Value Investing

Dividend Aristocrats Part 29: Emerson Electric Co. (EMR)

Dividend Aristocrats Part 29: Emerson Electric Co. (EMR) by Ben Reynolds, Sure Dividend

The news release Emerson Electric (EMR) revealed on June 30thof 2015 will forever transform the company.

Here’s the critical part of the company’s release:

“ST. LOUIS, June 30, 2015 – Emerson today announced it plans to spin off its Network Power business via a tax-free distribution to shareholders as part of a plan to streamline its portfolio, drive growth, and accelerate value creation for shareholders. Emerson will also explore strategic alternatives for its motors and drives, power generation and remaining storage businesses.”

Emerson Electric is splitting apart.

The company was founded in 1890 and has paid increasing dividends for 59 consecutive years.  Emerson Electric is one of only 17 Dividend Kings.

The company’s plan to spin-off the Network Power Division, and potentially several other business units will reshape Emerson Electric.

The effects of this restructuring are discussed in this article.  First, let’s get to know Emerson Electric as it is currently.

As it is currently, Emerson Electric has over 130,000 employees and 230 manufacturing facilities around the world.

Emerson Electric divides its operations into 5 segments which represent its various business ventures.  The 5 segments are listed out below:

  • Process Management
  • Industrial Automation
  • Network Power
  • Climate Technologies
  • Commercial & Residential Solutions

Process Management

The process management segment provides products and services to help businesses control, regulate, operate, measure, and analyze the manufacturing or automation process.

Industrial Automation

The industrial automation segment sells power generation, electrical protection, power quality, power transmission, fluid automation, machine motion, and precision cleaning products, among others.

Network Power

Emerson Electric’s network power segment protects and optimizes power supply for critical infrastructure like data centers, communication networks, healthcare, and industrial facilities.

Climate Technologies

The climate technologies segment is the world’s leading provider of heating, ventilation, air conditioning, and refrigeration products for commercial, residential, and industrial applications.  The segment operates under a variety of brand names including Emerson, Browning, Copeland, Dixell, and White-Rodgers.

Commercial & Residential Solutions

The commercial and residential solutions segment produces appliances, storage products, and tools for residential and commercial customers.  The segment operates under several brand names including InSinkErator, ClosetMaid, ProTeam, RIDGID, and Workshop.

Emerson Electric’s Competitive Advantage

Emerson Electric’s long streak of dividend growth is evidence of a durable competitive advantage.

The company’s large size and global reach give it a significant scale advantage over smaller competitors.

Emerson Electric’s 230 manufacturing facilities spread throughout the world show the strength and geographic diversity of the company’s supply chain.

About 40% of the company’s revenue is generated in emerging markets.  Emerson Electric’s size and scale advantage allows it to find the best locations to manufacture products at the cheapest prices.

Emerson Electric’s strong research and development department gives it a competitive advantage that smaller competitors cannot achieve.  The company spent the following amounts on research and development over the past 3 years:

  • 2012 research and development spending of $547 million
  • 2013 research and development spending of $576 million
  • 2014 research and development spending of $541 million

This spending is producing real results.  The company was granted 1,600 new patents in 2012, 1,700 new patents in 2013, and more than 1,900 new patents in 2014.

The company’s large size lets it hire more innovators to come up with new patentable products which the company can sell at a premium price.

Business Restructuring

Emerson Electric’s bold plan is to focus on its two best business segments:  Industrial Automation (automation solutions) and Commercial & Residential Solutions.  The favorable economics of these two segments versus the rest of the company is shown in the image below:

Emerson Electric

Source:  Emerson Electric Morgan Stanley Conference Presentation, slide 5

The divestiture of a large chunk of Emerson Electric’s business will free up cash flows from more productive segments.  If the company sells off its power generation and motors/drives business units it will generate a cash windfall.

How will management allocate its new cash flows?

A hint was given in the company’s fourth quarter 2015 presentation (side 11).  Management will focus on:

“(An) increased level of evaluation and acquisition of key strategic assets”

Emerson Electric appears to have (as of yet undisclosed) plans to make significant acquisitions that will refocus the company.  Presumably, these acquisitions will complement either the company’s Industrial Automation or Commercial & Residential Solutions segments.

Will Restructuring Benefit Shareholders?

The real question with all of Emerson Electric’s planned moves is, ‘will all of this benefit shareholders?’

I argue that it is likely these moves will likely be beneficial for shareholders.

The spin-off of the company’s Network Power business shows that management is not concerned in empire building; quite the opposite.

While the company does have an eye out for acquisitions, Emerson Electric has proven to be very shareholder friendly in its capital allocation.  In addition to the company’s 59 year streak of dividend increases, Emerson Electric has also repurchased an average of 1.8% of shares outstanding a year over the last decade.

Based on Emerson Electric’s historical dividend and share repurchase policy, I expect the company to continue to allocate capital in a shareholder friendly manner.  The pending spin-off and other potential divestitures will focus the company’s operations on its better opportunities, thereby creating more value for shareholders.

Total Return & Dividend Payback Period

Emerson Electric stock currently has a high 3.8% dividend yield.

The company has managed to compound earnings-per-share at 8.6% a year over the last decade.

The company is facing significant headwinds in the short-run, including:

  • Stronger United States dollar
  • Growth slow-down in emerging markets
  • Low oil prices (which impact sales from customers)

These factors will result in slow growth (and potential declines) for Emerson Electric in the near-term.

The company’s long-term growth prospects remain bright.  I expect earnings-per-share growth of at least 8.0% a year for the company.  With a more streamlined operation, there’s no reason Emerson Electric should not grow faster over the next decade than it did over the previous decade.

I expect long-term earnings-per-share growth of 8% to 10% a year from Emerson Electric.  This growth combined with the company’s current 3.8% dividend yield gives investors expected total returns of between 11.8% and 13.8% going forward.

Recession Performance

Emerson Electric was profitable throughout the Great Recession of 2007 to 2009.  The company’s earnings are closely tied to global capital investment spending and GDP growth.

As a result, the company saw earnings-per-share decline substantially through the Great Recession.

Emerson Electric did not hit new earnings-per-share highs until 2011; the company took about 2 years to recover from the worst of the recession.

Emerson Electric’s earnings-per-share are shown below during the Great Recession and subsequent recovery:

  • 2007 Earnings-per-share of $2.66
  • 2008 Earnings-per-share of $3.11 (new high)
  • 2009 Earnings-per-share of $2.27 (recession low)
  • 2010 Earnings-per-share of $2.60
  • 2011 Earnings-per-share of $3.24 (full recovery, new EPS high)

Final Thoughts & Recommendations

There is much to like about Emerson Electric stock:

  • Price-to-earnings ratio of 15.8
  • Profitability during recessions
  • Shareholder friendly management
  • 59 years of consecutive dividend increases
  • Expected total returns of 11.8% to 13.8% a year

All of these factors help Emerson Electric to rank highly using The 8 Rules of Dividend Investing.

Previously discussed short-term headwinds have driven down Emerson Electric’s stock price.  The company has a very reasonable price-to-earnings ratio as a result.  I believe Emerson Electric to be undervalued at current prices.

Much of the manufacturing industry is undervalued at current prices.

Emerson Electric is a buy at current prices.  Fortunately for investors, there are several other manufacturers (in slightly different manufacturing segments) that make more compelling investments at his time.

The 3 highest ranked manufacturers (publicly traded in the United States) using the Sure Dividend system currently are:

In addition, Pentair (PNR) has a compelling growth story.

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