Published by Bob Ciura on November 2nd, 2017
Out of the 500 stocks in the S&P 500 Index, there are just 51 Dividend Aristocrats. The Dividend Aristocrats have raised their dividends for 25+ consecutive years.
Each year, we review all 51 Dividend Aristocrats. The 30th installment in the series is industrial giant Emerson Electric (EMR).
Emerson is not just a Dividend Aristocrat. It is also a Dividend King, an even smaller group of companies, with 50+ consecutive years of dividend increases.
There are just 23 Dividend Kings, including Emerson. You can see all 23 Dividend Kings here.
Emerson has increased its dividend for 60 years in a row. It has one of the longest dividend growth streaks in the entire stock market.
This article will discuss Emerson’s business model, growth prospects, and whether the stock is undervalued right now.
Emerson Electric is a global industrial manufacturer. It operates in more than 150 countries. It has two business segments, Automation Solutions and Commercial & Residential Solutions.
The Automation Solutions business helps manufacturers maximize production, while minimizing their energy and operating costs. Meanwhile, the Commercial & Residential Solutions segment manufactures products that increase food quality and safety, boost energy efficiency, and create infrastructure.
Emerson has a $41 billion market capitalization, and generated more than $14 billion of revenue last year.
Source: 2017 Investor Conference Presentation, page 15
The company was formed in 1890 in St. Louis, Missouri. It was founded by two Scottish brothers, Charles and Alexander Meston, who saw a potential business opportunity in manufacturing reliable electric motors.
The two brothers received a start-up investment from John Wesley Emerson, a former Union army officer, judge, and lawyer. Together, the three formed The Emerson Manufacturing Company.
Emerson’s breakthrough product was manufacturing the first electric fans sold in North America. Today, Emerson does business around the world, and has 74,000 employees.
This is a period of transition for Emerson. The company has endured a difficult few years, due to a number of headwinds. The strong U.S. dollar, slowing economic growth in China, and the steep decline in oil and gas prices, have all weighed on Emerson.
As a result, Emerson’s sales fell each year, from 2013-2016, including a 10% decline in 2016. Although this was partly driven by divestitures, Emerson’s earnings from continuing operations declined 34% last year.
In response, Emerson has undertaken a significant restructuring of its business model. First, it slashed costs to keep profits afloat.
Source: 2017 Investor Conference Presentation, page 14
The restructuring has resulted in hundreds of millions in additional operating profits hitting Emerson’s bottom line.
This has helped restore growth in 2017. Net sales and earnings-per-share from continuing operations increased 2% and 4%, respectively, through the first three quarters.
It has also made several acquisitions and divestments to focus on its highest-growth opportunities.
For example, Emerson divested its large Network Power business in 2016, for $4 billion. In January 2017, it sold its Leroy-Somer and Control Techniques businesses for $1.2 billion.
Emerson has re-deployed this cash into areas that show greater potential for growth. In particular, Emerson’s Commercial & Residential Solutions segment is a growth catalyst.
Source: 2017 Investor Conference Presentation, page 28
Virtually every end market within the Commercial & Residential Solutions segment is poised for growth in 2017. All businesses within this segment are looking healthy, thanks to strong U.S. housing and commercial real estate markets.
The Commercial & Residential Solutions group has led the way for Emerson. Segment sales increased 7% last quarter, and are expected to rise 5%-6% for the full year.
Source: Q3 Earnings Presentation, page 8
For the full year, management expects net sales to increase 5%, due to 1% organic growth, and 4% growth from acquisitions.
Going forward, Emerson is still pursuing M&A deals, both large and small. On October 16th, Emerson announced the $510 million acquisition of Paradigm, which provides software to the oil and gas industry.
Even more recently, Emerson confirmed it had made an offer to buy Rockwell Automation (ROK). The offer was reportedly worth $27.6 billion. Rockwell has rejected the offer, and according to Emerson, talks have ceased between the two parties.
Still, this indicates Emerson could be on the hunt for another massive acquisition to boost growth.
Competitive Advantages & Recession Performance
Emerson’s two main competitive advantages are its global scale, and proprietary technology. Emerson generates high margins and returns on capital thanks to its global distribution network, which consists of 155 manufacturing locations.
Separately, Emerson’s R&D is a competitive advantage. It invests significant financial resources each year to ensure product innovation:
- 2014 research-and-development expense of $356 million
- 2015 research-and-development expense of $336 million
- 2016 research-and-development expense of $320 million
This investment has given Emerson a leadership position across its two product segments. Its competitive advantages also allow it to navigate recessions better than most industrials.
Emerson’s earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $2.66
- 2008 earnings-per-share of $3.11 (17% increase)
- 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)
Emerson performed relatively well during the Great Recession, with only one year of declining earnings. Normally, industrial manufacturers are tied to the health of the global economy. Its resilience during the Great Recession is a credit to its competitive advantages.
Valuation & Expected Returns
The one negative about Emerson right now, is its valuation. Emerson stock trades at a price-to-earnings ratio of 25.5.
According to ValueLine data, Emerson held an average price-to-earnings ratio of 17.3 in the past 10 years. This means Emerson stock is trading roughly 47% above its long-term average valuation.
Source: Value Line
Going forward, investors can expect total returns to be comprised of earnings-per-share growth and dividends. In the past 10 years, the company increased earnings-per-share by just 1% per year. Investors should not count on continued valuation multiple expansion for future returns.
As a result, it may be prudent to expect low-to-mid single digit earnings growth going forward. Combined with dividends, total shareholder returns could be as follows:
- 1%-2% organic revenue growth
- 2%-3% revenue growth from acquisitions
- 3% dividend yield
As a result, total shareholder returns could reach 6%-8% annualized. This is a satisfactory rate of return, but Emerson stock is not trading at a highly attractive valuation right now.
Emerson is a high-quality business, with a long history of steady growth. It has rewarded shareholders along the way, with six decades of annual dividend growth.
Right now may not be the best buying opportunity for the stock. Emerson is currently trading significantly above its average valuation. Investors should wait for a better price before initiating a position, or adding to an existing position.
However, Emerson has a solid 3% dividend yield, and remains a sure bet to increase its dividend each year.