Emerson Electric: Moderate Yield, But High Payout Ratio

Jan.17.14 | About: Emerson Electric (EMR)

Emerson Electric is a U.S. Dividend Champion stock but in the near term it won't likely be a champion in your portfolio. The yield of ~2.5% is a little above average, but the limited projected growth and high payout ratio (currently ~60%) will limit dividend growth and total return on the stock for the foreseeable future.

I. COMPANY OVERVIEW

Emerson Electric (NYSE:EMR) is a diversified global technology company. The Company is engaged in designing and supplying products and technology, and delivering engineering services and solutions in a range of industrial, commercial and consumer markets globally. The Company operates in five business segments: Process Management, Industrial Automation, Network Power, Commercial and Residential Solutions, and Climate Technologies. The Company's production operations are electronics assembly, metal stamping, forming, casting, machining, welding, plating, heat treating, painting and assembly.

II. HISTORICAL PERFORMANCE

2009 2010 2011 2012 2013
Revenue $20,102 $21,039 $24,222 $24,412 $24,669
% Growth n/a 4.7% 15.1% 0.8% 1.1%
Gross Profit 7,560 8,326 9,557 9,768 9,952
% Margin 37.6% 39.6% 39.5% 40.0% 40.3%
EBITDA 3,738 3,965 4,797 4,828 4,844
% Margin 18.6% 18.8% 19.8% 19.8% 19.6%
Net Income 1,724 2,164 2,480 1,968 2,004
Avg Diluted Shares 758.7 757.0 753.5 734.6 722.9
% Growth n/a -0.2% -0.5% -2.5% -1.6%
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Note: All figures are MM's (except per share data) unless noted otherwise.

Emerson Electric has performed well over the past five years with EBITDA expanding each and every year. The Company's revenue expanded every year since 2009 at a compounded annual growth rate of 5.3%. The gross margin has trended positively while also staying within a tight 2.7% range over the past five years (bottoming at 37.6% and peaking at 40.3%). Similarly, EBTIDA Margins have expanded from 18.6% in 2009 to 19.6% in 2013 resulting in EBITDA expansion from $3,738MM in 2009 to $4,844MM in 2013 (30% expansion) over the five year period.

Per Share Data
2009 2010 2011 2012 2013
Revenue $26.50 $27.79 $32.15 $33.23 $34.13
% Growth n/a 4.9% 15.7% 3.4% 2.7%
Gross Profit 9.96 11.00 12.68 13.30 13.77
EBITDA 4.93 5.24 6.37 6.57 6.70
Net Income 2.27 2.86 3.29 2.68 2.77
Dividends 1.32 1.34 1.38 1.60 1.64
Payout Ratio 58.1% 46.9% 41.9% 59.7% 59.2%
Dividend Growth n/a 1.5% 3.0% 15.9% 2.5%
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Note: Per share data based on weighted average diluted shares outstanding.

On a per share basis, we need to view the Company's historical performance in a different light. The Company has changed their weighted average shares outstanding through share redemption from 759MM to 723MM over the period (a 4.7% decrease), resulting in a more favorable performance on a per share basis. EBITDA per share has expanded from $4.93 to $6.70 (a 36% increase as compared to a 30% increase at the Company level). The Company's dividends per share have been growing, increasing from $1.32 per share in 2009 to $1.64 per share in 2013 (a 24% increase or a 5.6% compounded annual growth rate), while maintaining a stable payout ratio in the 40-60% range.

III. CAPITALIZATION

Market / Par Value EBITDA Multiple
- Cash and Equivalents $3,275 0.7x
+ Total Debt $5,642 1.2x
+ Minority Interest $133 0.0x
+ Market Capitalization $49,231 10.2x
Total Enterprise Value $51,731 10.7x
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Note 1: Based on TTM EBITDA of $4,844MM as of 9/30/13.

Note 2: Market Cap based on 705.1MM shares outstanding and a $69.82 market price as of 1/16/14.

Emerson Electric has an under leveraged capital structure. The Company is levered at 1.2x TTM EBITDA (0.5x net of cash) with a total enterprise value of 10.7x TTM EBITDA. Ideally, the Company would incur a little bit of low cost debt to leverage their equity returns. Even with moderate leverage the Company would have a low cost of debt and maintain significant financial flexibility, while enhancing returns to the equity holders.

IV. PROJECTIONS

2014 2015 2016 2017 2018
EBITDA $5,131.8 $5,476.0 $5,652.1 $5,652.1 $5,652.1
% Growth 5.9% 6.7% 3.2% 0.0% 0.0%
Interest Expense 234.0 234.0 234.0 234.0 234.0
Taxes 1,424.9 1,526.0 1,577.8 1,577.8 1,577.8
Capital Expenditures 718.3 766.5 791.1 791.1 791.1
Dividends 1,212.8 1,212.8 1,212.8 1,212.8 1,212.8
Addl' FCF $1,541.8 $1,736.7 $1,836.4 $1,836.4 $1,836.4
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Note: All figures are MM's (except per share data) unless noted otherwise. Consensus Estimates only relate to EBITDA projections. All other assumptions are based on unadjusted LTM actuals.

The consensus estimates for Emerson Electric are conservative, projecting a growth rate between 6.7% and 3.2% annually through 2016 at the EBITDA line (projections unavailable for 2017 and 2018). Under the consensus case the Company is projected to have significant additional free cash flow available to reinvest in the business, repurchase shares (always assumed for modeling purposes), or increase the dividend.

2014 2015 2016 2017 2018
Addl' FCF $1,541.8 $1,736.7 $1,836.4 $1,836.4 $1,836.4
Share Redemption Price $80.29 $92.34 $106.19 $122.12 $140.43
Shares Redeemed 19.2 18.8 17.3 15.0 13.1
Wtd Avg Diluted Shares 703.7 684.9 667.6 652.6 639.5
Dividends Per Share $1.72 $1.77 $1.82 $1.86 $1.90
Dividend Growth 5.1% 2.7% 2.6% 2.3% 2.0%
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The share redemptions are assumed to be at a 15% annually compounded price. I believe that this is structured very conservatively. If the weighted average redemption price exceeded this threshold, the investor would have ample opportunity and time to re-evaluate their position and consider selling their position for a gain from today's price. The Company's share redemption would allow for a 2% to 3% increase in the dividend annually from the share redemptions alone. Additionally, the Company's payout ratio would decline as the dollar amount of dividends paid would not be increasing while the Company's earnings (using EBITDA as a proxy) would be increasing.

If the Company performs in line with the consensus estimates and pay dividends / redeems shares as outlined above, the Company would achieve the IRR / Cash on Cash returns illustrated below based on the outlined terminal EBITDA multiples.

Returns Based on Terminal EBITDA Multiple
8.2x 8.7x 9.2x 9.7x 10.2x 10.7x
IRR 1.5% 2.8% 4.0% 5.2% 6.4% 7.9%
Cash on Cash 1.07x 1.13x 1.20x 1.26x 1.32x 1.41x
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V. RECOMMENDATION

Emerson Electric is a steady business that has grown revenues every year since 2009 (in 2009 revenue contracted ~15% from 2008 levels) right along with EBITDA. The Company fully recovered from the 2009 recession by 2011 and today supports an above average yield (2.5%). However, there is not a great history of growing the dividend (5.6% CAGR since 2009) or strong prospects to increase the dividend meaningfully due to marginal growth according to the consensus estimates and a payout ratio of ~60% today.

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.