Published November 8th, 2016 by Bob Ciura
Emerson Electric (EMR) is a legendary dividend growth stock.
The company was founded in 1890 in St. Louis, Missouri, when two Scotland-born brothers, Charles and Alexander Meston, saw an opportunity in manufacturing reliable electric motors.
The two brothers received a start-up investment from a man named John Wesley Emerson, a former Union army officer, judge and lawyer. Together, the three formed The Emerson Electric Manufacturing Company.
Emerson Electric’s breakthrough product was manufacturing the first electric fans sold in North America. In its first full year of operation, Emerson’s sales totaled $60,000.
Today, Emerson does business in more than 150 countries, and has 111,000 employees. It has a $32 billion market capitalization and generates more than $22 billion of revenue last year.
The ‘Dividend Aristocrats’ are a group of stocks with 25+ consecutive dividend increases in the S&P 500. You can see all 50 Dividend Aristocrats here. Emerson’s dividend streak is more than double the requirement to be a Dividend Aristocrat. The company is also one of only 15 Dividend Aristocrats to offer a no-fee DRIP.
Emerson has increased its dividend for a whopping 59 years in a row. This makes the company one of only 18 Dividend Kings – stocks with 50+ consecutive years of dividend increases.
Emerson has a long history of navigating through several recessions and coming out even stronger than before. In order to survive the swings of operating as an industrial manufacturer, it has had to stay nimble.
This is a period of transition for Emerson. It has conducted a significant restructuring of its business model over the past year. For example, Emerson divested its large Network Power business in 2016 for $4 billion.
Emerson is making some big moves to try to get things going in the right direction again. The past few years have been very difficult for Emerson. Last year, Emerson’s earnings-per-share fell 15%.
The company is sailing through a number of headwinds, including geopolitical risk due to the Brexit vote, the strong U.S. dollar, and the collapse in commodity prices.
Global economic uncertainty is elevated, and this is suppressing economic growth in many international regions including Europe and the emerging markets. In addition, the rally in the U.S. dollar has negatively impacted Emerson. A rising dollar makes U.S. exports less competitive, which is a problem for the company since 56% of total sales last year were from outside the U.S.
Lastly, the decline in oil and gas prices from $100 per barrel to $50 per barrel in the past two years has hurt the company. Emerson is an industrial manufacturer, and the oil and gas industry makes up a significant portion of its customer base.
Going forward, Emerson will focus its business on two key areas: Automation Solutions and Commercial and Residential Solutions. Emerson is going to be a much more streamlined company in the very near future.
Source: 2015 Annual Report, page 6
The goal of its divestment and broader restructuring plan is to focus on its highest-growth opportunities.
Once Emerson’s portfolio repositioning is complete, it will allow the company to focus on the industries it believes hold the highest growth potential. These will mainly be the process, industrial, commercial, and residential markets.
According to Emerson, its strategic portfolio repositioning would have resulted in significantly higher growth in recent years. For example, in the image below, sales growth from 2010-2015 would have been 2.2% higher per year. Meanwhile, earnings before interest and taxes, as well as return on total capital, would have been significantly higher in 2015.
Source: 2015 Annual Report, page 6
Another growth prospect for Emerson moving forward it international growth. Emerson generates more than half of its revenue from outside the U.S., incluidng a large operational footprint in Asia.
Source: 2015 Annual Report, page 20
Its large international presence has held the company back so far, due to changing foreign exchange rates. But investors should keep focus on the long-term; Emerson is generating high organic growth, which excludes the impact of currency movements.
For example, in 2015 Emerson’s organic revenue increased 7% in China and 2% in Latin America. Organic revenue also increased 1% in Europe. Emerson continues to grow organic revenue in a difficult macro-economic climate. This is an indication that demand for its products and services remains strong.
Competitive Advantages & Recession Performance
Emerson’s two key competitive advantages are its global scale, as well as its research and development. Emerson has reaped significant operational efficiencies from its global distribution network. For example, Emerson has 205 manufacturing locations worldwide, including 140 which are outside the U.S.
This provides Emerson with economies of scale and high margins. In 2015, Emerson generated a 22.8% return on total capital.
Separately, Emerson’s R&D is a competitive advantage. It invests significant financial resources each year to ensure product innovation:
- 2013 research and development spending of $576 million
- 2014 research and development spending of $541 million
- 2015 research and development spending of $506 million
This investment has paid dividends in a big way. Emerson was awarded 2,100 patents last year alone.
Unfortunately, Emerson Electric is reliant on a growing global economy. Since it operates in the industrial sector, it is not immune to periods of recession. Investors saw this first-hand during the Great Recession of 2007-2009, when earnings-per-share fell significantly:
- 2007 Earnings-per-share of $2.66
- 2008 Earnings-per-share of $3.11
- 2009 Earnings-per-share of $2.27 (27% decline)
- 2010 Earnings-per-share of $2.60 (15% increase)
- 2011 Earnings-per-share of $3.24 (25% increase, new post-recession high)
That being said, thanks to Emerson’s competitive advantages, the company still remained solidly profitable during the Great Recession.
Valuation & Expected Total Return
Emerson stock trades for a price-to-earnings ratio of 17.2 using adjusted earnings. This is below the average price-to-earnings ratio of the S&P 500, which is 24.
Emerson is also trading at a discount, relative to its historical standards. Since 2000, the stock has held an average price-to-earnings ratio of 18. As a result, the stock appears slightly undervalued.
Going forward, investors can expect total returns to be comprised earnings-per-share growth and dividends. As a result, total shareholder returns could be based on the following:
- 3%-5% organic revenue growth
- 2% growth through acquisitions
- 1%-2% share repurchases
- ~3% dividend yield (at 2.8% yield, currently)
As a result, total shareholder returns could reach 10% to 13% annualized.
Emerson has seen its share of bumps in the road during the past year. But over the course of its more than 100 years in businesses, Emerson has proved an ability to successfully navigate economic cycles.
The company ranks as a long-term hold at current prices using The 8 Rules of Dividend Investing.
Emerson’s portfolio restructuring should put the company on firmer ground moving forward. It should have little trouble continuing to increase its dividend each year.