When it comes to world class long-term wealth compounders, often the best choice isn’t the next great hyper-growth tech stock, but something far duller.
Take, for example, industrial companies such as 3M (MMM), which have legendary track records of consistent outperformance and dividend growth that span over half a century.
Emerson Electric (EMR) is another such legend, a venerable dividend king with 60 consecutive years of payout growth to its name. Investors can view data on all of the dividend kings here.
However, in recent years Emerson has faced some very serious growth headwinds.
Let’s take a closer look to see just what has made Emerson such a great business in decades past, what investors can expect going forward, and whether or not you might want to add it as a core holding to your own diversified dividend portfolio at this time.
Founded in 1890 in St. Louis, Missouri, Emerson Electric is a global industrial conglomerate that serves the oil and gas, refining, chemicals, power generation, pharmaceuticals, food and beverages, pulp and paper, metal and mining, and municipal water supply sectors.
Emerson Electric essentially brings together technology and engineering to provide solutions for customers in the process, industrial, commercial and residential markets.
Previously, the company had five operating segments. However, Emerson Electric is in the process of selling its network power segment and restructuring the company from four divisions (see below) to just two.
Process Management: valves, actuators, regulators, measurement and analytics software that helps companies monitor their operations and maximize safety, and efficiency.
Industrial Automation: fluid power and control systems, electrical distribution systems, precision motors, and industrial cleaning systems.
Climate Technologies: builds temperature monitoring and control systems for residential and commercial clients.
Commercial & Residential Solutions: tools for homeowners and professional contractors.
After the restructuring, Emerson will have just two business segments: Automated Solutions (industrial clients) and Commerical & Residential Solutions (non-industrial sales).
These businesses are focused on providing equipment for controlling industrial processes and different components used in heating and air conditioning systems.
As you can see, once the restructuring is complete the majority of Emerson’s revenue will come from its industrial automation division. However, the Commercial & Residential division’s superior margins make it well worth holding onto.
|Post Restructuring Business Segment||Q4 2016 Revenue||% of Revenue||EBIT Margin|
|Automated Solutions||$2.926 billion||66%||16.0%|
|Commercial & Residential Solutions||$1.49 billion||34%||22.5%|
Source: Q4 Earnings Presentation
Geographically, the company remains dependent on its core North American business. However, it is making great strides into diversifying its sales to faster-growing overseas markets.
Source: Emerson Electric Annual Report
Very few companies have been in business as long as Emerson Electric has, and even fewer can boast such a lengthy dividend growth streak. The company’s track record speaks to its durability, disciplined capital allocation, and numerous competitive advantages.
Emerson sells thousands of different products, but almost all of them account for just a small percentage of an end product’s total cost.
Most of Emerson’s products provide mission-critical functionality, such as gauging the pressure and flow rate of an oil well. The company’s customers need reliability, and Emerson’s longevity gives it a trusted reputation.
Unlike many other industrial companies, Emerson sells many of its products through a large direct sales force and also has thousands of field engineers working directly with its customers.
These efforts further solidify its favorable brand and customer relationships; deepening switching costs and helping the company continuously deliver innovative, rigorous solutions that solve customers’ most challenging problems.
Thanks to the company’s selectiveness with which product niches it enters and its focus on quality, reliability, and strong customer relationships, Emerson has been able to maintain a leading market share position in many core categories – control valves, fluid control, measurement devices, compressors, wireless devices, and more.
Holding onto top market share positions for 100+ years has many benefits, including a massive installed base in the tens of billions of dollars.
Having a huge installed base really helps smooth out results because it provides more reliable (and high-margin) aftermarket business – customers need to keep their equipment up and running.
Furthermore, a lot of Emerson’s industrial automation products (e.g. wireless sensors, software, instrumentation) are tied to the “industrial internet” theme. As this technology continues advancing, Emerson has potential to better monetize its installed base.
However, industrial companies are still cyclical, with growth in sales, earnings, and cash flow generally tied to that of the broader global economy.
Unfortunately for Emerson, the last few years have not been kind, with CEO David Farr declaring a “global industrial recession” in the first quarter of 2016.
A large part of this can be blamed on the worst oil crash in over 50 years, which has resulted in a massive decrease in orders from energy companies who have slashed capital spending in recent years.
Sadly, there are no signs that this industrial downturn is slowing. As you can see below, orders from Canada, which is highly dependent on oil production, have fallen off a cliff.
In addition, slowing economic growth in Asia, especially China, has also hurt sales and margins in recent quarters.
Meanwhile, decreased Chinese demand for commodities has, in turn, resulted in severe economic downturns in Latin America, which depends heavily on exporting commodities.
Source: Emerson Q4 Earnings Presentation
Now in fairness to Emerson, its management is world class, as represented by President, Chairman, and CEO David Farr, who has been with the company for over 30 years.
Since taking the top spot in 2000, he has done an admirable job of selling off low margin businesses, acquiring more profitable divisions, and expanding into developing markets, which will be a key for sustaining long-term growth.
With decades of experience in both good business cycles and bad, Farr has managed to use disciplined cost cutting to keep Emerson’s margins and returns on shareholder capital far above its peers.
|Company||Operating Margin||Net Margin||FCF Margin||Return On Assets||Return On Equity||Return On Invested Capital|
Perhaps most importantly, Emerson has maintained a high free cash flow (FCF) margin that has continued to support its dividend and allowed continued dividend growth even through numerous lean periods, including now.
However, management doesn’t expect orders to bottom and start increasing until the end of 2017, assuming that energy prices continue to recover.
In addition, due to the restructuring the company is undertaking, which includes sales of large divisions such as network power, as well as divestitures of Leroy-Somer and Control Techniques businesses (part of its old industrial automation division), the next few years are expected to be characterized by very slow growth, especially of the company’s FCF.
In fact, dividend investors need to be prepared for continued deterioration in sales, earnings, FCF, and margins for the next few years.
Until the global industrial recession finally ends, and/or the company can acquire enough new bolt on businesses (such as the recent $3.15 billion acquisition of Pentair’s valves and control business) to recover its previous revenue, lean times will likely continue.
That being said, while Emerson and most of its industrial rivals may be in for some lean years ahead, we can’t forget to look at the long-term fundamentals of the company.
Specifically, after the Pentair (PNR) acquisition closes Emerson will own 16% of the global industrial automation market, in which it has created a wide moat for itself thanks to