There are plenty of industrial companies that have had challenging times in 2012, particularly as the year has gone on. It has been even worse for Emerson Electric (NYSE:EMR), however, as poor execution and higher exposure to emerging markets has hurt results. While one quarter doesn't change anything, Emerson ended its fiscal 2012 on a stronger note and there are encouraging signs of not only better financial results, but also more realism in the executive suite.
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Solid Numbers to Close the Fiscal Year
To be clear, it's not as though Emerson blew out the doors with fourth quarter results. But given the overall trends at industrial companies such as ABB (NYSE:ABB), GE (NYSE:GE), Honeywell (NYSE:HON) and Danaher (NYSE:DHR), not to mention the steady trend of eroding analyst expectations, any good news is something worth celebrating. Emerson reported revenue growth of 2% (more or less in line), with organic sales growth of about 5%.
Unlike many industrials, Emerson's growth in the United States was weaker (up 2%) than in Asia (up 8%). Growth was led by process management, which saw sales climb 21% on an organic basis. Unfortunately, most of the other units were negative, with industrial automation, network power and climate down 2%, 3% and 3%, respectively. The commercial/residential solutions segment, however, was up about 5% in organic terms.
Where Emerson did best was with its profits. Gross margin improved almost a point and a half, helped by volume leverage and a more profitable business mix. The company basically maintained this momentum at the operating level, where operating income rose 9% and operating margin expanded 130 basis points (BPs). Although network power saw nearly two points of margin contraction, all of the other units showed improvements (up 130bp in commercial/residential, and up 280bp in industrial automation).
SEE: Analyzing Operating Margins
If You Can't Beat Them, Move on
I was particularly encouraged to see that management has apparently gotten a lot more realistic about its power business. Emerson has struggled to compete effectively with companies like Eaton (NYSE:ETN) and Schneider (OTC:SBGSF) in certain power markets, and the announcement that it may well sell the embedded computer and power business is a good one. With the sizable goodwill impairment (nearly $600 million this quarter), it's pretty clear that this business just hasn't worked out as well as planned.
Process Quite Strong, but Can It Last?
Emerson's strength in process management (up 21%) definitely leaps out at an investor, particularly after seeing the low single-digit results at rivals like ABB, Alfa Laval (OTC:ALFVY), Honeywell and so on. The question I have, though, is whether this performance is sustainable. Although Emerson continues to see strength in markets like oil/gas, chemicals, and power, the company did benefit from pent-up/delayed demand and easier comps tied to the severe flooding last year in Thailand.
Order growth of 5% was pretty good relative to its competition (ABB, Honeywell, et al), and Emerson does have more emerging market exposure than almost any other automation player (nearly one-third of sales). Still, while I think Emerson has room to grow (and the ability to broaden its offerings through M&A), I would be cautious about the prospects of GE or Siemens (NYSE:SI) stepping up in a bigger way and/or ABB grabbing more share.
SEE: An Evaluation Of Emerging Markets
The Bottom Line
In the past, I have criticized Emerson for its "death by a thousand papercuts" approach to guidance and its apparent unwillingness to face up to its problems in markets like power. One quarter doesn't reverse those concerns, but it does look like the company is on a better (or at least more rational) path now. What's more, I think Emerson has solid prospects in automation and should be able to benefit from an eventual improvement in construction (the company doesn't seem to be losing ground to United Technologies (NYSE:UTX), Johnson Controls (NYSE:JCI) or Ingersoll-Rand (NYSE:IR).
Right now, though, the stock looks like a lukewarm prospect. Even with the expectation of high single-digit free cash flow (FCF) growth (about 60% from revenue growth and 40% from free cash flow conversion improvement), fair value seems to be in the high $50s to low $60s. At these prices, then, I'd prefer ABB (which I own), but Emerson does stack up reasonably well to other industrial conglomerates like GE, Honeywell and Eaton.
At the time of writing, Stephen D. Simpson owned shares of ABB since September 2012.