Dividend Aristocrats in Focus Part 35: Emerson Electric

Examining the investment prospects of this industrial sector Dividend King

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Nov 08, 2016
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Emerson Electric (EMR, Financial) is a legendary dividend growth stock.

The company was founded in 1890 in St. Louis, Missouri, when two Scottish brothers, Charles and Alexander Meston, saw an opportunity in manufacturing reliable electric motors.

The two brothers received a start-up investment from a man named John Wesley Emerson, a former Union Army officer, judge and lawyer. Together, the three formed The Emerson Electric Manufacturing Company.

Emerson Electric’s breakthrough product was manufacturing the first electric fans sold in North America. In its first full year of operation, Emerson’s sales totaled $60,000.

Today, Emerson does business in more than 150 countries and has 111,000 employees. It has a $32 billion market capitalization and generated more than $22 billion of revenue last year.

The ‘Dividend Aristocrats’ are a group of stocks with at least 25 years of consecutive dividend increases in the S&P 500. You can see all 50 Dividend Aristocrats here. Emerson’s dividend streak is more than double the requirement to be a Dividend Aristocrat.

Emerson has increased its dividend for a whopping 59 years in a row. This makes the company one of only 18 Dividend Kings – stocks with 50-plus consecutive years of dividend increases.

Business overview

Emerson has a long history of navigating through several recessions and coming out even stronger than before. In order to survive the swings of operating as an industrial manufacturer, it has had to stay nimble.

Emerson is going through a transition period. It has conducted a significant restructuring of its business model over the past year. For example, Emerson divested its large Network Power business in 2016 for $4 billion.

Emerson is making some big moves to try to get things going in the right direction again. The past few years have been very difficult for Emerson. Last year, Emerson’s earnings per share fell 15%.

The company is sailing through a number of headwinds, including geopolitical risk due to the Brexit vote, the strong U.S. dollar and the collapse in commodity prices.

Global economic uncertainty is elevated and is suppressing economic growth in many international regions, including Europe and the emerging markets. In addition, the rally in the U.S. dollar has negatively impacted Emerson. A rising dollar makes U.S. exports less competitive, which is a problem for the company since 56% of total sales last year were from outside the U.S.

Lastly, the decline in oil and gas prices from $100 per barrel to $50 per barrel in the past two years has hurt the company. Emerson is an industrial manufacturer and the oil and gas industry makes up a significant portion of its customer base.

Going forward, Emerson will focus its business on two key areas: Automation Solutions and Commercial and Residential Solutions. Emerson is going to be a much more streamlined company in the very near future.

02May2017143010.jpg?resize=710%2C362

Source: 2015 Annual Report, page 6

The goal of its divestment and broader restructuring plan is to focus on its highest growth opportunities.

Growth prospects

Once Emerson’s portfolio repositioning is complete, it will allow the company to focus on the industries it believes hold the highest growth potential. These will mainly be the process, industrial, commercial and residential markets.

According to Emerson, its strategic portfolio repositioning would have resulted in significantly higher growth in recent years. For example, in the image below, sales growth from 2010-2015 would have been 2.2% higher per year. Meanwhile, earnings before interest and taxes, as well as return on total capital, would have been significantly higher in 2015.

02May2017143011.jpg?resize=710%2C417

Source: 2015 Annual Report, page 6

Another growth prospect for Emerson moving forward is international growth. Emerson generates more than half of its revenue outside the U.S., including a large operational footprint in Asia.

02May2017143011.jpg?resize=710%2C502

Source: 2015 Annual Report, page 20

Its large international presence has held the company back so far due to changing foreign exchange rates. But investors should continue focusing on the long term as Emerson is generating high organic growth, which excludes the impact of currency movements.

For example, in 2015, Emerson’s organic revenue increased 7% in China and 2% in Latin America. Organic revenue also increased 1% in Europe. Emerson continues to grow organic revenue in a difficult macroeconomic climate. This is an indication that demand for its products and services remains strong.

Competitive advantages & recession performance

Emerson’s two key competitive advantages are its global scale and its research and development. Emerson has reaped significant operational efficiencies from its global distribution network. For example, Emerson has 205 manufacturing locations worldwide, including 140 outside the U.S.

This provides Emerson with economies of scale and high margins. In 2015, Emerson generated a 22.8% return on total capital.

Separately, Emerson’s R&D is a competitive advantage. It invests significant financial resources each year to ensure product innovation:

  • 2013 R&D spending of $576 million
  • 2014 R&D spending of $541 million
  • 2015 R&D spending of $506 million

This investment has paid dividends in a big way. Emerson was awarded 2,100 patents last year alone.

Unfortunately, Emerson Electric is reliant on a growing global economy. Since it operates in the industrial sector, it is not immune to periods of recession. Investors saw this first-hand during the Great Recession of 2007-2009, when EPS fell significantly:

  • 2007 EPS of $2.66
  • 2008 EPS of $3.11
  • 2009 EPS of $2.27 (27% decline)
  • 2010 EPS of $2.60 (15% increase)
  • 2011 EPSÂ of $3.24 (25% increase, new post-recession high)

That being said, thanks to Emerson’s competitive advantages, the company still remained solidly profitable during the Great Recession.

Valuation & expected total return

Emerson stock trades for a price-earnings ratio of 17.2 using adjusted earnings. This is below the average price-earnings ratio of the S&P 500, which is 24.

Emerson is also trading at a discount relative to its historical standards. Since 2000, the stock has held an average price-earnings ratio of 18. As a result, the stock appears slightly undervalued.

Going forward, investors can expect total returns to be comprised of EPS growth and dividends. As a result, total shareholder returns could be based on the following:

  • 3%-5% organic revenue growth
  • 2% growth through acquisitions
  • 1%-2% share repurchases
  • ~3% dividend yield (at 2.8% yield currently)

As a result, total shareholder returns could reach 10% to 13% annualized.

Final thoughts

Emerson has seen its share of bumps in the road during the past year. But over the course of more than 100 years in businesses, Emerson has proved an ability to successfully navigate economic cycles.

The company ranks as a long-term hold at current prices using The 8 Rules of Dividend Investing.

Emerson’s portfolio restructuring should put the company on firmer ground moving forward. It should have little trouble continuing to increase its dividend each year.

Disclosure: I am not long any of the stocks mentioned in this article.

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