I'm starting to feel a little sympathy for the management team at Emerson (NYSE:EMR). While the recent financial performance from this industrial conglomerate hasn't been that great, it increasingly seems to me that a lot of the Street just waves off management's cautious commentary. If the Street is building up expectations ahead of what Emerson's own people say they're likely to do, I can't really fault the management for what happens.
In any case, I still think investors are too bullish on Emerson's prospects. I do believe the Climate business is do for a solid rebound and I like the company's underlying order trends in automation, but I do worry both about the company's long-term competitiveness in automation and whether expectations are still too high. At this point, I'd still not be a buyer of Emerson.

SEE: Conglomerates: Risky Proposition?
Another “Miss And Lower” Quarter?
The good news for Emerson shareholders with respect to this quarter is that it seems as though the sell-side was bracing for a tougher quarter as the weeks rolled on, and so there wasn't as much surprise.
Even so, revenue fell 2% as reported and about 1% on an organic basis. Revenue from process automation was up 3%, which was a respectable outcome relative to ABB (NYSE:ABB) and Honeywell (NYSE:HON). Industrial automation was down 7%, though, and that result is harder to spin to the positive. Network power dropped another 5%, Climate fell 2%, and the Commercial/Residential business saw organic growth of 4% for the quarter.
Overall, Emerson's profit performance was not particularly strong. Gross margin was flat with the year-ago period, which actually wasn't bad, but segment profits declined 9%. Only the Climate and Comm/Resi business showed year-on-year margin improvement, and Emerson posted a three-cent miss at the operating line relative to Street expectations.

SEE: Earnings: Quality Means Everything
Orders Seem To Be Getting Better, But Guidance Isn't
Management once again lowered its expectations for the year, albeit this time the change vis a vis Wall Street expectations wasn't all that consequential. To put this guidance in context, post-Q1, management was talking about 2% to 5% growth for the year. After Q2 that guidance went down to 1.5% to 2.5%, and now it's down to about 1% growth. This really isn't so much different than what companies in similar businesses like Eaton (NYSE:ETN), ABB, Honeywell, and Siemens (NYSE:SI) are seeing/saying, but it does show pretty clearly that the big second half rebound story isn't likely to come to fruition.
A Decent Value For Network Power, But Emerson Has Work To Do
Investors may be cheered to see the valuation that Emerson was able to secure for its Network Power business. This unit has been a laggard for some time now, with competitors like Eaton and Schneider and self-inflicted operational issues leading to poor performance. That said, while an implied value of almost $600 million is more than many expected, the structure of the deal (selling a 51% stake to Platinum Equity) doesn't strike me as the cleanest exit. Still, I imagine Emerson didn't find a crowd of buyers clamoring for this asset, so the company's options were likely limited.
With Network Power more or less resolved, Emerson may now be able to turn to other business. In Climate, I think the story is still a waiting game – I think that there's enough pent-up demand for companies like United Technologies (NYSE:UTX) and Emerson to do well, but it's likely to be a slower, shallower recovery than investors have been hoping for until recently.
Turning to automation, I think Emerson really has some work to do. While the order flow is looking better (process automation orders up about 8%, with industrial automation apparently troughing), I do worry that the company, like Eaton and Rockwell (NYSE:ROK), has over-invested in hardware and under-invested in software. Although Emerson had once approached Invensys (a company with a strong industrial software business) about a merger, it looks as though Emerson may allow Invensys to go to Schneider without challenging the latter's bid. There are still worthwhile properties in the industrial software space that Emerson could buy, but the clock is ticking and a failure to improve its software offerings could compromise long-term growth and competitiveness.
The Bottom Line
I'm presently looking for Emerson to produce about 4% long-term revenue growth and almost 7% long-term free cash flow growth – less than both Honeywell and ABB. I would also say, however, that Emerson has upside if the Climate business recovers faster than I expect and/or if the company can gain share in the process and industrial automation markets. Even so, as is, I think Emerson should trade around the mid-$50s today, and that target is supported by discounted cash flow, EV/EBITDA, and ROE/PBV.
Disclosure – At the time of writing, the author owned shares of ABB

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center