Emerson Electric - Great Company, Lack Of Compelling Value

May.14.14 | About: Emerson Electric (EMR)

Summary

Emerson has a strong track record, a great business, as well as solid geographic diversification.

Improving growth, acquisitions and a focus on efficiency should drive earnings growth later this year.

That being said, the current valuation already reflects a great deal of good news, making shares not that attractive, in my opinion.

Emerson Electric (NYSE:EMR) updated the market about its second-quarter performance last week as the report unveiled improving underlying strength in its businesses.

Despite this and the confidence for the remainder of the year, I remain cautious, as the valuation is not too compelling at the moment.

Second-Quarter Results

Emerson reported second-quarter sales of $5.81 billion, which is down 2% compared to last year. Gross margins improved by 140 basis points to 41.2% of sales, made undone by other charges which more than doubled from $59 million to $137 million.

These "other" charges include amortization charges, restructuring costs and the Artesyn equity loss, among others.

Reported earnings fell by 2% to $547 million, while earnings per share came in unchanged at $0.77 per share on the back of sizable share repurchases over the past year.

Diverse performance

Within the business, Emerson saw both strength and weakness as reported sales fell by 2%. The divestiture of Artesyn reduced revenues by 5%, while acquisitions added a percent to reported overall revenues. Underlying sales rose by just 2% amidst harsh weather and weak first-quarter GDP growth within the US.

Its largest process management business reported 4.4% revenue growth, with sales coming in at $2.11 billion. Growth was driven by acquisitions, with underlying growth coming in at just 1%. Promising is the 12% growth in order intake, adding to the backlog, which bodes well for the coming quarters.

Climate technology revenues were up by 5.4% to $1.04 billion, driven by strength in the global refrigeration business.

The network power business saw some weakness, which should not come as a surprise. Reported revenues fell by 20.9% to $1.17 billion. Of course, the latter is entirely explained by the Artesyn divestitures.

Unchanged Outlook For 2014

Based on the second-quarter earnings report, Emerson continues to see underlying sales growth of 3% to 5% for the remainder of the year. Reported sales are expected to come in between a 1% fall and growth of 1%, reflecting the combined effect of acquisitions, divestitures and foreign exchange movements.

Driven by half a percent margin expansion, reported earnings are foreseen between $3.68 and $3.80 per share, which is up 4% to 7% excluding impairment and repatriation charges. Analysts were looking for earnings of $3.77 per share.

Valuation

Emerson ended the quarter with $2.72 billion in cash and equivalents. Total debt stands at $6.50 billion, resulting in a net debt position of $3.78 billion.

Trading at $68 per share, Emerson's equity is valued at around $48 billion. Based on the outlook for roughly unchanged sales, equity is valued at roughly 2 times annual revenues of around $25 billion.

The company trades at roughly 18 times earnings, based on the full-year outlook. This excludes rather structural impairment and repatriation charges, which totaled $0.78 per share last year. Therefore, GAAP earnings could come in at around $2.0 billion, valuing the business at 24 times annual earnings.

Emerson currently pays a quarterly dividend of $0.43 per share, for an annual dividend yield of 2.5%.

Takeaway For Investors

While Emerson reported a modest drop in second-quarter earnings, underlying earnings, excluding restructuring costs, continue to improve, which should bode well for the second half of the year. In combination with the company's comments that the backlog is increasing, Emerson expects growth to pick up later this year.

Shareholders like these words as CEO Farr is "turning up the heat" on its operations, as well as identifying potential acquisition targets. This came after the company acquired a 44.5% minority interest in EGS Electrical Group for $571 million at the start of the year from SPX Corporation (SPW).

These words and actions, combined with a strong market have propelled shares to highs of $68 at the moment, close to Emerson's all-time high around $70 per share. Investors like the shares as well for the strong track record and well-diversified operations both in the segments as well as geography.

Despite the promising prospects, I believe the current valuation already reflects a great deal of good news at around 24 times earnings of $2 billion. While the company continues to make the right strategic moves, it is being lifted in the general strong equity market performance, and is not that appealing to me at current levels.

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.