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Emerson Beats Estimates But the Firm Issues Cautious Guidance

publication date: Nov 6, 2012
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author/source: RJ Towner

Dividend growth gem Emerson Electric (click ticker for report: EMR) reported better than expected earnings for its fiscal fourth quarter Tuesday morning. Adjusted earnings per share jumped 7% year-over-year to $1.11 per share, which was much higher than consensus estimates. Revenue growth remained subdued, ticking up just 2% year-over-year to $6.7 billion. We don’t expect to make a change to our fair value estimate.

The firm’s process management segment continues to be a standout component, with sales growing 18% year-over-year on a reported basis (21% ex-currency) to $2.4 billion. Every geographic region performed well, with the US growing 16%, Asia up 24%, and Europe up 11%. Improvements in the supply chain, as well as cost control initiatives, helped operating margins expand 200 basis points year-over-year to 24.3%. Net underlying orders in the segment grew just 5%, but the firm remains confident that demand from oil and gas, as well as chemical and power end markets will remain strong for some time. The company’s value-added automation products are experiencing positive secular tailwinds, which should alleviate pressure on other segments.

Emerson’s industrial automation segment was not nearly as strong, as global demand for manufacturing investments and capital goods remains weak. Total sales during the fourth quarter declined 6% year-over-year (down 4% excluding currency), while underlying sales fell 2%. Europe, which accounts for 40% of sales, remains particularly weak, with sales falling 5% during the quarter. However, the firm is bullish on the long-term outlook for the segment, as operating margins expanded 280 basis points year-over-year to 17.5%. Given this pace of margin expansion, any increase in sales will be highly accretive to earnings going forward.

Telecom spending continues to weigh on underlying network power sales, which tumbled 3% year-over-year (down 2% excluding currency and acquisitions). Weak demand from every end market played a role in the sales decline, resulting in segment margins falling 190 basis points year-over-year to 11.6%. Alcatel Lucent (click ticker for report: ALU) reported poor results late last week primarily due to a lack of equipment spending, so we believe it is an industry-wide problem instead of one that is company-specific.

The firm’s climate technologies segment was relatively weak as well, with sales slipping 3% during the quarter. Expansion in China was disappointing, but this isn’t too shocking given the wealth of negative data we’ve heard about the region recently. Emerson noted weakness in the country’s residential housing market as the main culprit, which could have broader negative implications for Chinese consumption. Sales in the US fell 4%, with all end markets displaying poor performance. We don’t think such performance is great for the US economy, but it may be more a result of cautious investment ahead of the presidential election and looming fiscal cliff than any permanent sign of weakness.

Going forward, the firm expects revenue growth of 0-5%, with expansion loaded in the first half of 2013. Emerson’s operating margin is expected to expand 10-20 basis points year-over-year, leading to mid- to high-single-digits earnings growth over the company’s fiscal 2012 earnings level of $3.39 per share. We think the company’s improved focus on cost controls and efficiency could lead to favorable earnings upside if revenue growth is better than expected.

Emerson generated a solid $2.2 billion in free cash flow during its fiscal year 2012, and we think cash flow can be improved next year. We continue to like the company’s dividend growth potential—the firm even hiked its dividend 2.5% to $0.41 per share, bringing its annual yield to 3.2% at current levels. We will continue to hold the name in the portfolio of our Dividend Growth Newsletter.

Please click the following link for our Dividend Report on Emerson Electric:

http://www.valuentum.com/downloads/20111220_19/download

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