EMR’s stock price has plunged by more than 25% in 2015. Many of the company’s markets are being impacted by falling oil prices, sluggish industrial spending trends, manufacturing weakness in China, and a strong US dollar. We believe the company’s dividend is very safe and will continue to grow each year, maintaining EMR’s status as one of the 52 dividend aristocrats.
Beyond the dividend, we think EMR’s current stock price offers attractive returns for long-term dividend investors who are willing to wait out volatility in the company’s markets. With so much attention being given to EMR’s challenging markets and dismal outlook for the next year, we believe the company’s restructuring activities, significant portfolio realignment, and opportunity for long-term earnings growth are being underappreciated. Trading at less than 15x forward earnings estimates, EMR is one of our top dividend stock ideas.
EMR was founded in 1980 as a regional manufacturer of electric motors but has grown into a global manufacturer of a wide variety of industrial and technical equipment. Its products include valves, wireless sensors, compressors, various precision instruments, server enclosures, software, and much more. EMR’s main expertise is in bringing together technology and engineering to provide solutions for customers in the process, industrial, commercial and residential markets.
Over the summer, EMR announced a plan to spin or sell off non-core assets to refocus on its highest-margin, fastest-growing segments. Once these actions conclude by September 2016, EMR will be left with businesses mostly focused on equipment for controlling industrial processes and various components used in heating and air conditioning systems.
While EMR’s 2014 sales base would decline from $24.5 billion to $16.3 billion, its EBIT margin would improve from 16.5% to 19.7% and underlying sales growth from 2010-2014 would have been 6.9% per year rather than the 4.5% annualized rate EMR recorded. While there is some uncertainty regarding the value EMR will receive for these non-core assets, we are excited by the higher quality mix of assets the company will be left with and management’s increased ability to focus more on the factors that have made EMR a great company for more than a century.
Once these moves are complete, EMR will be left with strong positions in two market segments totaling $130 billion in size:
Process and Industrial (65% of sales, 5-7% market growth) provides automation and electrical technology and services to oil & gas, chemical, life sciences, food & beverage, mining, power, petrochemical, and water & wastewater markets. EMR has number one market share in measurement devices, control valves, wireless devices, and fluid control.
Commercial and Residential (35% of sales, 4-6% market growth) provides infrastructure and tools used for commercial buildings, retail sites, contractors, and homeowners. EMR has number one market share in residential & commercial compressors, commercial controls, plumbing tools, wet/dry vacs, and food waste disposers.
By geography, EMR generated 46% of its 2014 sales from the United States and Canada, 22% from Asia, 20% from Europe, and 12% from the Middle East, Africa, and Latin America.
Few companies have been in business as long as EMR. Not surprisingly, the business contains numerous attributes that allow it to generate high returns on invested capital. From a product perspective, EMR is well diversified. However, many of its products share a common, profitable characteristic – they represent a small percentage of an end good’s total cost but are part of a mission-critical piece of functionality. In other words, customers are happy to pay up for reliability and dependability.
For example, EMR sells many advanced instruments to oil well operators. These pieces of equipment immediately obtain pressure, temperature, flow rates, and valve position, providing operators with real-time information they need to reach quickly to any change in the condition of the well. Some of the company’s industrial valve products might also be used in deep-water oil extraction, requiring a high level of precision. Given the operational differences between customers, many of EMR’s solutions are customized and solve complex challenges. This requires an employee base composed of engineers, researchers, and other specialists.
Beyond the products’ reputation for quality and dependability, EMR sells most of its products through a direct sales force and employs thousands of field engineers to work directly with its customers to enhance their processes. These long-standing customer relationships improve EMR’s brand and stickiness. As a result, EMR has maintained a number one market share position across most of its key products – measurement devices, control valves, wireless devices, fluid control, compressors, commercial controls, plumbing tools, wet/dry vacs, and food waste disposers.
Of course, EMR’s sheer size provides benefits as well. The company maintains a large portfolio of products and services and operates all around the world. This makes it a one-stop shop for just about any infrastructure solution a customer is seeking, from process automation to plant optimization to climate control and more. Smaller competitors cannot match EMR’s breadth of business. EMR’s size also allows it to invest heavily in R&D and acquire complementary product offerings to sell around the world. EMR has invested more than $500 million per year in R&D each of the last three years, racking up nearly 2,000 patents last year alone.
Finally, EMR has built up a massive installed base. In just the past 10 years, EMR built a global installed base of $65 billion in its process management segment alone. While the installed base provides high-margin aftermarket business (maintenance & repair work) and increases customer stickiness, it will likely become an even bigger asset in future years as the “industrial internet” ramps up – this is also one reason why we bought GE in July 2015.
EMR benefits from this theme because many of its business lines are directly tied to the number of digital devices in the field. EMR’s wireless sensors, instrumentation, and software can help digital field devices run real-time monitoring and diagnostics across many types of production processes. EMR’s predictive maintenance software can then alert customers when issues are detected, enabling appropriate correction before operation are impacted. EMR launched its first wireless product in 2003 and generated over $300 million in wireless sales last year. While it is a smaller piece of the story today, we view EMR’s installed base as an important asset that could provide numerous high-margin revenue opportunities in years to come as industrial analytics grow in use.
Read through any of EMR’s recent earnings call transcripts, and a dismal economic picture will be painted for you pretty quickly. EMR expects overall business trends will remain weak for the next year and is working quickly to adjust labor costs in response to lower demand levels.
The factors impacting EMR are lower oil prices, sluggish global industrial spending, a sharp drop in sales to China, and a strong US dollar. Unless you have been living under a rock, these issues are well known and at the center of almost every question EMR receives from investors.
While none of this sounds very good, it is important to remember that the stock market is forward-looking and has already cut EMR’s price by nearly 30% this year. For this reason, we like to ask ourselves, “What could the next big downside surprise be that causes EMR to fall another 20%?”
Given the pessimism currently surrounding the stock, we think further downside