Will 2014 Be Emerson's Year?

| About: Emerson Electric (EMR)

Emerson (NYSE:EMR) signed an agreement with SPX Corporation (SPW) to acquire SPX's 44.5% stake in EGS Electrical Group for $571 million, and the deal is expected to close in the next two months. This will give Emerson full controlling stake in EGS Electrical Group, and Emerson will consolidate EGS in its industrial automation segment. EGS's operation lies primarily in North America, and I believe the consolidation will allow Emerson to expand EGS's geographic reach and position in the global energy market. The deal will strengthen Emerson's position in the oil and gas and the chemical market as 50% of SPX's revenue is derived from these two sectors. In the last few months, Emerson has restructured to focus on these two sectors. Due to high demand in the oil and gas and the chemicals markets, EGS will benefit from full ownership of EMR; it will give Emerson strategic control over the business and will allow Emerson to EGS's international presence through its global distribution channels.

I think the EGS acquisition will be a positive catalyst for Emerson's growth in 2014, as both have similar exposure in the oil and gas industry and a complementary business line. Emerson is also stepping up its merger and acquisition activity and plans to spend $1.5 billion in acquisitions in 2014, continuing its focus on the process management and industrial automation segments.

As a result of the deal, SPX will gain around $220 million, or $6.50 per share, in the first quarter of 2014. With this capital, divestitures of operations, and cash on hand, SPX will buy back shares worth $500 million and reduce its gross debt by approximately $300 million. SPX has been under pressure from its largest shareholder to demonstrate strength in its share price. It is selling its stake in order to focus on its flow technology division. There is high demand for pumps, valves, and filtration technology used to generate power, so SPX is focusing on this segment. Due to high demand, the company has received orders in this segment, with the most recent being in December to provide a processing plant using Flow Technology in France. The segment is expected to show growth around 12%-15% in the fourth quarter. SPX will continue to focus on flow technology and divest its non-flow businesses.

Growth opportunities in process management

The EGS acquisition is consistent with Emerson's strategy of making small acquisitions in the $400-$500M range and shifting its focus towards process management, industrial automation, and climate. In line with its strategy, Emerson acquired APM Automation Solutions in December 2013, which will become part of process management segment. APM Automation is the leading developer of solid volume and level measurement instrumentation, and its technology is used in power, chemical, food, and beverage industries. The acquisition will strengthen its process management capabilities in solid measurement, and it will be able to deliver a wide variety of products to its customers.

The growth in this segment is dependent on the external environment, especially as the orders start to pick up in North America and Europe. Emerson's process management segment witnessed order growth of 0%-5% in the month of November, led by improvement in the macro environment. During the second half of 2013, Emerson acquired Virgo Valves and Controls Ltd. and Enardo to innovate and strengthen its offering in process management. There will be more investment spending allocated to process management since its share of profits is growing, and I believe this should be a positive catalyst for Emerson this year.

Process automation is quickly gaining popularity in the oil and gas industry as the discovery of new oil wells occurs in deep sea regions. With the rising demand for oil and gas and the increased extraction of shale gas, automation has assumed an important role in extraction, transmission, and refining process of oil and gas. Automation in the oil and gas industry also has benefits such as reduction of cost, increased productivity, and enhanced safety. The process and automation in the oil and gas market is expected to grow at a CAGR of 8.23% from 2013-2020, and reach $31.24 billion by 2020. Companies operating in the process automation segment of the oil and gas sector are likely to benefit from this.

Bottom-line

The macro environment will play a key role for top-line and bottom-line growth of Emerson during fiscal year 2014. There are some signs of acceleration, as Emerson has forecasted revenue growth of 3-5% in 2014. Emerson has turned its focus to process management and industrial automation, which has helped it drive order growth. While orders have started to recover, I believe that it would take healthy demand growth to drive a meaningful improvement in profitability.

Process management was an important segment for Emerson's growth, and the company is stepping up M&A with plans to spend $1.5 billion on acquisitions in 2014. The company won't be focusing on big deals, but instead on small deals in the range of $400-$500 million. Despite the fact that Emerson possesses potential for additional earnings growth, it seems a bit overvalued, and it is trading at almost 25.13 times its earnings in comparison to its peers and the industry average.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.