Manufacturing giant Emerson Electric (EMR) reported an 8% growth in underlying sales for the quarter ended December 2021 (Q1 2022), driven by continued strength in major end markets and all regions. Net income doubled to USD 896 million from USD 445 million the same period a year earlier.
Emerson’s biggest business segment – Automation Solutions – which offers a broad portfolio of hardware products (such as valves, controllers, pressure regulators, and monitoring devices) and software products (such as geological modeling software, SCADA system software, automation software, control software, industrial edge software, and life sciences operations management software) to help process and discrete manufacturers automate their production processes – reported a 5% YoY rise in underlying sales which reached USD 2.8 billion for the quarter, driven by continued strength in discrete, life sciences, chemical, and power.
Underlying sales for Emerson’s Commercial and Residential Solutions – which offers climate control systems such as heating, ventilation, air conditioning, and refrigeration solutions, and other tools and appliance solutions such as food waste disposers, water heaters, and pipe-working tools for residential, commercial, and industrial customers, and – rose 13% to USD 1.671 billion during the quarter, driven by strength across commercial, industrial, and residential end markets.
Source: Emerson Electric investor presentation, Q1 2022
Going forward, all of Emerson’s major end markets are expected to remain robust. Emerson management cited strong anticipated demand in Automation Solutions and Commercial and Residential Solutions when they raised their full-year guidance for net sales growth to 6%-8% from 5%-7% earlier.
The automation market – where Emerson holds first or second place in terms of market share in a variety of automation-related product categories – has ample room for growth with about 60% of global manufacturing sites yet to be automated according to estimates from Siemens (OTCPK: SIEGY).
Moving on to the O&G space, which accounts for the bulk of Emerson’s revenues, after a pandemic-induced drop in 2020 (IHS Markit figures show energy sector capex fell about 11% from USD 1.42 trillion in 2019 to USD 1.26 trillion in 2020), global capex spending in the oil and gas sector (which is Emerson’s biggest end market, accounting for 17% of sales in FY 2021) is expected to gradually recover in the coming years, however, they are not expected to reach pre-pandemic levels until 2025.
Source: Fitch Solutions, Oil & Gas Capex Outlook, July 2021
Meanwhile, the outlook for Emerson Electric’s second-biggest end market – residential – is generally positive. In America, Emerson Electric’s biggest market by sales (Americas accounted for 68% of sales for its Commercial and Residential Solutions, under which its Climate Technologies division generated 64% of sales from the Americas, and its Tools & Home Products division generated 78% from the region in FY 2021), housing starts – a measure of new home construction – are recovering from a pandemic-induced drop in 2020 but despite an uptick in housing activity, housing starts were outpaced by household formations, as lockdowns and labor shortages curtailed housing supply while low interest rates and work-from-home arrangements drove up housing demand during the period, which resulted in a widening of the U.S. housing supply gap in 2021.
With inventory at an all-time low, buyers are having a hard time finding a home according to Lawrence Yun, chief economist National Association of Realtors (NAR). The prolonged housing supply shortage is leading to soaring house price inflation – U.S. house prices have risen 20% in real terms from the onset of the pandemic in February 2020 and September 2021.
An estimated 4 million more housing units are needed to satisfy America’s housing demand.
From Emerson Electric’s power end market, the company could benefit from multi-year tailwinds from an anticipated capex upcycle. In the U.S., which is part of the Americas region – Emerson’s biggest market by region accounting for 53% of overall revenues – the Biden administration’s USD 1 trillion infrastructure spending plan could potentially drive demand for components and equipment for electrical transmission solutions from Emerson. Power accounts for about 10% of Emerson’s revenues as of FY 2021. Emerson recently acquired Open Systems International (OSI) whose software platform is used in power transmission and distribution. Along with Emerson’s expertise in power generation, Emerson offers end-to-end capabilities related to monitoring, controlling, and optimizing operations across the electric grid.
Evolving business mix in response to changing long-term trends
Emerson Electric has significant exposure to the O&G industry; sales to the O&G sector accounted for 17% of Emerson Electric’s sales in FY 2021 (11% from upstream and 6% from midstream), making it Emerson’s biggest end market.
