Friday, June 26, 2015

Emerson Electric (EMR) Dividend Stock Analysis 2015

Emerson Electric Co. provides technology and engineering solutions to industrial, commercial, and consumer markets worldwide. It operates through five segments: Process Management, Industrial Automation, Network Power, Climate Technologies, and Commercial & Residential Solutions. Emerson Electric is a dividend king, which has raised dividends for 58 years in a row. There are only 16 dividend kings in the world.

The most recent dividend increase was in November 2014, when the Board of Directors approved a 9.30% increase in the quarterly dividend to 47 cents/share..

The company’s largest competitors include General Electric (GE), ABB (ABB), and Honeywell (HON)

Over the past decade this dividend growth stock has delivered an annualized total return of 9.10% to its shareholders.

The company has managed to deliver a 7.40% average increase in annual EPS over the past decade. Emerson Electric is expected to earn $3.41 per share in 2015 and $3.64 per share in 2016. In comparison, the company earned $3.03/share in 2014. Most of the earnings growth occurred between 2005 and 2008, as earnings per share have been essentially flat ever since then. Without further increases in earnings over time, the dividend growth streak is in danger, and the intrinsic value of the business will not increase.

Earnings per share have also been aided by share buybacks. The number of shares outstanding has decreased from 836 million in 2005 to 684 million by 2015.

The company’s strategy for long-term growth is focused on product innovations, strategic acquisitions and growing its presence in emerging markets. Emerson Electric’s fortunes are dependent on the economic cycle. However, as the global economy expands, its sales should increase over the next few years

Emerson Electric has 5 businesses, with different economic characteristics and advantages. Overall, Emerson is a cyclical business, which will do well when economies do well, and badly when economies do badly. However, it does have some competitive advantages such as switching costs, cost advantages due to scale, and intangible assets such as strong brands in its variety of segments.

In several of its business segments, the company is leveraging a large and growing Industrial/Commercial installed base to drive incremental sales and service. With an installed base of over $250 billion in 2015, that is expected to reach $500 billion by 2025, Emerson is well positioned to capture those incremental sales. This also means sticky customer relationships for years, and potential for service revenues, upgrades and replacement after equipment is fully depreciated.

Process Management - provides measurement, control and diagnostic capabilities for automated industrial processes producing items such as fuels, chemicals, foods, medicines and power. This segment generated 36% of Emerson’s revenues in 2014, and 44% of income. This segment has been growing nicely in the past few years, due to demand in the energy sector that accounted for 43% of sales for the segment. More than 2/3rds of those revenues are from downstream and midstream energy clients however, which means that lower oil prices should not have a very big impact.

Industrial Automation - brings integrated manufacturing solutions to diverse industries worldwide. This segment generated 20% of Emerson’s revenues in 2014, and 18% of income.

Network Power - provides power conditioning and reliability, and environmental control to help keep telecommunication systems, data networks and other critical business applications operating continuously. This segment generated 20% of Emerson’s revenues in 2014, and 10% of income.

Climate Technologies - enhances household and commercial comfort, as well as food safety and energy efficiency, through air conditioning and refrigeration technology. This segment generated 16% of Emerson’s revenues in 2014, and 17% of income. Given innovation, longer term demand for infrastructure development in emerging markets, and potential rebound of the US construction activity, this segment could deliver a nice boost to revenues and profits in the future.

Commercial & Residential Solutions - provides tools for professionals and homeowners, residential and commercial storage systems, and appliance solutions. This segment generated 8% of Emerson’s revenues in 2014, and 10% of income. I expect that the rebound in US construction, along with increased demand from emerging economies could translate into higher sales for this business segment.

Emerson Electric is targeting earnings per share of $5.50 - $6 by 2019, which is almost double the amount of earnings from 2014. Management also targets annual sales growth of 5% - 6%/year. A large portion of sales growth is targeted to occur organically, with 1% - 2%/year incremental growth driven by acquisitions.

The company expects to return approximately 50% – 60% of operating cash flow to shareholders in the form of dividends and share buybacks through 2015. Based on presentations I have reviewed, it looks like the amount will be roughly evenly split. The firm is growing sales in emerging markets, such as India and China.

The annual dividend payment has increased by 8% per year over the past decade, which is slightly higher than the growth in EPS.

An 8% growth in distributions translates into the dividend payment doubling almost nine years on average. If we check the dividend history, going as far back as 1974, we could see that Emerson Electric has actually managed to double dividends every eight years on average.

In the past decade, the dividend payout ratio has oscilated between a low of 38.60% in 2008 to a high of 59.90% in 2012. At 56.80% today, it is sustainable, though at the high end of the range. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.

Return on equity increased between 2005 and 2008, decreased for a few years around the Great Recession, spiked again through 2011, and has gone down since. On the bright side, it always remained above 19%. I generally like seeing a high return on equity, which is also relatively stable or rising over time.

Currently, Emerson Electric is attractively valued at 17 times forward earnings and a sustainable yield of 3.20%. While I own shares of the company, I do not like the fact that Emerson has been unable to grow earnings per share between 2008 and 2014. I do like the fact however, that earnings per share are finally starting to grow, as they are expected to reach $3.41/share in 2015. I would consider adding to the stock, subject to availability of funds.

Full Disclosure: Long EMR, GE

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