Our respective investment objectives and goals are two considerations when we make investment decisions. Some investors, for example, have a goal of creating a portfolio that generates a reliable stream of dividend income that replaces their employment income. For this reason, they may gravitate toward companies with a lengthy track record of consecutive years of dividend increases. Emerson Electric, a repositioned Dividend King, has 65 consecutive years of a dividend increase. This qualifies it to be a member of the exclusive Dividend King group of companies; a Dividend King is a company with 50 or more consecutive years of dividend increases.

Emerson Electric (EMR) has an enviable record of consecutive years of dividend increases. It is, however, vitally important to look at the underlying fundamentals. This is because the deterioration in the underlying fundamentals can put an end to this dividend streak leading to a dividend cut or suspension.

Another consideration is the degree to which the company’s dividend is growing. In the case of EMR, we have a company whose dividend increases have been abysmal almost every year since 2012. The annual dividend increase has typically been under 2% except in 2014 when the increase was just under 5%.

EMR’s Average Annual Total Return with the reinvestment of dividends is ~10.85% since the beginning of 2012. Exclude dividend reinvestment and this drops to ~9.48%. In contrast, the returns from an investment in the broad S&P 500 index are ~15.73% and ~14.66% when we include and exclude dividend reinvestment.

Another consideration is the company’s valuation. An investor who invests in EMR at an attractive valuation will have a much different opinion of the company than an investor who acquires shares at a less than favourable valuation.

Investing in high-growth companies can sometimes compensate for the purchase of richly valued shares. The same can not be said about investing in a company like EMR where growth is much slower.

We also want to look at a company’s valuation, underlying fundamentals, and future prospects and not just the stock price so as not to fall into the ‘this time it’s different’ trap.

The challenge investors currently face is that many companies are richly valued because of:

• The low-interest rate environment. This often leads some investors to invest in equities as opposed to other forms of investment with inferior rates of return.
• The use of margin debt like never before. The Financial Industry Regulatory Authority’s (FINRA) margin debt statistics are evidence of this.
• A whole new breed of equity investors who view the equities market like a casino.

Emerson Electric – Dividend King – Business Overview

EMR designs and manufactures products and delivers services that bring technology and engineering together to provide innovative solutions for customers in a wide range of industrial, commercial and consumer markets around the world. FY2020 sales by geographic region are:

• the Americas 53%;
• Europe 18%; and
• Asia, Middle East & Africa, 29% (China 11%)

It reports in 3 segments:

• Automation Solutions; and
• Climate Technologies and Tools & Home Products, which together comprise the Commercial & Residential Solutions business.

I strongly recommend investors read Section 1 of the company’s most recent 10-K. This is a great source from which to obtain a comprehensive overview of a company and its risks.

February 2021 Investor Conference

EMR has undergone an extensive transformation over the years. This is borne out from the following image extracted from the company’s February 16, 2021 Investor Day presentation.

Emerson Electric 2021 Investor Conference

Looking at the following, we see EMR’s annual revenue has fluctuated widely during this transformation..

Emerson Electric 2021 Investor Conference

At the 2021 Investor Day, senior management explained how EMR has been restructuring its portfolio to position it for a better future and to drive sustainable value creation. With most of the heavy lifting already done, Emerson Electric is now a repositioned Dividend King poised to create value as growth returns.

After preparing for a zero or low growth environment since June 2019, EMR is positioned to execute during the coming global business upturn in 2021 and 2022. In fact, excluding the impact of potential divestitures, EMR is targeting more than $20B in annual sales in FY2023.

Emerson Electric 2021 Investor Conference

Emerson Electric 2021 Investor Conference

Open Systems International Acquisition

Acquisitions and divestitures are a regular occurrence with EMR. Details of such events are found here.

In August 2020, EMR announced its agreement to acquire Open Systems International, Inc. (OSI) for $1.6B in an all cash transaction; this most recent large acquisition closed October 1, 2020.

OSI is a leading operations technology software provider that broadens EMR’s software portfolio and ability to help customers in the global power industry, and other end markets, to transform and digitize operations to more seamlessly incorporate renewable energy sources and improve energy efficiency and reliability.

Emerson Electric – Dividend King – Financial Review

Q2 and YTD 2021 Results

EMR’s Q2 and YTD results were released May 5, 2021; its Q2 10-Q provides more detail.

On the Q2 earnings call with analysts, EMR’s newly appointed CEO and President indicates momentum is building. The strengthening recovery in most of EMR’s end markets coupled with the benefits from cost control actions drove strong Q2 operating performance. This momentum is across a larger number of the company’s markets than it was three months ago. Expansion is across both platforms and is expected to enable the company to make critical technology investments.

Demand is significantly stronger with sales ahead of expectations at 2% underlying growth. March 2021 orders were also toward the high end of expectations at 4% underlying growth.

Automation Solutions continues its steady improvement in both orders and sales. The Commercial & Residential Solutions business continues to experience robust demand across all its lines of business and in all geographies. It has experienced 11% sales growth and 21% orders growth for the trailing three months through March.