Source: Author, data from company filings
Net-zero ambitions and growing shareholder and regulatory pressures to reduce carbon emissions are expected to intensify in the coming years, which could put a lid on upstream capex spending by oil and gas companies who may instead be prompted to divert increasing amounts of capex away from upstream businesses and towards low-carbon energy sectors, such as renewable energy. A survey conducted by energy consulting firm DNV GL revealed that 66% of senior oil and natural gas executives said their organizations would be “actively adapting to a less carbon-intensive energy mix” in 2021, up from just 44% in 2018. IHS Markit expects global energy sector capex in 2021-2025 will be about 8% lower than the 2015-2019 period, falling to about USD 6.6 trillion from around USD 7.2 trillion. Cumulative investment in the upstream and downstream oil and gas sectors, coal mining, and fossil fuel-fired power generation (coal and gas) is projected to be around USD 840 billion during the 2021-2025 period, about 20% lower than the 2015-2019 period according to IHS Markit. By comparison, non-hydro renewable energy investments are projected to rise to USD 1.3 trillion in 2021-2025, about 14% higher than 2015-2019 levels.
The trend could dampen long-term demand from what is Emerson’s biggest end market. However, the company is working towards adapting to this long-term trend by setting its sights on new energy solutions. Last December, Emerson acquired Mita-Teknik (wind turbine control systems), and in 2020 acquired Open Systems International (smart grid management software solutions), strengthening its renewable energy capabilities.
Meanwhile, the company is morphing into an industrial software giant having made a slew of software-related acquisitions to beef up its industrial software capabilities. Software is generally a higher-margin business which could potentially have a positive impact on Emerson’s margins going forward.
Financials
A shift towards higher-margin software businesses as well as software-related acquisitions appears to be lifting Emerson’s free cash flows, which have consistently increased over the past few years.
However, with acquisitions playing a major role in the evolution of Emerson’s business mix, the company’s debt to equity has been gradually creeping up as well recently and stood at around 73% at the end of FY 2021 (year-ended September 2021). By the end of December 2021, this had crept up further to 85%.
Source: Macrotrends
Emerson’s debt burden is relatively low compared to peers such as Rockwell Automation (NYSE: ROK)however, with Emerson likely to remain acquisitive in the future due to its ongoing business mix evolution as well as prevailing industry trends such as ongoing consolidation in the industrial software space, Emerson’s debt burden may possibly continue trending upwards if it turns to outside capital to supplement cash reserves, enabling the company to finance acquisitions and investments while maintaining its “Dividend Aristocrat” status as well as share buybacks. Emerson has increased its dividend for 65 years in a row, paying out about USD 1.2 billion in dividends in fiscal 2021 (amounting to a dividend payout of about 45%), and repurchased shares worth about USD 500 million. The company intends to repurchase shares worth USD 250-500 million in fiscal 2022 and pay dividends of about USD 1.2 billion in 2022.
Total debt to equity ratio (%) as at fiscal year-end
Emerson Electric |
73% |
Rockwell Automation |
183% |
Siemens |
109% |
Risks
Rising interest rates could curb capex spending and house price inflation could dampen housing demand and thus anticipated tailwinds from these end markets may not materialize.
Company-specific risks include the company’s relatively high exposure to O&G accounting for nearly a fifth of revenues. Although Emerson is making investments to take a slice of new energy industries, it remains to be seen how well the company manages to realign its portfolio. Moreover, with acquisitions seemingly playing major role in this evolution, integration risks cannot be ruled out as well.
Summary
Emerson Electric has had a strong start to FY 2022. Going forward Emerson is poised to benefit from strength in most major end markets as well as tailwinds from an anticipated multi-year capex upcycle. Business mix evolution towards sunrise industries in response to long-term trends could help offset potential declines in the O&G space.
Analyst ratings are largely split for Emerson, with bull ratings having a slight majority.
With a P/E of 19, some may see Emerson as fair relative to higher-margin but higher-priced peers such as Rockwell Automation and Honeywell (NASDAQ:HON). Others may see Emerson as a buy given its relatively high margins plus a competitive valuation compared to peers such as Eaton (NYSE:ETN) and Hubbell (NYSE:HUBB).