EUR 850.00 For Business Accounts Only

Morningstar | The Market Missed the Boat With Wide-Moat Rated Emerson’s Fiscal 1Q Results

Despite the negative reaction in the stock, wide-moat Emerson reported solid results Feb. 5, and after modeling in the effects of recent acquisitions, we maintain our fair value estimate of $83 per share. The stock narrowly missed top-line consensus estimates (we don’t model quarterly estimates), and we suspect the market reacted negatively to two factors: 1) the slowing HVAC environment in China during the front half of the year and 2) concerns over the oil and gas cycle (about 39% of the automation solutions segments has exposure to the oil and gas market between upstream, midstream, and refining end markets at 19%, 10%, and 10% of respective segment revenues, with automation solutions constituting about two thirds of sales). Nevertheless, we maintain our wide-moat, stable trend, medium uncertainty, and Standard stewardship ratings.

We’re not overly concerned with these fears as we expect declining Chinese HVAC sales to moderate during the back half of the year. While management expects these to trend positively later this year, we now model 0% top-line growth in the non-North American air conditioning market out of conservatism. We also consider oil and gas fears, while a reasonable concern, an overreaction given the amount of “KOB 3” project sales, or higher-margin aftermarket revenue. Tellingly, CEO David Farr has made this a point of differentiation when highlighting the differences between this cycle and the prior cycle (when the price oil in 2014 fell from about over $100 a barrel to the mid-30s in 2016), and that automation solutions has managed to keep this portion over 50% of segment sales, from our understanding.

Longtime followers of the stock will notice the firm’s top and operating lines are typically back-end loaded, and the firm tends to improve sequentially as the year proceeds. As the firm’s raised guidance indicates, management also believes it can make up this perceived lost ground as the year progresses. The firm raised both the top and low end of its sales growth range (to 7%-10% growth from 6%-9% previously), as well as the top and low end of its GAAP EPS estimates (to $3.60-$3.75 from $3.55-$3.70 previously). Out of conservatism, we model GAAP EPS of $3.63, about the midpoint of the prior range.

More important was news of share repurchases, in our view. While many companies now use share repurchases almost as a matter of course, and Emerson had already pre-planned about $1 billion of share repurchases, we were most impressed by the pace of repurchases, which we think confirms our view that the stock was attractively undervalued during the month of December when it tripped our five-star rating. The stock only traded at our five-star price for a few days, sometime between Dec. 19 and 26. While we still believe shares are modestly undervalued at current prices (at over $67 per share for an 18% discount), we no longer believe they represent compelling value at today prices after a 22% run-up in the market in just over a month. Even so, if prices come down significantly, and the M&A environment remains challenged, we suspect Farr could obtain authorization from the board for additional repurchases.

We reiterate our thesis that Emerson is the undisputed powerhouse in process manufacturing on this side of the Atlantic, led by the growing automation market, with the total addressable market totaling $204 billion according to 2017 data. We expect Emerson will be a leading participant in this space since a large portion of the market remains non-serviced. Trends that will benefit Emerson specifically include less available skilled labor in the United States and innovations like digital twin technology, which allows testing new processes without disruption. Finally, while not in current management’s near-term plans, a potential catalyst in the stock would include the breakup of its automation and commercial and residential platforms given the disparate nature of the two platforms’ end markets and business models.