The cost reset benefits for the reorganization program implemented ~2 years ago are being realized as planned. This has resulted in adjusted segment EBIT growth of 15% and 150 bps of increased margin to 19.1%.

Cash flow (discussed in the Operating Cash Flow and Free Cash Flow section below) continues to be strong.

The bulk of EMR’s cost reset actions are complete. The company, however, still initiated $21 million of additional restructuring in Q2.

The OSI integration continues to proceed as planned with the expected synergies being realized. In addition, the order backlog is at $5.3B and is up 14% YTD.

FY2021 Guidance

Senior management expects Y2021 net sales to be just a bit above $18B.

Overall continued improvement in industrial and commercial demand is expected over the remainder of 2021. Residential demand is expected to remain robust. However, management thinks demand will begin to taper in the second half of FY2021.

Emerson Electric 2021 Investor Conference

Despite some profitability headwinds, management is raising its guidance and is also tightening its GAAP EPS and adjusted EPS ranges. This is because management is encouraged by:

• the underlying strength of the business; and
• the effectiveness of the cost reset actions the lines of business have been working on for ~2 years.

The additional headwinds are mainly an additional ~$50 million of unfavourable price/cost, driven by continuing increases in raw materials costs. There is also another ~$20 million of stock compensation expense versus previous estimates made in February.

EMR is no different from many other companies that I have recently analyzed. Many companies are telling the investment community that the speed and the magnitude of price increases in key inputs (i.e. steel, copper, plastic resins, etc.) are unprecedented.

EMR is actively working to mitigate the margin impact through selected price and cost containment actions. The progress made on this front gives senior management confidence to raise the guidance despite these increased headwinds.

On a positive note, EMR expects to retain ~$10 million more of the COVID-related savings than previously estimated. This is because basic activities, such as business travel, will return to the norm more slowly than previously projected.

Operating Cash Flow and Free Cash Flow

Free Cash Flow is an important metric I look at when analyzing a company. It is also a metric EMR’s management deems to be important. I reference page 15 of 64 in the FY2020 10-K in which management states:

Management believes that free cash flow, free cash flow as a percent of net sales and dividends as a percent of free cash flow are useful to both management and investors as measures of the Company’s ability to generate cash and support its dividend (U.S. GAAP measures: operating cash flow, operating cash flow as a percent of net sales, dividends as a percent of operating cash flow).

Looking at Q2 results we see that EMR reported $0.807B of Operating Cash Flow. This is a 37% increase from Q2 of the prior fiscal year. Year-to-date EMR has generated $1.615B of Operating Cash Flow which is a 60% increase from the first half of FY2020.

On the Free Cash Flow front, EMR generated $0.707B. This is a 48% increase from the same period in the prior fiscal year and is a free cash flow conversion of 125%. Year-to-date Free Cash Flow of $1.393B is a 77% increase from the first half of FY2020. This cash flow improvement reflects higher earnings due to operational execution across the two business platforms and favourable trade working capital.

Emerson Electric 2021 Investor Conference

Emerson Electric 2021 Investor Conference

EMR has generated Free Cash Flow of $2.586B, $2.388B, $2.971B, $3.041B, $1.941B, $2.434B, $1.436B, $2.275B, $2.412B, and $2.545B in FY2011 – FY2020. Looking at management’s guidance on the use of Free Cash Flow, it appears reasonable to expect continued share buybacks and potentially superior dividend increases over the next couple of years.

Emerson Electric – Dividend King – Credit Ratings

Moody’s affirmed EMR’s A2 rating on March 22, 2021 while S&P Global affirmed an A rating on May 19, 2021. Both ratings are the middle tier of the upper medium tier investment-grade category.

The ratings define EMR as having a STRONG capacity to meet its financial commitments. EMR, however, is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than entities in higher-rated categories.

EMR’s ratings are acceptable for my prudent investor profile.

Dividends and Share Repurchases

Dividend and Dividend Yield

Management’s actions to adjust to the lower demand caused by COVID-19 supported EMR’s commitment to its dividend plan. On November 3, 2020, it approved an increase from $0.50/share/quarter to $0.505/share/quarter. This increase marks EMR’s 65th consecutive year of dividend increases.

I do not dispute this is an admirable track record but a closer look at EMR’s dividend history shows the rate at which the dividend has increased in recent years is negligible. EMR has distributed the following dividends per share in FY2011 – FY2021: $1.44, $1.61, $1.66, $1.76, $1.88, $1.90, $1.92, $1.95, $1.97, $2.01, and $2.02.

Dividends were $1.209B ($2.00/share) in 2020, compared with $1.209B ($1.96/share) in 2019 and $1.229B ($1.94/share) in 2018. The bracketed figures represent the distributions in the calendar years whereas the figures in the previous paragraph are on the basis of EMR’s fiscal year which ends at the end of September.

Based on the current ~$97.50 share price, the current dividend yield is ~2.07%. As a Canadian resident, I hold EMR shares in a retirement (non-taxable) account. Were I to hold shares of this US-listed company in a taxable account, I would incur a 15% dividend withholding tax.

Source: Portfolio Insight

Share Repurchases

In several of my posts at my Financial Freedom is a Journey blog, I stress that investors should not fixate on dividend yield. It is preferable to look at an investment’s total potential investment return.

