A Word Of Caution About Emerson Electric's Buyback

Dec.18.13 | About: Emerson Electric (EMR)

Emerson Electric (NYSE:EMR) has been one of the best companies you could purchase over the past 40-50 years. Heck, the company's dividend growth track record is equal to Procter & Gamble's in that both companies have been giving shareholders a raise at least once every twelve months for 57 years running now. Over most long-term periods, Emerson has proven to be a quite satisfactory investment.

Over the past ten years, every $10,000 invested in the company has turned into $27,850, compounding at 10.78% annually.

Over the past twenty years, every $10,000 invested in the company has turned into $88,266, compounding at 11.55% annually.

And over the last thirty years, every $10,000 invested in the company has turned into $501,000, compounding at 13.93% annually.

In other words, Emerson Electric has the long-term credentials of creating shareholder wealth. Despite Emerson's ability to make investors wealthy over the long-term by just about any way you can define the term, the company does seem to have difficulties in executing well-time share buybacks.

In particular, I question the effectiveness of using the $300 million in cash on hand (from selling an equity interest to Platinum Energy) to create more buybacks for the company, with the most recent announcement indicating a desire to repurchase $850 million worth of shares outstanding.

It just doesn't seem to me that Emerson has good timing with their stock buybacks-they tend to reduce shares outstanding when the price is expensive or reasonable, and halt buybacks once the shares become cheap and it is clearly advantageous to take the shares off the market.

From 2003 to 2008, the company was willing to take 70 million shares off the books. When the program hit its stride, the company was reducing its share count by 15 million each year.

But then, once the financial crisis hit and the shares became cheap in the low $20 range, the company suddenly stopped buying back its own stock. In 2009, Emerson had 751 million shares outstanding. And in 2010, due to executive compensation, the shares outstanding actually increased a little bit to 752.6 million shares outstanding. During the worst of the financial crisis, the company was able to issue cheap shares as compensation to executives, but it suddenly decided that it would stop its share buyback program, precisely during the period in time in which it would be most effective (fortunately, the company was raising its dividend from $1.20 in 2008 to $1.33 in 2009 so that shareholders were able to take advantage of Emerson's cheapness by reinvesting their dividends).

But now that we are out of the financial crisis, and Emerson's shares are trading at an expensive multiple, the company is now finding time to repurchase its shares. Since 2010, Emerson has resumed its habit of reducing its share count by 10-15 million per year. The 2010 share count of 752 million has reduced to 715 million today. This seems to be an indication that Emerson might be engaging in the practice of buying its stock when the price is high and declining to do so when the price is low.

Right now, Emerson Electric is trading at its loftiest valuation in the past generation. This company does not regularly trade at 24x earnings-this is the very high end of where Emerson has historically been valued. Even we are charitable in our assessment of the company's valuation and manually remove one-time items to conclude that the company is currently sitting on $3.50 per share in actual earnings power, this is still a company trading at 19x earnings.

Even under this scenario, this still means that Emerson is trading at the same valuation that the company last saw during the late 1990s tech boom. From 1997 to 1999, Emerson was a company trading in the 19-21x earnings range. So at the very least, it would seem, Emerson's valuation is currently as steep as it was in the late 1990s. This leads me to the conclusion that Emerson is continuing its practice of "buying high" in regards to its share buyback valuation.

In many ways, this is somewhat of a typical situation for blue-chip cyclical companies. When the profits are at all-time highs, and the valuations are generally at corresponding all-time highs, then the company uses the excess cash to engage in large share buybacks at somewhat inopportune times. And then, when share prices and profits plummet, the company needs to retain cash for stability and does not engage in buybacks at the moment it would be the most effective to do so.

Emerson seems to be fitting this pattern well. Emerson spent most of the 2000s buying back its own stock until the financial crisis hit, and then the common started to slightly dilute shareholders. Now that profits and valuations are quite high, the company finds room to retire $850 million worth of shares. Buybacks are only effective when the shares are cheap, or at the very least, reasonably priced. Given that Emerson's valuation is north of 20x earnings, it seems an imprudent use of shareholder cash to be reducing the share count now. I'd like to see management keep the cash on hand for an economic slowdown, and then aggressively retire shares then.

Disclosure: I am long EMR. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.