In an earlier article on General Electric (GE), I provided operating projections and concluded by reiterating my belief that the "buy" rating on the Street - now more of a "strong buy" - is slightly generous. With that said, efficiency improvements and cost reductions are nevertheless driving margin expansion while diversification and high dividend distributions substantially reduce risk.
Similarly, Emerson Electric (EMR) is much safer than what meets the eye, but a lack of catalysts and irregular earnings hold shareholder value back. This diversified global technology company had its first relatively successful quarter following a string of misses. Thus, it is appropriate to now analyze the position of the company amidst macro headwinds.
From a multiples perspective, the stock is neither cheap nor expensive. It is trading at a respective 15.6x and 12.6x past and forward earnings with its premium to competitors being above historic levels. Whether or not it can sustain this above-historic premium is a matter of concern to investors. The brand is strong, but the fundamentals are not being innovated to the extent that some may have hoped. On the liquidity side, however, the company is healthy with net debt at $3.2B, representing only 8.3% of market value. Thus, the ability to increase returns of free cash flow to shareholders is a viable option going forward. General Electric, on the other hand, has a staggering $374.8B worth of net debt - more than double market value. This figure has successfully come down over the years. Over the last 12 months, General Electric has appreciated by 0.6% while Emerson has declined by 7.7%.
During the fourth quarter, Emerson's EPS of $0.98 slightly beat consensus estimates. However, the greatest highlight of the earnings call was the chairman and CEO's optimistic outlook:
"In my opinion, 2011 finished strong. We are moving in to fiscal 2012 in a very strong position from a balance sheet standpoint, technology, new products and emerging markets, which we see the significant increase in incremental investments last year. We will drive a solid 5% to 7% underlying sales growth and I believe another record operating margin around 18%, even with an additional incremental advance growth technology investments that we put forth, again, here in 2012, based around our new products, our technology, based around global sales organization, technology organization, based around our expanded service organization, some new solutions, technology organizations and some new business models. We fundamentally believe from the OCE perspective, in the business area perspective, that we need to take and invest our record profitability into programs to drive growth. We are looking at what I would look at a moderate growth environment in the mature markets, no different than I said back in February of 2011. We are looking at still a good emerging market growth in GFI, gross fixed investment, though, it will be less in the next couple of years that it has been in the last five years. But it will still be GFI growth in the 5%, 6%, 7% range, which we've been able to get a multiplier effect, as you well know, over the last 10 years."
While I believe 7% organic growth is realistic, the lack of specifics in innovation gives me pause. Process and Industrial Automotive offset losses in other segments, but margins remain an issue for long-term value creation. Additionally, exposure to Europe is a concern with $100M worth of restructuring planned there and possibly more if conditions flounder like I expect them to. The CEO also mentioned how he expects the global economy of 2012 to be dynamic - if so, then how is Emerson positioning itself now to take market share away from competitors?
Opportunities include penetration in China and increased share repurchases. Declining margins in Network Power illustrates a global challenge. Successfully turning around this trend will drive meaningful increases in shareholder value. As much of the stock is being held back due to concerns over macro indicators in key segments, focusing on this area would renew confidence. Value drivers include the solid fundamentals in Process and Climate, in addition to the diverse offering of technology and services more generally.
Consensus estimates for EPS are that it will increase by 11.4% to $3.61 in 2011 and then by 11.9% and 10.9% in the following two years. Of the 20 revisions, half have gone up. Assuming a 16.5x multiple and a conservative 2012 EPS estimate of $3.90 yields a rough intrinsic value of $64.35. Macro headwinds and a declining premium will reduce that figure, but the 26.3% margin of safety nevertheless limits the downside. A dividend yield of 3.14% further goes a long way in reducing the risk inherent in the beta of 1.24. The Street currently rates the stock between a "hold" and a "buy" largely due to the strong brand name and strength in Process.