If a company repurchases shares at attractive valuations, this enhances an investor’s total investment return.

EMR’s Board of Directors authorized the purchase of up to 70 million common shares in November 2015. In March 2020, the Board of Directors authorized the purchase of an additional 60 million shares. A total of 66 million shares remain available for purchase under the authorizations.

EMR purchased 16.4 million shares in 2020, 19.9 million shares in 2019 and 15.1 million shares in 2018 under the authorizations. Purchases amounted to $0.942B, $1.25B, and $1B in 2020, 2019 and 2018, respectively, at average prices of $57.41, $62.83 and $66.25.

The following is the number of issued and outstanding shares (in millions) in FY2011 – FY2020: 754, 735, 723, 704, 677, 647, 643, 635, 621, and 607. For the 3 months ending March 31, 2021 the share count has dropped further to 602.8.

Emerson Electric – Dividend King – Current Valuation

Management’s current FY2021 guidance is diluted GAAP EPS of $3.55 – $3.65 and adjusted diluted EPS of $3.85 – $3.95.

We also see that EMR is targeting $4.75 – $5.00 of adjusted diluted EPS for FY2023. Anything can happen within 2 years so I place minimal reliance on this guidance to gauge EMR’s valuation.

It is also important to consider that EMR regularly acquires and divests. It is, therefore, quite possible the EMR of 2023 will be somewhat different than the EMR of the present.

Emerson Electric 2021 Investor Conference

Shares are currently trading at ~$97.50. On the basis of FY2021 diluted GAAP EPS, we have a forward P/E range of ~26.7 to ~27.5. In comparison, EMR’s FY2011 – FY2020 diluted P/E levels are: 14.38, 18.98, 25.43, 20.37, 11.99, 22.76, 27.44, 17.27, 20.56, and 24.81.

If we use EMR’s $3.85 – $3.95 adjusted diluted EPS guidance and the $3.93 mean and $3.85 – $4.00 low/high range from 21 brokers, we get forward diluted adjusted /PE levels of ~24.8 and ~24.4 to ~25.3.

For comparison purposes, I provide the valuation for the three occasions in which I purchased EMR shares within one of our retirement accounts; I do not disclose details of such accounts. With the reinvestment of dividends, my average cost is ~$37.56.

• July 2, 2009 @ $32.15/share;
• July 20, 2015 @ $52.55; and
• September 16, 2016 @ $51.07.

I know the EMR of several years ago is different from the EMR of the present. However, I want to gauge EMR’s valuation at the time of those purchases versus the current valuation.

• In FY2009 EMR generated $2.26 in earnings from continuing operations and $0.01 in earnings from discontinued operations. Using my $32.15 purchase price and $2.26 in earnings from continuing operations I acquired shares at a P/E of ~14.23.
• In FY2015 EMR generated $3.71 in earnings from continuing operations and $0.28 in earnings from discontinued operations. Using my $52.55 purchase price and $3.71 in earnings from continuing operations I acquired shares at a P/E of ~14.16.
• In FY2016 when I made my smallest EMR share purchase, EMR generated $2.45 in earnings from continuing operations and $0.07 in earnings from discontinued operations. Using my $51.07 purchase price and $2.45 in earnings from continuing operations I acquired shares at a P/E of ~20.84.

While I agree EMR is a repositioned Dividend King and management indicates we can expect improved results, I think a ~26.7 to ~27.5 forward diluted P/E range based on GAAP estimates is a bit on the rich side. As indicated earlier, EMR is not a high-growth company and its annual dividend increases are negligible.

Having said this, I think waiting for a GAAP P/E in the upper teens might result in a very long wait before such an attractive valuation is reached.

Using FY2021 diluted GAAP EPS guidance of $3.55 – $3.65 and a P/E of 22, a price in the low/mid $80s seems more reasonable to me. If EMR’s share price does not retrace to this level, then so be it. EMR is not the only company in which to invest.

Emerson Electric – A Repositioned Dividend King – Final Thoughts

I view Emerson Electric as a repositioned Dividend King following all the changes made in the past few years.

EMR has been a ‘challenging’ investment over the past few years. For investors who have stuck with EMR during challenging times, however, I certainly hope management is correct about the company’s prospects.

The company is now being led by a new CEO and President and I am certain all eyes are on how the company will perform under his tenure. As a result, I envision he is extremely focused on restoring investor confidence.

On a positive note, Operating Cash Flow and Free Cash Flow are a priority.

Although some investors fixate on dividend yield, I think it is preferable to look at an investment from a total return perspective. Dividend income is nice to receive (it enabled my wife and me to retire early) but dividend distributions are not always the preferred means by which to increase shareholder wealth. Sometimes reinvesting in the business so as to improve its competitiveness and profitability is a superior use of funds.

As much as management claims EMR is a repositioned Dividend King, I am not adding to my EMR exposure at the current valuation. I will continue to wait for a long-overdue market correction. If/when one does occur and if EMR’s share price drops to the low/mid $80s then I will consider adding to my position.

Stay safe. Stay focused.

I wish you much success on your journey to financial freedom.