 2012.
Emerson’s Industrial Automation segment accounts for 21% of revenue. They provide a variety of automation products for companies, including industrial equipment, power systems, motors and drives, mechanical power transmission, and fluid automation. Revenue from this particular segment comes strongly from Europe and North America, though Asia and other areas provide revenue as well. Compared to 2011, sales and earnings were down 2% and up 5%, respectively, in 2012.
Emerson’s Climate Technologies segment accounts for 15% of revenue. Emerson provides compressors, temperature controls and electronics, and sensors, as well as a variety of other products and services, to provide homeowners and businesses with the tools needed for heating, air conditioning, refrigeration, and overall climate control. Slightly over half of the revenue from this particular segment comes from North America, while the rest is spread out fairly equally around several other parts of the world. The segment is rather concentrated in compressors, as they account for three quarters of this segment’s total sales. Compared to 2011, sales and earnings for 2012 were both down 6%.
Commercial and Residential Solutions
Emerson’s Commercial and Residential Solutions segment accounts for 8% of revenue. They produce a variety of products in this segment, ranging from commercial motors to waste disposals to storage solutions to pipe-working tools. Over 80% of the revenue from this particular segment comes from within North America. Compared to 2011, sales and earnings were up 2% and 6% in 2012.
RatiosPrice to Earnings: 21
Price to Free Cash Flow: 16
Price to Book: 4
Return on Equity: 20%
(Chart Source: DividendMonk.com)
Revenue grew at a rate of approximately 5% per year on average over this period. As can be seen by the chart, the revenue pattern is that growth was followed by a retraction during the recession with a fairly robust rebound.
Earnings and Dividends
(Chart Source: DividendMonk.com)
The EPS growth rate was 6.7% per year on average over this period, but the chart is a bit misleading and looks worse than the reality. In 2012, Emerson had a $0.72 per share goodwill impairment, which means they took a significant accounting loss this year from historical acquisitions. Specifically, they cited slow growth from telecommunications and IT industries resulting in slower than expected growth from their computing and power segment. The overall numbers for the year are solid though, and the goodwill reduction is a non-cash accounting event. With the goodwill impairment factored out, 2012 EPS was $3.39, which was higher than 2011 and a company record. This impairment-adjusted 2012 EPS figure is far more meaningful for assessing current performance than the officially reported figure.
Emerson’s estimated 2013 EPS is $3.53-$3.63.
As far as I’m aware, the company has the fifth longest dividend growth streak in the world, at 56 years. Dwight Eisenhower was the president of the United States when Emerson began this pattern of consecutive annual dividend increases. Due to the 2013 bull market, the dividend yield has dropped below 3% to 2.84%, and the payout ratio is moderate at under 60% of earnings and under 50% of impairment-adjusted earnings. The growth rate for the dividend over the last seven years is approximately 10%.
Approximate historical dividend yield at beginning of each year:
How Does Emerson Electric Spend Its Cash?
Emerson brought in a bit over $7.7 billion in free cash flow during the fiscal years of 2010, 2011, and 2012. During the same period, the company spent $3.2 billion on dividends, $1.8 billion on share buybacks, and $2.2 billion on acquisitions. This is a fairly balanced use of cash in my view, with a nod towards both dividend yield and dividend growth.
Balance SheetTotal debt/equity is around 0.5. Total debt/income is well under 3x. The interest coverage ratio is over 15. These are all very sturdy metrics; Emerson Electric has a strong balance sheet.
Approximately $8 billion of the assets consist of goodwill, which is nearly 80% of existing shareholder equity. Their goodwill impairment is a useful example of why I usually check the amount of goodwill in relation to equity and report it; there’s no hard number for what represents a decent figure (and it largely depends on what portion of company growth comes from acquisitions), but it’s a useful number to know because the accounting assets of goodwill are not as dependable as real assets.
Investment ThesisEmerson Electric Company produces technology and services that stretch across numerous industries and are highly necessary. Process Management and Automation control systems allow manufacturers and energy producers to do what they do, and Network Power allows data centers and telecommunications networks to do what they do. Much fundamental backbone business infrastructure relies on Emerson. As the world continues to develop and modernize, Emerson has an ocean of opportunities to grow as long as it can continue to be competitive.
Emerson is an engineering company that doesn’t require a huge amount of technical expertise to invest in. Although sometimes technically complex, the products are straightforward, easily understood in principle, not flashy, and they have long product life times. They sit in the back room and keep the business running. Emerson also has a role to play in clean energy, providing products and services to control and optimize various forms of energy production.
