I've commented before that Emerson Electric (NYSE:EMR) is an “it's always something” company – there's always something going a little wrong with some part of the business and creating worries for long-term investors. To that end, while Emerson's reported sales growth was actually pretty good on a relative basis this quarter, the incoming orders look ugly, management sounds pessimistic about the second half, and there are still serious issues in network power. While I do believe Emerson would be worth more than today's share price if it could fix its persistent problems, I have incrementally less confidence that management can.
Fiscal Q2 Results – Where Is Your Focus?
How Emerson did this quarter really depends on your point of reference. Results were below expectation, but then with all of the disappointments in the industrial sector that's hardly a surprise. Relative to what other companies delivered this quarter, you could make the argument that Emerson was a relative out-performer.
Revenue rose almost 1% as reported, or about 2% on a core organic basis. That stacks up pretty well against General Electric's (NYSE:GE) industrial business (down 6%), Honeywell (NYSE:HON) (down 1%), United Technology (NYSE:UTX) (down 2%), Illinois Tool Works (NYSE:ITW) (down 3%), Eaton (NYSE:ETN) (down 5%), or Dover (NYSE:DOV) (down 1%). But then again, it was also inferior to ABB's (NYSE:ABB) 3% organic growth, so like I said, it's a matter of perspective.
Process management led the growth, with sales up 9% and much better than the up 1%/down 1% mix of ABB, Honeywell, Alfa Laval, and Rockwell (NYSE:ROK). Industrial automation sales were hurt by inventory corrections at Caterpillar (NYSE:CAT), and declined almost 6% (against 4% growth at ABB). Climate was quite strong (up 7%), but commercial/residential was down 4% and network power was down another 4% on double-digit declines at embedded power and computing.
Margins were “okay-ish”. Gross margin was basically on target (and up 30bp from last year), but adjusted operating income fell about 3% and missed expectations such that the company fell a penny or two short of most analyst estimates. While process management and climate both logged double-digit segment profit increases, industrial automation and network power were both quite weak.
It Doesn't Sound Like The Cavalry Is Coming
Emerson has earned its fair share of analyst and investor scorn over the years, failing to deliver much margin leverage and making questionable acquisitions. At least for now, though, I don't think you can accuse management of being blithely too optimistic.
Where most of Emerson's industrial peers reiterated the mantra about a second half rebound, Emerson's CEO said that he doesn't see that happening. Not only is global demand weak, but there aren't many (if any) catalysts for it to get meaningfully better and companies are cutting back on capex spending – creating a so-called “productivity trap”. It's also worth noting that the company trimmed it's 2015 revenue target by about 10% back in February.
Weak orders for March were followed by continued weakness in April, making it harder to build the+ case for a real rebound any time soon. True, industrial automation may be bottoming as customers run down inventories and Emerson's exposed to the right (that is, growing) markets in process automation, but it seems unlikely that growth in businesses like climate will continue. What's more, while the core network power business may be more inline with Eaton and Schneider these days, it's still not a successful business.
The Bottom Line
There are a lot of ways in which Emerson could be a solid long-term performer. Automation (process and industrial) is, in my opinion, one of the best markets for the long haul. Emerson has also hopefully learned its lesson in M&A and will make smarter deals going forward. Likewise, the company actually generates very good free cash flow and returns on invested capital. So if the company would stop shooting itself in the foot, a lot of good things could happen.
But the real question is will they or won't they? I'm looking for long-term free cash flow growth of about 7%, which is quite a bit better than I expect from many of its peers. It's hard to have full confidence in those numbers, but I have to wonder if further underperformance would see the arrival of activist investors and more agitation for more aggressive restructuring efforts. In any case, I wouldn't pay more than the mid-$50s for these shares, so I have a hard time getting excited about these shares today.
At the time of writing, Stephen Simpson owned shares of ABB
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