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Is Emerson Electric Stock a Buy?

Lee Samaha, The Motley Fool

Emerson Electric's (NYSE: EMR) second-quarter report certainly didn't pan out as expected, and its full-year guidance cuts disappointed investors, especially given that it also updated its forecast with a more favorable than previously expected tax rate for 2019. Is it time to throw in the towel on a stock that looked like a good value just a couple of months ago? 

What happened to Emerson Electric?

In a nutshell, conditions were weaker than expected in both of the company's segments -- underlying sales growth slowed to 4% in the quarter -- and management consequently reduced its full-year sales and earnings growth forecasts.

Emerson Electric Underlying Sales Growth

Data source: Emerson Electric presentations. Chart by author.

As you can see in the table below, the EPS guidance reduction wasn't really that significant, but bear in mind that the company's full-year tax rate is now expected to be around 23%, compared to a previous estimated range of 24% to 25%. That's worth around $0.10 per share, assuming the midpoints of the earnings and tax guidance ranges.

While it's not a major difference in the near term, it would be a concern if the slippage in underlying sales growth indicated a beginning of a trend that extends into 2020.

Metric

New 2019 Guidance

Prior 2019 Guidance

Automation Solutions (AS) underlying sales growth

5%-7%

5%-8%

Commercial & Residential Solutions (CRS) underlying sales growth

2%

3%-5%

Total underlying sales growth

4%-5.5%

4%-7%

GAAP EPS

$3.60-$3.70

$3.60-$3.75

Operating cash flow

$3.2 billion

$3.2 billion

Free cash flow

$2.55 billion

$2.55 billion

Data source: Emerson Electric presentations.

Automation solutions looked set for good results

On balance, the details from the quarter suggest that conditions in Emerson's most important end market are still solid, but there are areas of weakness that might not improve in the near term.

In automation solutions (AS), Emerson is more focused on process automation (continuous flow of fluid materials) than, for example,  Rockwell Automation's (NYSE: ROK) or Honeywell International's (NYSE: HON) process solutions businesses -- those two are more involved with automated processes in manufacturing.

However, looking at its peers' exposure to process automation reveals some good things. Honeywell reported   organic growth of 7% in its process solutions segment in its first quarter, and Rockwell's oil and gas based revenue grew by double digits in its recently reported fiscal second quarter.

Given that, there were high hopes that Emerson's heavy exposure to energy-related spending would stand it in good stead for 2019. So, what went wrong?

Why automation solutions could improve

The first, and easy to understand, issue is the slowdown in the global discrete automation market -- primarily seen in the automotive and semiconductor sectors. Frankly, a slew of companies, including Rockwell and machine vision specialist Cognex have lowered sales and earnings expectations to reflect a deterioration in the capital spending plans of their automotive and consumer electronics customers.

The second issue is a weakness in spending by upstream oil and gas companies in North America. Management cited a few points:

  • There was a pause in spending in the Permian Basin.
  • Rough winter weather caused a decline in new activity in the Bakken Field in North Dakota.
  • Infrastructure investment in Western Canada suffered from "political hesitation," according to AS President Lal Karsanbhai. 

It's hard to know how matters will play out in terms of Canada's political atmosphere, but Bakken-related spending is likely to pick up with improving weather. Meanwhile, management went into some detail about what drove the pause in Permian Basin spending: The sub-$45 price of oil at the end of 2018; a lack of takeaway capacity; and an industry consolidation that led to better capital-management strategies among oil companies.

But here's the good news for Emerson. The price of oil has steadily risen in 2019 (it's around $63 as I write), and the ongoing investment in pipelines means new takeaway capacity is set to come online in the Permian in the second half. Meanwhile, oil companies' conservative stance on spending will surely relax if the price of crude stays stable.

Indeed, the management teams at Rockwell and Honeywell both expressed confidence that capital spending by the oil and gas industry would improve, based on current oil prices.

Oil pipelines.

A lack of takeaway capacity in the Permian basin hurt Emerson Electric in the second-quarter. Image source: Getty Images.

Commercial and residential solutions

The problems in the CRS business appear to be limited to a combination of some inventory destocking in North America, and weakness in its Southeast Asia and Middle East markets. The former issue could resolve soon enough, provided end demand remains strong. 

In the case of the latter issue, regional growth was "slower than expected, putting our expected Asia recovery two months to three months behind plan" said Director of Investor Relations Timothy Reeves. In addition, CRS President Bob Sharp spoke of challenges due to "competitive dynamics in the region."

However, Sharp also noted that "April has turned out in line or I'd say a little above our expectations in orders. So we're confident about how the second half is going to play out."

A stock to buy

All told, Emerson Electric's AS end markets look likely to improve in the second half, and CRS looks set to improve too. Moreover, the updated guidance puts the stock on a forward PE ratio of 18.5, and forward price-to-free-cash-flow ratio of 16.2. Throw in the stock's dividend, which is yielding near 2.8%, and Emerson Electric still looks attractive despite last quarter's negatives.

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Lee Samaha owns shares of Honeywell International. The Motley Fool owns shares of and recommends Cognex. The Motley Fool has a disclosure policy.