ROK - Emerson Electric: The Coming Years Will Show The Effectiveness Of The Acquisitions

2023-06-05 05:38:24 ET

Summary

• Entering the automation markets gives the company an opportunity for further growth.
• Emerson Electric has a reasonable valuation at this point.
• The company's sensitivity to recession should not be a problem for the long-term investor.
• The results of the following quarters will show whether the restructuring was effective. My rating for Emerson Electric stock is currently a Buy.

Editor's note: Seeking Alpha is proud to welcome Aaro Pertmann as a new contributor. It's easy to become a Seeking Alpha contributor and earn money for your best investment ideas. Active contributors also get free access to SA Premium. Click here to find out more »

Investment Thesis

Companies that bravely go along with change are usually more successful than those that stick with their business model in the past. The investor is reassured to know that the implementer of change is an experienced manager and that the company has a long history of successful operations. A favorable valuation gives an opportunity to find a good timing for the purchase. It is in my opinion that Emerson Electric (EMR) is in the situation described above.

Investors' Hesitancy Has Pushed Down The Share Price

Emerson Electric has a long and distinguished history of operations, which has led it to the ranks of dividend kings. For 65 years in a row, the company has been able to increase dividends. However, slow growth has become a problem for Emerson. Several acquisitions and divestments have been made in recent years to increase sales and profit growth. The restructuring has created many "moving parts" and has caused hesitation among investors. These hesitations are also reflected in the fall in the share price during the last six months.

While the company's profit growth has been modest in recent years, on the other hand, during the Great Recession period of 2007-2011, the results were impressively good.

• 2007 earnings-per-share of $2.66
• 2008 earnings-per-share of $3.11 (17% increase)
• 2009 earnings-per-share of $2.27 (27% decline)
• 2010 earnings-per-share of $2.60 (15% increase)
• 2011 earnings-per-share of $3.24 (25% increase)

E merson Electric Co. EPS 2007-2011. Source: Sure Dividend

The company currently has a price-to-earnings ratio of 16.10. However, its 5-year average P/E ratio is 20.79. The current valuation is 22.55% cheaper compared to the 5-year average. Based on the fact that the company's TTM EPS is currently $4.93 and the 5-year average P/E ratio is 20.79, we get a fair price of Emerson Electric at $102.49. So we currently have a margin of safety as high as 19.20%.

A longer 10-year view of this ratio gives the following result:

PE ratio at the end of each year

Emerson Electric's quarterly earnings forecasts as of 05/31/2023

Source: Seeking Alpha

As we can see, YoY growth is projected from Q1 2024 onwards. However, the next two quarters are forecast to show declining profits compared to a year ago due to restructuring.

I think the financial health of Emerson Electric is quite satisfactory. The company's current debt/equity ratio is 0.89. This is roughly the average rate for the last 5 years. Therefore, there is no need to worry about excessive leverage now.

An Economic Moat Protects Against Recession

Although the company has shown sensitivity during periods of market downturns, it still has a strong economic moat that gives confidence to the long-term investor. Emerson's innovative solutions give it the opportunity to influence the price. This is also reflected in high ROE figures.

Emerson's return on equity is currently average among its peers, but it has managed to maintain an ROE of around 20% over the long term.

Return on equity for Emerson Electric and similar companies. Source: Seeking Alpha

Emerson Electric's ROE in 2013-2022

Source: roic.ai

In the field of industrial automation, there are companies with even higher long-term return on equity numbers (for example, Rockwell Automation (ROK)), but its business model is slightly different from Emerson's.

Risks

The most important risk factor for Emerson Electric, in my opinion, is whether acquisitions and divestitures are effective. I mean whether they will achieve the expected growth in the future. If they are not, it can lead to years of downtime for the company and give competitors an advantage. Even if the acquisitions are made at a slightly too high price, it is not a big problem in the long run. It is important that the acquired businesses are able to grow and be innovate.

The restructuring of Emerson Electric is significantly related to the issue of climate change. It is a broad field related to various innovative products and services. The success of Emerson Electric depends on how effectively automation solutions can make companies' production activities more environmentally friendly. At the same time, here the company has so-called to hurry "slowly". The reason is that the company is still significantly involved in the products and services offered to the oil sector. The association with the oil sector cannot be cut off overnight because it would cause a sharp decline in revenue.

Whether the undertaken restructuring will be successful will be shown by the results of the coming years. If the quarterly results start falling short of forecasts several times in a row, this is a hint to the investor that the restructuring has not been successful.

High interest rates due to the current economic environment are rather temporary in nature. They do have a negative effect on Emerson Electric's business, but they also have the same inhibiting effect on competitors. Thus, high interest rates have no intrinsic effect for decades. Much more important for Emerson Electric is to maintain innovation and an economic moat over competitors.

Conclusion

I believe EMR is a buy at this point. The restructuring of the company creates a good premise for growth and the valuation is reasonable. Emerson's new CEO has already worked for the company for a long time and has extensive experience in leading the field. The industrial automation sector has good growth prospects for the next decade. In my view, Emerson Electric has favorable prospects for profiting from this fourth industrial revolution.

For further details see: