Summary
- Management is focused on transforming the company to increase profitability in the intermediate term.
- The company’s launch of a reliability management consulting service is continued evidence of efforts to increase profitability.
- Divesting of low-margin businesses and focusing on higher-margin businesses should increase profitability.
- A rising dividend payout and substantial share repurchases will reward shareholders while waiting for the business transformation to lift profitability.
Emerson Electric’s (NYSE:EMR) shares have not participated in the overall market’s rise to new highs in 2014. The shares are down about 9 percent in 2014, as the company reported in their latest quarterly earnings, a lower-than-expected quarterly profit and sales pointing to “persisting economic challenges,” indicating that their full-year results would be at the low-end of the company’s estimates. In the company’s latest earnings report, EMR announced that sales for the fiscal 2014 third quarter decreased 1 percent, including a divested business. Growth in mature markets was stronger than in emerging regions, reflecting global political instability and economic uncertainty in some developing countries. Earnings per share were $1.03, and grew 6 percent. EMR indicated that despite areas of ongoing uncertainty around the world, economic momentum continues to improve gradually but unevenly. With the end of the 2014 fiscal year approaching, the company expects results in financial performance to trend to the low-end of previously estimates of 3 to 5 percent underlying sales growth, with earnings per share in the range of $3.68 to $3.80. The company’s CEO indicated, however, that robust orders grew order backlog to a record level, supported by large projects with long lead times.
The company is continuing their effort to transform their portfolio of businesses to focus on higher-growth and higher-profit businesses. EMR’s latest announcement to launch a reliability management consulting service is evidence of the company’s continued move towards higher-profit businesses. The company’s shares currently yield about 2.8 percent, and the company has a long history of yearly dividend increases. Long-term investors should strongly consider taking advantage of the weak 2014 performance of EMR shares and initiate a half position now and a full position if shares continue to trend lower below $60 a share. In the intermediate and long term, shareholders will benefit. In addition, some insiders purchased large amounts of EMR shares in 2014 at about $67 a share, about 10 percent higher than the current share price.
Background
EMR is an industrial conglomerate operating in five business segments: 1) process management; 2) industrial automation; 3) network power; 4) climate technologies; 5) and commercial and residential solutions. The company generated about 55 percent of revenues in the U.S. and Canada during fiscal year 2013, with 23 percent from Asia, 12 percent from Europe, 6 percent from Latin America, and the remainder from Middle East and Africa. Those divisions produce and/or provide services as follows: 1) the process management division produces process management software and systems, analytical instrumentation, valves, control systems for measurement and control of fluid flow, and integrated solutions for process and industrial applications; 2) the industrial automation division manufactures industrial motors and drives, transmissions, alternators, and controls for automated equipment; 3) the climate technologies division manufactures home and building thermostats and compressors (cooling components used in heating and air conditioning units and refrigerators); 4) the commercial and residential solutions division manufactures household appliances, handheld tools, piping and other related equipment, and storage solutions; and 5) the network power division manufactures power systems and precision cooling products used in computer, telecommunications and Internet infrastructure sold mainly to large data centers.
Company is launching a reliability management consulting service
This month, EMR announced they were addressing industry issues of excessive operational cost and unrealized profit through their Emerson Process Management division. They noted that industrial producers in industries such as oil and gas, chemical, refining, and power with 24-hour/7-day-a-week operations, routinely suffer 5 to 7 percent unplanned downtime losses due to poor maintenance practices. EMR’s new global reliability management consulting practice will guide and assist industry leaders in such industries on how to better manage maintenance costs, improve reliability, and increase profitability. The goal of the company’s economic-based management consulting practice is to save companies millions in wasted expense and lost revenue. The company indicated that “With the right strategy, the typical $1 billion plant can save $12 million or more annually in maintenance costs – not including the corresponding operational and production benefits from reduced downtime. Extend that across a corporation’s network of facilities and soon reliability becomes the number one strategic lever for a safer, more profitable enterprise.” By reducing scheduled and unscheduled downtime, companies can reduce their maintenance spending by 50 percent or more EMR noted.
EMR recently expanded their portfolio of reliability-focused services by acquiring Management Resources Group, Inc. (MRG), a management consulting firm with experience in improving reliability in industrial manufacturing. Such acquisition enhanced EMR’s existing lifecycle services offering as well as the company’s leadership in “pervasive sensing,” which provides manufacturers more operational insight through greater sensor-based coverage of their plants and assets. Through their consultants, EMR can advise global customers on enterprise-wide reliability management programs that connect the data collected in a manufacturing facility, providing actionable information to trigger maintenance activities before equipment fails.
Company to divest power transmission business
EMR announced their intention to sell its power transmission solutions business earlier in 2014 in a deal that could be worth more than $1 billion. EMR is preparing for an auction, and is in the early stages of contacting potential buyers, including other industrial companies and buyout firms. The power transmission business is estimated to have earnings before interest, tax, depreciation, and amortization of around $120 million, and could be valued at about 10 times that amount in a sale. EMR’s decision to divest the division is the continuation of a trend by large conglomerates to streamline their business lines and focus on high-growth areas.
Large insider purchases in 2014
Earlier in 2014, two insiders made substantial purchases of EMR shares on the open market. On May 8, 2014, EMR directors Randall Stephenson and Arthur Golden bought 7,455 and 3000 shares of the stock respectively on the open market. The stock was purchased at an average price between $67.06 and $67.12 per share, for total transactions of $499,932 for Mr. Stephenson and $201,360 for Mr. Golden.
Analysts’ views and our views
Analysts believe that EMR is well-positioned to benefit from any strengthening in the global economy. They also indicate that the company’s shares are fairly valued at recent levels. The outlook for global fixed investment remains subdued, but orders across EMR’s business divisions, including those in Europe and Asia, have bottomed. In addition, analysts see increased construction spending in North America and continued global energy investments. Overall, analysts recommend EMR shares for the long term on valuation grounds, as many of the recent company’s challenges are beginning to fade. Analyst ratings in the near term are mixed about evenly between “hold” and “buy” ratings for EMR, with price targets ranging from $64.00 to $84 a share.
We agree with analysts and their intermediate- and long-term outlook for EMR. Management of EMR is working to transform EMR by exiting low-margin businesses and focusing on higher-margin businesses. The company’s launch of a reliability management consulting service is continued evidence of the company’s efforts to increase profitability. This transformation is ongoing, and the results will become more appreciated by Wall Street and individual investors in the next 18 to 24 months. EMR’s current price-to-earnings ratio is about 17.20, their fiscal 2014 year (ending September 2014) earnings estimate is $3.70, and its 2015 fiscal year earnings estimate is $4.07. The company’s forward price-to-earnings ratio is about 15.05, based on fiscal 2015 year earnings estimates. We believe that investors should initiate a half position of the company’s shares now and establish a full position if the shares move below $60 further toward their 52 week low. Even if long-term investors do not time their share purchase exactly, they will be rewarded with an about 2.8 percent dividend yield. Our confidence in such recommendation is strengthened by large EMR insider share purchases earlier this year at prices higher than the current share price. Over the long term, EMR will reward investors with increasing dividends, substantial share repurchases, and a rising share price.
Disclosure: The author is long EMR. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. (More…)
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