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Morningstar | Emerson Electric Posts Strong Fiscal 3Q Results; We Are Raising Our FVE by $2. See Updated Analyst Note from 07 Aug 2018

Wide-moat Emerson Electric turned in strong results on Aug. 7, and we are raising our fair value estimate to $75 per share from $73 previously based on more optimistic near-term assumptions. About $1 of this raise relates to the time value of money, with the other $1 due to improving fundamentals. That said, nothing in the firm's latest results alters our long-term fundamental outlook. In fact, we think the firm's latest results support out thesis that its automation solutions segment will benefit from customers' desires to remotely control all facility operations from centralized locations. We're bullish on automation, and these products and services we believe, should ultimately benefit Emerson’s profitability by providing the firm with higher-margin sales. As a result, we previously modeled, and continue to model an over 3-point rise in GAAP operating margins by 2021 (to 19.6% from 16.4% at end of year 2017).

The firm's net sales rose by 10 percent year over year in the third quarter, or 8% year over year on an organic basis. Increased sales were thanks to broad-based growth across several of the firm's end markets. Operating margins rose 150 basis points year over year to 18.1% for the total firm. On the heels of this strong third quarter, management increased its full-year 2018 outlook, and expects organic sales growth in automation solutions of approximately 9%, and in commercial and residential solutions of 4.5%. We agree with management's most optimistic take, but it only prompts us to raise our automation solutions organic growth assumptions by a point (from 8% previously). We’re also fine-tuning our tax benefit assumptions derived from the Tax Cuts and Jobs Act and arrive at a 2018 GAAP EPS assumption of $3.34 against management’s guidance of $3.30-$3.40.

For the firm’s segments, automation solutions' net sales increased 18% in quarter, with organic sales up 12%. Like some of its diversified industrial counterparts, management continues to leverage its installed base and then benefits from strong short-cycle maintenance and repair demand (which we think is more related to a customer's operating expense spending versus its capital expenditures spend). Even so, management affirms that both market research and customer insights support its view that Emerson should continue to see a strong automation market over the next two to three years, indicative of higher customer capital expenditures spending on the horizon.

Both mature and emerging market demand was strong, furthermore, particularly in North America, China, and India. Commercial and residential solutions' net sales were down 1% year over year on a reported basis thanks to divestitures, but up 2% on an organic basis year over year. This segment has comparably less attractive growth prospects (it sells professional tools and air conditioning products and services), but still demonstrates steady demand.