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Emerson Electric Co.: Weak 2020 Guidance Pressures Sentiment

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About: Emerson Electric Co. (EMR)
by: BOOX Research
BOOX Research
Contrarian, long/short equity
Summary

EMR reported its fiscal Q4 earnings mostly in line with expectations, while a weak outlook with flat growth for the year ahead was disappointing.

Automation Solutions has been the growth driver while the drop in sales from the HVAC and air-cooling business was blamed on the weather.

EMR is a dividend aristocrat and the company just announced a new dividend increase to a new quarterly rate of $0.50 per share. The stock yields 2.7% on a forward basis.

Emerson Electric Co. (NYSE:EMR) is an industrial conglomerate with global operations structured between its two main businesses: Automation, and Commercial & Residential Solutions. The company produces a variety of equipment and technologies from process manufacturing parts and instrumentation, refrigeration and HVAC systems, along with several household consumer appliance brands. Investors are attracted to the company given its steady growth and impressive 63-year history of consecutive annual dividend increases, making EMR one of the original dividend aristocrats. The company just reported its Q4 fiscal 2019 earnings presenting another year of growing profits even as management noted a difficult macro environment with a more cautious outlook for 2020. This article recaps the latest results and our view on where the stock is headed next.

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Source: Finviz.com

EMR Q4 Earnings Recap

EMR reported its fiscal 2019 Q4 earnings on November 5th with non-GAAP EPS of $1.07 which was in line with expectations while GAAP EPS of $1.16 beat market estimates by $0.08. Both measures of earnings represented a strong 20% year-over-year increase compared to fiscal 2018. Revenues in the quarter of $4.97 billion were up by 1.6% compared to the period last year, and slightly below published consensus.

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Source: Company IR

The story this quarter was the firming margins even as growth continues to be tepid. The gross profit reached 42.8%, up 70 basis points compared to last year, and also the highest gross margin since 2017. The company made a successful effort at holding down costs and expenses as SG&A as a percentage of sales fell 180 basis points driving an adjusted EBITDA margin of 22.8% from 20.7% in Q4 last year. The results for the full year fell within the range of guidance the company offered back in 2018 with the full year EPS result at $3.71, just above the top end of the guidance range.

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Source: Company IR

By segment, management noted a strong performance in Automation Solutions as net sales increased by 4% year over year on the quarter. Growth was supported by strong demand in "process and hybrid end markets" particularly from Asia, Middle East & Africa with sales up 10% while the North American upstream oil and gas business remained negative and was a weak point in the quarter. Automation Solutions has been the growth driver for the company with segment sales increasing by 7% for the full year

Results were weaker for the Commercial & Residential Solutions segment as net sales decreased 3% in the quarter with the company blaming cooler weather in the North America market as pressuring sales of air conditioning and HVAC systems. Results were also weak in Europe with sales down 2% y/y while a 7% decline in the Asia, Middle East & Africa region is more concerning. The company sees broader macro headwinds as pressuring growth globally going forward.

EMR Fiscal 2020 Guidance

Guidance announced for the year ahead was on the soft side with management targeting net sales growth in a range between negative 3% to positive 1%, while the adjusted EPS of $3.60 at the midpoint if confirmed would be 3% below this year's $3.71. The company appears overall bearish on the macro outlook with CEO David Farr making the following comments during the conference call:

With the slowing macroeconomic backdrop and continuing geopolitical tension, we are planning for a lower no growth environment in 2020. For the full year, we expect underlying sales growth of down 2% to up 2% with Automation Solutions down 1% to up 3% and Commercial and Residential Solutions down 3% to up 1%. We expect reported sales to be slightly down with a point of FX headwind on the stronger dollar... also I'm concerned, that's something is going to happen here from an election standpoint or Europe or something happens in the Middle East and the GFI forecast numbers are really going to happen. If that happens, we are going to be looking at a very low growth.

The company is hoping to support earnings based on the expectation of maintaining pricing even as they expect some tax, FX, and stock compensation headwinds to the bottom line. Favorably, the operating cash flow guidance for 2020 at $3.1 billion compares to $3.0 billion in 2019.

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Source: Company IR

One of the important developments for the company was an announcement back in October that the Board of Directors was initiating a strategic review. Emerson hopes to present the findings and conclusions at the annual investor conference in February 2020. The company noted that, some "restructuring investments" are likely to be announced, although the current 2020 guidance isn't considering any potential measures. In this regard, we view it as likely the EPS numbers would be revised lower through next year. From the earnings conference call:

As announced on October 1st, the Board initiated a review of operations, capital allocation, and portfolio initiatives, the 2020 outlook framework presented here does not include any potential implications of the Board's review. At our February Investor Conference, we expect to present a detail the outcome of the Board's review and an updated 2020 framework -- outlook framework. Although we anticipate significant restructuring investments in 2020 as a result of the Board's review, our adjusted guidance framework excludes restructuring charges entirely. That is we have zero restructuring charges built into the outlook.

A Dividend Aristocrat

It's important to remember that Emerson Electric is a dividend aristocrat with a very impressive 63-year history of increasing the quarterly rate, one of the longest streaks in the market. The company just announced its latest dividend increase to a new quarterly rate of $0.50 per share, a 2% increase from the previous quarterly. We expect the company to take a conservative approach towards future rate hikes in the 1%-2% range keeping the earnings payout ratio around 50%-55% on earnings. The stock yields 2.7% on a forward basis, which is on the lower end of the 10-year trading range. By this measure, the stock is relatively expensive.

ChartData by YCharts

Analysis And Forward-Looking Commentary

Overall, our take is that the numbers for EMR are "OK" but comments by management haven't been confidence-inspiring. This is a case where the financial profile appears firm while the operating outlook is weaker. We think the near-term risks to the stock price are tilted to the downside.

In terms of valuation multiples, the numbers here are otherwise reasonable, considering a P/E ratio of 20.8x, EV to EBITDA at 13.1x, even if they are slightly above the 5-year and 10-year average for the company. Price to free cash flow at 21.5x has already trended higher in recent years as a weak point compared to a 10-year average of 15.5x.

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Source: Data by yCharts/table by author

The concern here into 2020 is the weak growth, which by management's own revenue guidance is set to be flat and EPS may fall by 3%. It's also disappointing that the company is presenting weak momentum in regions like Asia and Europe for its Commercial and Residential Solutions business. We expect the stock to trade with higher volatility as the pessimistic macro comments by management attracts a bearish sentiment.

Takeaway

Emerson Electric with a 152-year history has rewarded shareholders with steady growth and impressive returns continuously proving itself capable of evolving to remain relevant in a changing market. While reporting an increase in EPS and record profits for its fiscal 2019, revenue growth has slowed, and the company is taking a more cautious view for 2020.

We find it difficult for the stock to climb significantly higher in the near term without a boost to sentiment or better than expected results for the upcoming quarters. Investor monitoring points should include trends in margins and the company's performance in regions beyond the United States. We rate shares of EMR as a hold.

Disclosure: I/we 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.