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Emerson: "Washington is arranging the chairs on the Titanic"

publication date: Aug 2, 2011
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author/source: Valuentum Analysts

Emerson Electric (EMR), a diversified industrial manufacturing company, posted decent fiscal third-quarter results Tuesday, but management’s comments regarding the ongoing debt problems in Europe and the US suggest the firm is less than satisfied with internal performance, and we agree. There are better plays in the industrial sector than Emerson, in our opinion.

Net sales advanced 16% (10% organic) in the period thanks to solid international performance, while net earnings jumped 17% from the year-ago quarter. Emerson’s operating profit margin was essentially flat, falling 30 basis points from the same period a year ago due to acquisition-related costs. The firm noted that the pace and momentum of the industrial-led recovery has slowed, but we view this as a temporary phenomenon and look to strong order growth at General Electric’s (GE) industrial segment and United Tech (UTX) as a sign that things are still looking bright for corporate earnings. Even Emerson’s orders remained strong, jumping 6.5% in the quarter. And the firm’s largest revenue segment, Process Management, experienced a 27% surge in backlog. We think management seems pre-occupied with the political climate and could be taking its eye of the ball.

All told, the firm reiterated fiscal 2011 guidance, with earnings per share expected in the range of $3.20 to $3.30 and sales growth of 15% to 18% (10% to 13% organic). However, management did indicate the lower end of the full-year sales growth range is more likely, given a slower pace of order growth experienced in the past two months. In all, we remain on the sidelines with Emerson and provide an excerpt from CEO David Farr on the conference call that we think may be an interesting read for investors:

“Now why did we call out last week in our orders that things are getting weaker? Because they are. They are weaker. We have always been very open in our communication to our shareholders and to our investors, and when we see fundamental change, we call it out. There's no reason to hide it. It's a fact, and we did it. Our underlying orders grew only 6.5% the last 3 months. That is outside the range that I have been talking about for several months, in the 7% to 10% range. And yes, it's against tough comps, but I saw a fundamental weakness happening over the last 60 days.

And then a couple of days later, they announced GDP. GDP in the U.S. grew in the first half less than 1%. Let's get that said: less than 1%. You look at all the facts that have been coming out the last couple of weeks and the economics have been weakening. It's not new news. We have to deal with it. We have a tradition in the company to deal with those things.

Then we have a government situation, their inability to deal with the real gut issues of excess spending and debt. All we hear out of government is: We're going to raise taxes. We don't like corporate planes. We're going to sue Boeing, one of the most strategic companies we have in this country, for building a new plant in South Carolina. We have no desire to really go after corporate tax reform, which would fundamentally change this country and encourage people to invest and reinvest and create jobs in this country but rather, demigods -- and go after people that actually create those jobs, be it corporations and people that are successful.

We have a difficult issue right now to deal with in this country, and the same hack is going on in Europe. They are in no better conditions. So as I look at what's coming at us in the second half of this year, I do not see the catalyst that would say the economy will be fundamentally different in the second half than we saw in the first half. Maybe the gross GDP will grow a little bit more in the second half. But fundamentally, there's nothing going on in the U.S. right now that would encourage corporations to ignore the excessive regulations coming at us, not to mention the new Dodd-Frank bill relative to whistleblowers or producing or mentioning what we had to do with minerals. We have to publish now what minerals we use. You look at new healthcare bill. You look at the last week. We decided in Washington to raise the CAFE standards for the second time within 3 years on the day that we announced less than 1% first half GDP growth in the U.S. economy.

I would say Washington is arranging the chairs on the Titanic, the way look at it. So we're dealing with realism here in this company. We're looking at slower growth. We don't know exactly what that growth is. We will manage accordingly. Our orders in the industrial world will stay up. I can't tell you right now what the second half will be. I can't tell you what 2012's going to be. So don't bother to ask me, because I will not tell you. If you tell me what -- if you ask me what 2012 is, the first thing I'm going to ask you is, "What is your forecast for the second half of GDP? And what is your forecast for the GDP in the first half of 2012?" Let me know and then I'll tell you what my forecast will be.”

CEO Farr seems a bit frustrated with the political and economic environment, to say the least.


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