Even in the deepest part of the recession, although EMR was very much affected, the cyclical company continued to produce a profit. Their stable financial condition, necessary products, and geographical spread around the world allowed them to weather the storm. In fact, Emerson spent $2 billion for acquisitions during 2010 to take advantage of the difficult environment. Specifically, the largest acquisitions were Avocent, which provides a host of technologies for data centers, and Chloride, which provides uninterruptible power supplies.
It’s not too hard to argue that being a leading player in the data center industry is going to be a good long term growth area for Emerson. In addition to continued growth in emerging markets, data centers play a key role in the shift of computing hardware from the client side to the server side with what is termed “cloud computing”. Various online media sources and business tools all need to run in data centers, and data centers need to be supported by multiple redundant systems and continually improved cooling technology. Emerson provides a broad set of products and services that support data centers, and recent acquisitions should strengthen its already strong position.
The fact that Emerson serves telecommunications carriers with similar technology is a bonus in my book as well, even though 2012 figures were disappointing. Data consumption isn’t going down any time soon.
The process management and industrial automation segments are in industries that, globally speaking, have nowhere to go but up, in my view. Improved technologies allow Emerson to put wireless automation and measurement systems in extremely hot metal production areas, in arctic oil production areas, and in Middle Eastern deserts. As another example, in February 2012 Emerson won a contract to install a control system with 7,500 I/O points into one of the largest waste-to-energy facilities in China. That’s a good trend to be involved in. Automation technologies from Emerson also play a role in wind turbines and solar installations, which are well-known growth areas.
Combining these necessary products and services with a company culture that has produced over a half-century of consecutive dividend increases, I expect Emerson to continue to do well for years to come. Their balance sheet and cash flow are fairly strong, and the company exists within growing industries and operates around the world. I specifically like the largest business segments of Emerson Electric (Process Management, Network Power, and Industrial Automation), and I believe this gives them a very strong position for good total shareholder returns.
RisksEmerson has a bit of a moat due to the scale and complexity of their services, but they still face considerable competition from companies of a similar size.
Emerson sells primarily to other businesses, so slowdowns in those industries can lead to a slowdown for Emerson. Their computer and power goodwill impairment which was caused by slower than expected growth due to slowdowns in the IT and telecommunications industries is an example of this.
As an engineering company and as a business that sells mostly to other businesses, the financials can be a bit volatile during recessions and the stock can be volatile for a blue chip in general. This should be viewed positively by long-term investors because the stock generally provides ample opportunities to buy at fairly cheap prices.
Occasionally, I use Glassdoor.com to review investments. From an outside investor’s perspective, it can be difficult to get a grasp of a company’s culture, which does play an important long-term role in performance. Glassdoor includes a large number of reviews from employees, and while each one should be taken with a grain of salt, it is interesting to look for trends in the reviews.
The company has an employee review ranking that is a bit on the lower side for a large company, at around 3 stars out of 5. One of the trends cited in the reviews are that the company lacks good work/life balance and is prone to outsourcing. The other common trend cited was a lack of diversity- a low ratio of women to men, low management turnover, a bit of an old-school corporate culture, conservative towards new ideas or inflexible, etc. At least according to the employee reviews. This is likely related to their low score in the ‘Corporate Equality Index’, which is a measure of how LGBT-friendly a company is by the Human Rights Campaign.
All else being equal, this sort of review can shed a bit of light on company culture and the company’s ability to hire top talent (especially from the younger generations) going forward.
Conclusion and ValuationEmerson has proven through the decades to be a stable dividend growth business. Last year in the report, I stated that Emerson looked fair at $50. The stock remained fairly flat for the year and jumped up to the high $50′s in early 2013.
Working backwards with the Dividend Discount Model, we can see what long-term dividend growth rate is needed to justify the current price of a bit under $58. Based on $1.62 in dividends paid during the past 12 months, a 7% long term dividend growth rate and a 10% discount rate result in a fair value of a bit under $58. In comparison, the company’s dividend growth rate over the past 56 years has been 11% on average, over the past 7 years has been 10% on average, and over the past 3 years has been a bit under 7% on average.
Therefore, I view Emerson as roughly fairly valued, but not with an attractive margin of safety after this early 2013 bull market. This calculated fair value (and the current price) is at an earnings multiple of a bit under 21, but at a goodwill impairment-adjusted earnings multiple of 17 and a forward P/E of around 16.
As a blue chip engineering business with long-term stability but short-term volatility, Emerson tends to be a good stock to write puts for in order to generate income and/or enter the stock at a low cost basis. By writing January 2014 puts at a strike price of $57.50, you could either make a high single digit rate of return on a flat stock or upward stock, or enter the position with a cost basis of under $53 if the stock price were to dip.
Full Disclosure: As of this writing, I am long EMR.
Stocks Discussed: EMR,