Since I first published my bullish article on Emerson Electric (EMR) and General Electric (GE) here, the returns have been -5.2% and 18.4%, respectively, while the Dow Jones rose by 4.6%. Emerson was down as a result of a first quarter miss that was historically worse than what the industry has seen for some time. I find that the market under-reacted to the poor performance and thus advise shareholders to hold off from an investment for now. The more attractive pick is Honeywell (HON) with its stellar performance and great exposure to high-growth sub-markets.
From a multiples perspective, Emerson is the cheaper of the two. It trades at a respective 14.7x and 12x past and forward earnings while Honeywell trades at a respective 17.6x and 12.7x past and forward earnings. For many investors, Emerson's higher dividend yield of 3.4% merits holding an interest, but with a beta of 1.2 and uncertainty in macro trends, it is a close call. In addition to having stronger fundamentals, General Electric offers an even higher dividend yield at 3.6%, albeit with more volatility. These tough comparables will prevent investor entry. Currently, the Street rates shares of Emerson a "hold" and those of Honeywell a "buy." I find myself in agreement with this general sentiment.
With ROIC, margins, and net cash all modeled to rapidly expand, it is not hard to see why analysts are bullish about Honeywell. On the third quarter earnings call, the company's CEO, David Cote, noted strong results and the company is well positioned for 2012:
"You might imagine that we're pretty anxious to talk to you about how we did because there's a lot of caveats (ph) this quarter. As you saw from our press release, we had another great quarter with better-than-expected operational performance reflecting terrific execution and continued momentum in most of our key end markets, that yielded EPS above the high end of our range.
Now before we get to the financials, we're obviously pleased with the progress we made in the quarter on new repositioning actions, smartly redeploying book gains and CPG sale proceeds in the third quarter… (W)e utilize both the gain on the sale of CPG, as well as the OPEB curtailment gains to fund substantial business repositioning. That will deliver tangible benefits in 2012 and beyond."
During the third quarter, EPS exceeded the high-end of guidance and sales grew 8% organically, fueled by supportive end market demand. Management has thus far proved successful in reinvesting profits, cutting costs, and penetrating high-growth markets - a track record that will keep investors confident should a double dip occur. Great exposure in aerospace, turbo and ACS, coupled with greater productivity, will help drive outperformance. Honeywell has a stellar EE/MI story going for it with solid EPS expansion in the past.
Consensus estimates for Honeywell's EPS are that it will grow by 34% to $4.02 and then by 10.7% and 11.7% more in the following two years. Assuming a multiple of 16x and a conservative 2012 EPS of $4.38, the rough intrinsic value of the stock is $70.08, implying 24.1% upside. If the multiple were to plummet to 11x and 2012 EPS turns out to be 4.3% below consensus, the stock would fall by 17%. This may be worse risk/reward than what the market acknowledges, but nevertheless worthy of taking an interest if shares trend lower.
While Honeywell has produced stellar results, Emerson has produced poor results. First quarter EPS missed expectations by around 30%, which ranks among the top three industry misses over the last decade. Network is overly struggling, facing secular headwinds that have ravaged revenue. Process may be partly excused due to the effect of the Thailand flooding, but climate has disappointed. In light of this struggle, it is stunning that management reiterated EPS, which would require 17% earnings growth for the remainder of the year.
Consensus estimates for Emerson's EPS are that it will grow by 9.3% to $3.54 and then by 12.4% and 16% more in the following two years. Of the latest 18 revisions to EPS, all have gone down for a net change of -2.1%. Assuming a multiple of 15.5x and a conservative 2012 EPS of $3.69, the rough intrinsic value of the stock is $57.20, implying 19.6% upside. If the multiple were to decline to 11x and 2012 EPS turns out to be 13.6% below consensus, the stock would fall by 20.9%. While the latter case is not likely, exaggerated correlation to the market makes it a cause for concern in the context of poor economic forecasts. Keep in mind, however, that peers are trading around 17x, so the potential is geared toward multiples expansion.