In part 32 of the 54-part Dividend Aristocrats In Focus series, Emerson Electric’s (EMR, Financial) competitive advantage and future growth prospects are analyzed. The diversified manufacturer has over 130,000 employees and 230 manufacturing facilities around the world. Emerson Electric has a long history of success, with an amazing 57 consecutive years with dividend increases. The company’s business is analyzed below.
Business Overview
With a market cap of $43 billion, Emerson Electric is one of the larger diversified manufacturers in the world. With that said, Emerson Electric is about half the size of fellow Dividend Aristocrat diversified manufacturer 3M Company. Emerson Electric divides its operations into 5 segments which represent its various business ventures. The 5 segments are listed out below, along with percentage of earnings each segment contributed to total earnings in the company’s most recent third quarter.
- Process Management: 41.63% of total earnings
- Industrial Automation: 18.25% of total earnings
- Network Power: 10.81% of total earnings
- Climate Technologies: 20.81% of total earnings
- Commercial & Residential Solutions: 8.50% of total earnings
The company’s process management division is by far the largest, generating over 40% of total income or the company. The process management divisions produces a variety of products to help businesses control, regulate, operate, measure, and analyze the manufacturing or automation process. In addition, the company offers service personnel to support its customers.
The industrial automation segment is Emerson Electric’s third largest. It sells power generation, electrical protection, power quality, power transmission, fluid automation, machine motion, and precision cleaning products, among others.
Emerson Electric’s network power segment is its second smallest by income. The network power segment protects and optimizes power supply for critical infrastructure like data centers, communication networks, healthcare, and industrial facilities.
The company’s second largest segment by income is climate technologies. The climate technologies segment is the world’s leading provider of heating, ventilation, air conditioning, and refrigeration products for commercial, residential, and industrial applications. The segment operates under a variety of brand names including Emerson, Browning, Copeland, Dixell, and White-Rodgers.
Finally, the company’s commercial and residential solutions segment produces various appliances, storage products, and tools for residential and commercial customers. The segment is the company’s smallest contributing 8.5% of income in the most recent third quarter of 2014. The segment operates under several brand names including InSinkErator, ClosetMaid, ProTeam, RIDGID, and Workshop.
Competitive Advantage
Emerson Electric’s competitive advantage comes from a confluence of several factors. The company’s large size and global reach gives it a significant scale advantage over smaller competitors. Emerson Electric’s 230 manufacturing facilities spread throughout the world speak to its supply chain advantage. The company’s revenue comes from around the world. Currently, about 40% of revenue is generated in emerging markets. Emerson Electric’s size and scale advantage allows it to find the best locations to manufacture products at the cheapest prices. It also gives the company a foothold in countries throughout the world.
Additionally, Emerson Electric employees over 9,000 engineers. The company was granted 1,600 new patents in 2012, and 1,700 new patents in 2013. Emerson Electric’s strong research and development department gives it a competitive advantage that smaller competitors cannot achieve. The company’s large size lets it hire more innovators to come up with new patentable products which the company can sell at a premium price.
Growth Prospects
The last decade has not been Emerson Electric’s best. The company has seen revenue per share growth of just 4% per year over the last decade. Share repurchases accounted for nearly half the company’s revenue per share growth, meaning the underlying business is growing very slowly. Emerson Electric’s current and future growth is being driven by several sources.
First, the boom in North American oil and natural gas is driving US sales for the company. Sales in the company’s US segment grew 5% in its most recent quarter. Growth is also being driven by data center cooling projects. As an example, the company shipped over 250 data center cooling modules to Facebook’s (FB, Financial) new data center in Lulea, Sweden.
Emerson Electric also has significant exposure to emerging markets. As a result, the company’s future growth is largely dependent on emerging market growth. The company grew revenue in China 8% for its most recent quarter, but overall revenue growth in Asia was up only 3%, with negative growth in the Middle East and Africa.
In total, Emerson Electric expects to grow at about 3% to 5% annually. This is in line with its historical growth rate. The company’s growth is heavily tied to worldwide GDP growth and capital investment trends around the world. As a result, I believe the best estimate for future growth at Emerson Electric is about 4% per year.
Dividend Analysis
Emerson Electric currently has a dividend yield of about 2.8% and a payout ratio of 64%. The company’s current payout ratio is about in line with its target payout ratio of 60%. Emerson Electric’s dividend payments will likely grow in line with overall company growth for the forseable future. This will likely be around 4% per year. If Emerson grows its dividend payments at 4% per year, it will have the following yields on cost over the time frames below:
- Current yield: 2.8%
- Yield in 3 years: 3.1%
- Yield in 5 years: 3.4%
- Yield in 10 years: 4.1%
Valuation
Emerson Electric is currently trading at a PE ratio of about 17.5. Historically, the company has traded in line with the S&P 500’s PE ratio. The S&P 500 currently has a PE ratio of about 19. At current prices, I believe Emerson Electric to be slightly undervalued. If the market reverts to its historical PE ratio of around 15, Emerson Electric’s fair value will be around the same.
Recession Performance
Emerson Electric was profitable throughout the Great Recession of 2007 to 2009. The company’s earnings are closely tied to capital investment spending and GDP growth throughout the world. As a result, the company saw EPS decline substantially through the Great Recession. Emerson Electric did not hit new EPS highs until 2011; the company took about two years to recover from the worst of the recession. Emerson Electric’s EPS are shown below during the Great Recession and subsequent recovery:
- 2007 EPS of $2.66
- 2008 EPS of $3.11 (new high)
- 2009 EPS of $2.27 (recession low)
- 2010 EPS of $2.60
- 2011 EPS of $3.24 (full recovery, new EPS high)
Final Thoughts
Emerson Electric is not growing quickly. The company does have a solid dividend yield and relatively safe investment prospects. I prefer 3M at this time over Emerson Electric for a high quality dividend growing diversified manufacturer. Shares of Emerson Electric may appeal to investors seeking relatively high current income and exposure to the manufacturing industry.
