In an earlier article here, I explained why the 20% downside for Emerson Electric (EMR) was worrisome and recommended Honeywell (HON) as an alternative investment for exposure into industrials. Since then, Emerson has fallen by 8.2% and been outperformed by Honeywell by 1,740 basis points. The company is still rated a "hold" on the Street vs. a "buy" for Honeywell.
From a multiples perspective, Emerson appears to be cheaper. It trades at a respective 16x and 13.2x past and forward earnings while Honeywell trades at a respective 25.5x and 11.9x past and forward earnings. In addition, Honeywell's current PE multiple is 136% its historical 5-year average while Emerson is roughly in-line. But even after factoring in substantial multiples contraction, we still find that Honeywell will outperform.
At the first quarter earnings call, Emerson's CEO, David Farr, noted an optimistic outlook despite recent disappointment:
[W]e had a very challenging quarter, and as we discussed in December, there's a lot of moving parts. And we still expect a record year in sales, profit margins, net earnings, cash flow, free cash flow and a 20-plus percent return on total capital. The management team, the organization, the people across this company clearly know we have created a huge hole that we have to dig out of in the rest of this year.
Orders in December decelerated from those in November, but management nevertheless reiterated sales growth of as high as 7% for 2012. Much of the poor results in December were expected due to the Thailand flooding impact and visibly poor business trends. ROIC is estimates to expand by around 480 bps to 27.2% in 2014 as net cash quickly convert into a net cash position. Going forward, network power and climate technologies, however, are fundamentally weak and will offset gains in tools and process.
Consensus estimates for Emerson's EPS forecast that it will grow by 8% to $3.50 in 2012 and then by 13.4% and 11.3% in the following two years. Modeling a CAGR of 10.9% for EPS over the next three years and then discounting backward by a WACC of 9% yields a fair value figure of $56.26, implying 7.8% upside.
Honeywell, on the other hand, had stellar performance in its most recent quarter. EPS came above the high-end of guidance as sales grew 7% organically off of greater exposure to emerging markets. Margins expanded by 90 bps to 15.1% while an impressive $1.4B worth of free cash flow was generated. Margins, ROIC, and net cash flow are all anticipated to grow as productivity gains continue to drive value creation.
Consensus estimates for Honeywell's EPS forecast that it will grow by 9.9% to $4.45 in 2012 and then by 11.7% and 12.5% in the following two years. Assuming a multiple of 15x and a conservative 2013 EPS of $4.91, the rough intrinsic value of the stock is $73.65, implying 24.1% upside. This multiple, however, is well below the 5-year historical average and thus provides a safe estimate.