Emerson Electric: A Spin-Off Followed By A Major Acquisition? Bet On It

| About: Emerson Electric (EMR)

Summary

Recent earnings exceeded expectations due to restructuring efforts and an improved operational performance as the company faces weakness across its businesses.

The company expects adverse operating economic conditions to continue, but does recognize signs of demand stabilization and improving order trends.

The company has been focusing on driving revenue and earnings growth by exiting low-margin businesses and focusing on higher-margin businesses.

The company is raising funds through divestitures and its network power division spin-off and will likely announce a substantial acquisition soon after such spin-off.

An investment in the company’s shares will pay investors an over 3.5 percent dividend as the company transforms by acquiring businesses with higher margins to drive growth.

Emerson Electric (NYSE:EMR) is a company in transition as it has struggled in the face of a weak global economy and deeply depressed oil prices (אhe financial media has frequently noted that depressed oil prices have adverse effected EMR's largest division, which provides software and instruments for controlling and measuring liquids that assist oil explorers to efficiently pump oil). The company is an industrial conglomerate operating in five business divisions: 1) process management; 2) industrial automation; 3) network power; 4) climate technologies; 5) and commercial and residential solutions. EMR, however, is not standing still in the face of significant headwinds negatively affecting its businesses.

The most significant initial step the company is taking is the spin off of its network power division through a tax-free distribution to shareholders as part of its plan to streamline its business portfolio, drive revenue and earnings growth. In particular, EMR announced it would spin off its network power division by the end of 2016. In addition, at that the time the company announced such spin-off it also announced it would explore strategic alternatives for its motors and drives, power generation and remaining storage businesses. Finally, the company indicated that it would review and assess its corporate services and structure to bring them into alignment with its smaller scale. A current or potential investor in EMR shares should recognize that each of these steps announced by the company will raise additional funds that we believe will be used for acquisitions that will drive revenue and earnings growth in addition to higher margins.

EMR's network power division will become a spun off company that will be the global leader and provider of thermal management, A/C and D/C power, transfer switches, services and infrastructure management systems for the data center and telecommunications industries. The upcoming spin-off of EMR's network power division is another step it is taking to exit many of its weaker-performing businesses and to allow it to improve growth of its better-performing divisions through acquisitions.

In a previous article, we noted that EMR would engage in a strategy to grow long-term through acquisitions. A spin-off of the network power division will allow the company to finance acquisitions as the company will receive a cash dividend from the spun-off network power division. Further, any additional divestitures taken by EMR will provide additional financing for acquisitions. (For a more detailed analysis on EMR's acquisition options, in addition to our above-noted article, see this article.) In the last few years, EMR has not announced any significant acquisitions, but rather has been focusing on improving revenue and earnings growth by exiting low-margin businesses and focusing on higher-margin businesses. EMR investors, however, have believed in recent years that the company should make more substantial acquisitions to boost revenue and earnings growth as efforts to boost organic growth in the past have failed. Analysts and investors have suggested the company grow its business in discrete automation (the equipment and software for assembly lines) through acquisitions of companies or business divisions such as: 1) National Instruments Corporation (NASDAQ:NATI); 2) Mitsubishi Electric Corp.'s factory-automation division; or 3) Rockwell Automation Inc. (NYSE:ROK).

We believe as well that the company needs to take more significant steps to reignite revenue and earnings growth through more substantial acquisitions. We also believe that investors should consider EMR's shares during a substantial overall market sell off and collect an over 3.5 percent dividend to reinvest until the company announces further steps to drive growth in the intermediate term.

Fiscal second quarter 2016 earnings

In early May 2016, EMR announced adjusted earnings of 66 cents per share, a 1.5 percent increase from the year-ago quarter. Net sales decreased 9 percent from the year-ago quarter to $4.928 billion due to a weak macroeconomic environment and a significant decrease in spending by global customers in the oil and gas and industrial markets. The company's process management division's net sales decreased 11 percent to $1.828 billion due to weak orders from weak global spending in the oil and gas industry. The industrial automation division revenues decreased 16 percent to $870 million due to continued weakness in industrial spending and upstream oil and gas markets. Revenue for the network power division decreased 4 percent to $1.018. The climate technologies division revenue, however, increased 1 percent to $995 million due to strong demand in the U.S. residential and commercial air conditioning market. The commercial and residential solutions division revenues decreased 15 percent due to $394 million due to the company's divestiture of its commercial storage business. (Excluding the divestiture, revenue increased 2 percent due to an improving U.S. construction market.).

EMR expects net sales for fiscal 2016 to decrease 5 percent to 8 percent. The company also expects adjusted earnings per share for fiscal 2016 to be from $3.05 to $3.25.

Our View

EMR's most recent earnings report exceeded expectations due to restructuring efforts and an improved operational performance as the company continues to battle weakness across its businesses and weak revenue growth. The company expects adverse operating economic conditions to continue, but does recognize signs of demand stabilization and improving order trends. The company also expects a continued weak global economic environment, a strong U.S. dollar, depressed industrial spending and weakness in emerging and mature economies. Further, EMR expects lower near-term profitability due to weakness in sales and costs in restructuring initiatives. The company's cost cutting and restructuring efforts, however, are improving margins and cash flow and will continue to benefit the company.

In recent years, the company has been focusing on driving revenue and earnings growth by exiting low-margin businesses and focusing on higher-margin businesses. Even with such focus on higher-growth businesses, however, the company will likely need to make more substantial acquisitions to increase revenue and earnings growth. We believe too that the company needs to take more significant steps to drive growth. Strategic acquisitions in growing markets that enjoy higher margins would allow EMR to expand its presence in growing industries while decreasing its overall reliance on its oil-price-pressured process management division.

EMR's current price-to-earnings ratio is about 17.95, and the forward price to earnings ratio is 16.80 based on the company's fiscal 2016 earnings estimate of $3.09, and 15.70 based on the company's fiscal 2017 fiscal year earnings estimate of $3.31. We should note that earnings estimates for both years have increased slightly in recent months. Look for EMR to announce an acquisition as its network power division approaches or within the year after such spin off occurs. EMR's free cash flows from its business operations added to cash already held when added to cash received from any divestitures or spin-offs will provide more than adequate funds to make medium or large sized acquisitions near term.

In addition, the company halted its share repurchase plan in its fiscal second quarter 2016 to build up its cash pile in anticipation of funding possible acquisitions. Investors could play this scenario in two ways. They can purchase EMR shares on weakness between $45.00 and $49.00 during an overall market sell off or they can purchase potential acquisition targets NATI or ROK as noted above. Finally, we continue to note that in recent years a few EMR insiders have made what we consider substantial insider purchases that signal to us such insiders' belief in the company's transformation plan.

In the near term, EMR investors will be paid an over 3.5 percent dividend yield to reinvest as the company transforms. Over the long term, we believe EMR's transformation will reward investors with increasing dividends, substantial share repurchases, and share price appreciation from revenue and earnings growth due to upcoming acquisitions.

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Disclosure: I am/we are long EMR, NATI.

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.