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.
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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
Year | P/E ratio | Change |
---|---|---|
2021 | 20.1 | -12.83% |
2020 | 23.1 | 6.98% |
2019 | 21.6 | |
2017 | 27.9 | 23.85% |
2016 | 22.5 | 79.94% |
2015 | 12.5 | -35.78% |
2014 | 19.5 | -21.51% |
2013 | 24.8 |
Emerson Electric's price/earnings ratio in 2013-2022 Source: CompaniesMarketCap
The average P/E ratio in the 10-year period 2013-2022 was 20.89. This is also higher than the current corresponding ratio. I think that acquisitions and divestitures, of course, cloud the objectivity of this valuation metric, but it still gives a rough idea. Also, the ((FWD)) P/E ratio of 18.64 is slightly lower than the last 10-year average ratio of 20.89.
However, since we no longer live in extremely low interest rate conditions, past valuation metrics may not be correct. Emerson Electric has a FWD EPS of $4.21 and a FWD PE of 18.64. Based on this data, we would get a fair price for the company at $78.47. This is significantly lower than the $102.49 obtained based on previous metrics. But it does suggest that Emerson Electric is also currently trading at a reasonable valuation.
Other valuation metrics also suggest that the stock is rather undervalued. For example, the P/B metric below:
Emerson Electric's P/B metric and fair value of the company (www.finbox.com)
Here I use the Finbox.com portal model to determine the fair value of the company based on the P/B metric. As you can see from the slide above, Emerson Electric's historical average P/B ratio has been 5.0. However, the current P/B ratio is 4.1. Finbox's model shows the fair value of the company according to this metric to be $95.56. The room price increase is, therefore, currently 15.39%.
Or let's look at the P/S ratio:
Emerson Electric P/S metric and fair value of the company (www.finbox.com)
The company has a current P/S ratio of 2.3. Selected FWD P/S multiple is 3.3 according to the Finbox model. The model puts the company at a fair value of $93.32 based on the P/S metric.
There is no single valuation metric that one would prefer, but various metrics suggest that Emerson Electric's stock is in my opinion currently rather undervalued.
Industrial Automation Provides Growth Opportunities
The industrial automation software market CAGR to 2030 is 7.9%-8.84% according to Mordor Intelligence and Spherical Insights. If in 2021 the size of this market was $177 billion, by 2030 it is predicted to be $441.7 billion.
Global Industrial Automation Market Growth Forecast 2021-2030 (www.sphericalinsights.com)
On the basis of components, the industrial automation market is classified into hardware, software and services. Among them, in my view, the services segment will grow the fastest in the coming years, as these services reduces time and costs associated with optimizing systems. Emerson Electric's latest acquisitions have been made precisely with the services segment in mind.
Another important growth driver in this market is the Industrial Internet of Things ('IIOT') as it helps to create and streamline effective, affordable and responsive systems architectures. Acquired companies such as National Instruments (NATI) and Aspen Technology (AZPN) have significant roles in the Industrial Internet of Things space.
According to Spherical Insights :
On the basis of industries, the global industrial automation market is segmented into chemicals, aerospace & defense, automotive, healthcare & medical devices, energy & utilities, manufacturing, oil & gas, mining, electronics & semiconductors and transportation. Among them, the manufacturing segment has the largest 38% market share in the upcoming period.
The Results Of The Last Quarter Are Promising
The coming years will likely show whether the acquisitions and divestitures will justify themselves. The question always remains whether the acquisitions carried out were made at a reasonable price. I believe that one way to check if this is reasonable is to see whether or not the company can consistently beat forecasts for subsequent quarters. The newly published results for the 2nd quarter of 2023 are promising anyway. The company's adjusted EPS were $1.09. This result beat the estimate of $0.97 by 12.37%. Sales results beat estimates by 3.01%, coming in at $3.76 billion vs. $3.65 billion, respectively.
Emerson Electric Company 2023 Q2 Performance Summary (Earnings Call Presentation)
Next, let's look at the company's results based on business segments. Beginning in the first fiscal quarter of 2023, the company began reporting under two segments. These are the Intelligent Devices and Software and Control Automation Solutions segments. Sales of The Intelligent Devices segment increased to $2.924 billion. Compared to the 2nd quarter of 2022, the increase was 10%. The Software and Control Automation Solutions segment generated revenue of $853 million in the most recent quarter.
For a more detailed overview, let's also look at the four sub-segments of Intelligent Devices and two sub-segments of Software and Control Automation Solutions.
Subsegment name | Final Control | Measurement &Analytical | Discrete Automation | Safety & Productivity |
Revenue Q2 2022 | 884 | 769 | 644 | 355 |
Revenue Q2 2023 | 992 | 888 | 683 | 361 |
Growth rate | +12.21% | +15.47% | +6.05% | +1.69% |
Sub-segments of the Intelligent Devices segment. Figures are in millions of dollars.
Source: Yahoo Finance
Subsegment name | Control Systems & Software | AspenTech |
Revenue Q2 2022 | 573 | 188 |
Revenue Q2 2022 | 623 | 230 |
Growth rate | +8.72% | +22.34% |
Subsegments of The Software and Control Automation Solutions segment. Figures are in millions of dollars.
Among Emerson's sub-segments, Aspen Tech is growing the fastest. Compared to the second quarter of 2022, the increase in revenue here was 22.34%. But here it should be taken into account that Emerson owns only 55% of Aspen Technology. Currently, Aspen Tech's revenue accounts for only 3.3% of Emerson Electric's revenue. Aspen Tech probably won't be able to maintain a growth rate of more than 20% for long.
Below, I add Emerson Electric's profit forecasts for the next 10 quarters. If the company can exceed a large part of them in its results, then the acquisitions can be considered successful. Of course, changes in market conditions can also play a role in the results, but it still gives a general picture of the effectiveness of the undertaken restructuring.
Fiscal Period Ending | EPS Estimate | YoY Growth | Low | High | # of Analysts |
---|---|---|---|---|---|
FQ3 2023 (Jun 2023) | 1.09 | -20.80% | 1.04 | 1.11 | 15 |
FQ4 2023 (Sep 2023) | 1.25 | -18.62% | 1.18 | 1.32 | 15 |
FQ1 2024 (Dec 2023) | 0.94 | 21.13% | 0.89 | 0.97 | 8 |
FQ2 2024 (Mar 2024) | 1.16 | 6.44% | 1.12 | 1.20 | 7 |
FQ3 2024 (Jun 2024) | 1.22 | 11.70% | 1.15 | 1.26 | 6 |
FQ4 2024 (Sep 2024) | 1.35 | 8.06% | 1.25 | 1.39 | 6 |
FQ1 2025 (Dec 2024) | 1.03 | 8.72% | 1.02 | 1.03 | 2 |
FQ2 2025 (Mar 2025) | 1.23 | 6.30% | 1.19 | 1.28 | 2 |
FQ3 2025 (Jun 2025) | 1.29 | 5.80% | 1.28 | 1.30 | 2 |
FQ4 2025 (Sep 2025) | 1.43 | 6.15% | 1.39 | 1.47 | 2 |
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.
Company | EMR | AME | WEGZY | ROK | NJDCY | LGRDY |
ROE % | 20.63% | 16. 24% | 33.06% | 40.98% | 3.40% | 16.66% |
Return on equity for Emerson Electric and similar companies. Source: Seeking Alpha
2013 | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 |
18.9% | 21.2% | 33.5% | 21.6% | 17.4% | 24.6% | 28.0% | 23.4% | 23.3% | 31.2% |
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:
Emerson Electric: The Coming Years Will Show The Effectiveness Of The Acquisitions