WHR - Emerson Electric: Interesting Times

Summary

• In November 2022, I found shares of Emerson Electric Co. a bit too rich at $96.
• I concluded that there were many moving parts on the portfolio of businesses, perhaps a bit too much movement.
• Emerson Electric Co. shares have fallen to the $80 mark, which looks interesting, albeit that Emerson has gotten involved in a hostile deal to acquire National Instruments.
• This casts additional uncertainty at this point in time, as the appeal looks evident, yet I am waiting for a small further pullback before initiating a position.

In November, I concluded that Emerson Electric Co. (EMR) was pursuing a continued transition, as the company was allocating money into higher growth and higher margin businesses, divesting more challenged business activities.

The strategic rationale made sense, but created a complicated picture in the meantime, as the situation is quite complicated by many moving parts. I like the long-term potential, as the pace of the transition is a bit too quick for me.

The Base

Emerson Electric was an $18.2 billion diversified industrial play in 2021, reporting sales across two segments. The largest was the $11.6 billion automation solutions segment, posting margins of 18%. This was complemented by a $6.7 billion commercial and residential solution, posting margins of 21%.

The company posted adjusted earnings of $4.51 per share, with the company guiding for modest growth in 2022 sales and earnings, while net debt of $4.3 billion was largely in line with reported EBITDA. The 601 million shares traded at $91, as the company commanded a $55 billion equity valuation and $60 billion enterprise valuation, with shares trading at 20 times earnings.

What followed were some complicated deals, as the company announced the acquisition of a majority stake in AspenTech in a rather complex deal in which the company would hand over its OSI and Geological Simulation assets at a $2.5 billion valuation. Emerson, furthermore, paid $6 billion to obtain 55% of the equity in the new business. That complicated and expensive deal made me cautious at $91 in 2021.

Since the end of 2021, shares had traded in a $70-$100 price range while the company hiked the 2022 earnings guidance to about $5 per share, as the company announced a $3 billion deal to divest the InSinkErator business to Whirlpool Corporation ( WHR ) .

In October, the company announced the sale of a majority stake in the climate technologies business (part of commercial and residential business) to Blackstone at a $14 billion valuation. The deal includes HVAC and refrigeration assets generating $5 billion in sales, as the company was set to receive $9.5 billion in pre-tax proceeds, while maintaining a 45% minority stake in the business.

The company, furthermore, posted 2022 results at the time, with sales up 8% to $19.6 billion, and adjusted earnings up 16% to $5.25 per share. Note that results from continuing operations only came in at $13.8 billion in sales and earnings of $3.64 per share, that is pro forma the divestment to Whirlpool and the deal with Blackstone. With 595 million shares outstanding at $96, and believing that the company operated with a net cash position of around $10 billion (or $17 per share), operating assets trade at $80.

This looked like a rich valuation in relation to the pro forma earnings power. This was the case, even as the company called for 2023 sales to rise by 7-8%, with earnings seen at $4.00-$4.15 per share, including a $2 billion share buyback program.

The pace of the transition and the valuation of the Blackstone deal left some question marks with me. A potential IPO or spin-out might have been real good alternatives as well in my eyes. That said, I concluded that dips to the $80 marks might be interesting given the long term growth profile.

Coming Back

A $96 stock late in 2022 has now come down to $82, marking quite a significant pullback while markets at large have done quite well. Investors were spooked by an apparent hostile acquisition attempt to acquire National Instruments Corporation ( NATI ), as announced mid-January. The company has made an offer to acquire the company at $53 per share, valuing the business at $7.6 billion to thereby essentially wipe out its pro forma net cash position.

National Instruments posts $1.7 billion in sales, suggesting that Emerson is willing to pay a 4.5 time sales multiple for the business. This high valuation seems justified by the higher gross margins of the to be acquired business and the strategic rationale, with National Instruments appearing to be less efficient in terms of sales productivity, and general cost effectiveness, making it essentially a turnaround story. Clearly, Emerson sees potential to increase subpar margins to a premium compared to own reported margins.

The company has been talking to National since the spring of 2022, but talks have not gone anywhere and hence the company has gone hostile by making the talks public. The deal is driven by the rationale to increase the focus on automation. A week later, Emerson announced that it saw some progress since the initial deal announcement, although it has been quiet ever since on this front.

Early in February, Emerson announced a 7% increase in first quarter sales to $3.4 billion, with underlying sales growth reported at 6%. The company already closed on the $2 billion buyback program, with adjusted earnings posted at $0.78 per share. For the year, the company still maintained the (adjusted) guidance. The company ended the quarter with $7.6 billion in net debt, that is, after the InSinkErator deal has closed already but the deal with Blackstone not yet, of course.

A current share count of 588 million shares have now fallen to $82 per share, for a $48 billion equity valuation. This is equal to about 3 times sales and about 20 times earnings, although the current debt load is a bit uncertain as we are awaiting after-tax proceeds from the Blackstone deal.

Continued Uncertainty

The elevated Emerson Electric Co. dealmaking pace has only continued. Not just is the Blackstone deal still pending, the issue is that the hostile deal for National Instruments casts some additional uncertainty on top of this. This pace of dealmaking seems a bit elevated, but I am happy to see a meaningful pullback in the share price.

While Emerson Electric Co. shares are now back to the $82 mark, basically the levels at which I saw appeal in November, there have been the moving parts which complicated the picture, of course. Given all this, I am a bit cautious, as National Instruments will cast some uncertainty for a time to come. Waiting on some implications of the dealmaking spree, I have cut my desired entry level for Emerson Electric Co. to around $75 per share here, as the picture remains tumultuous for some time to come.

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