Sunday, December 13, 2015

Emerson electric (NYSE: EMR)

 The business
http://finance.yahoo.com/q/hp?s=EMR
Emerson electric is a American multinational corporation that is founded over 100 years ago. It is hailed as one of the dividend kings that has indisputable reputation for dividend payouts and have not stopped any payments consecutively and even increased their dividends payout for 59 years. Their businesses are largely categorized as:

• Process Management - provides measurement, control and diagnostic capabilities for automated industrial processes producing items such as fuels, chemicals, foods, medicines and power.
• Industrial Automation - brings integrated manufacturing solutions to diverse industries worldwide.
• Network Power - provides power conditioning and reliability, and environmental control to help keep telecommunication systems, data networks and other critical business applications operating continuously.
• Climate Technologies - enhances household and commercial comfort, as well as food safety and energy efficiency, through heating, air conditioning and refrigeration technology.
• Commercial & Residential Solutions - provides tools for professionals and homeowners, residential storage systems and appliance solutions.
Source: EMR2015 - 10k filing.

While having a diversified portfolio helps to reduce risk of a crash of a single asset class, similarly they are unable to profit from a great boost in any one of them. However, with the recent turmoil in the economy, personally I would choose a reduction in risk over a chance of massive growth. Having huge capitalization also allows them to maintain their durable competitive advantage. 

Although the company is involved in various aspects of manufacturing, they are ultimately under manufacturing, and a large aspect of manufacturing is oil. Thus oil prices will always have a impact on Emerson although to a much lesser extent than O&G companies.

A couple years ago until rather recently, their high share prices of 60-ish have caused the yield to hover around 2.5% but with the more recent stock market slump mid 2015, their current price of 47.83 have brought yield up to nearly 4%*. Let's proceed to some analysis, where I will go through several factors of importance one by one.

*As of writing, I usually write my articles over a period of time and thus there might be price inconsistencies throughout.

1) Gross profit margin:

year
revenue
% (Gross profit margin)
2010
21,039
10.54%
2011
24,222
10.45%
2012
24,412
8.29%
2013
24,669
8.37%
2014
24,537
8.90%
2015 (adjusted)
22,304
9.79%


In this case, gross profit might be labelled net profit in some other reports, but to clarify, gross profit margin mentioned above takes into consideration cost of sales, SGA and interests paid. Basically the margin shown is the margin of cash the company earns, with nothing much to deduct anymore.

There is a definite downtrend to be observed, but the rather substantial rise in profit margin signals me that the management is doing things right. Given the fact that revenue increased instead from 2010 to 2013, the drop in profit margins might be caused by some other factors instead of poor sales and fierce competition. Digging through financial statements, it is seen that 'In the fourth quarter of 2012, the Company’s annual goodwill impairment... As a consequence, the carrying value of these businesses
was reduced by a noncash, pretax charge to earnings totaling $592 ($528 after-tax, or $0.72 per share).'


The company spent quite a copious amount of money for acquisitions in 2012 which didn't bring back expected profits or 'fair value'. The money that the company paid that exceeds returns are goodwill impairment, which takes up a sizable chunk of 2012's gross profit margin. Since then (i believe) management has seemed to be making wiser acquisition choices, as profit margins are slowly rising in a falling market (2013 - 2015).

Comparatively, General Electric's gross profit margin of average 13.43% over the past 5 years could signal that Emerson might not be spending money as wisely as another company in the similar field. However, the fact that Emerson deals in a extremely huge array of industries might cause this comparison to be rather useless. We will then take a look at how similar industries fare up:

Electrical Equipment -11.71%
Electronics (General) - 8.11%
Machinery - 10.90%
 Not so bad.

2) EPS
An extremely major factor in deciding share prices, earnings-per-share is a strong indicator that can attract or spook investors at first sight. Let's see Emerson's.

year
EPS (diluted)
2010
2.84
2011
3.27
2012
2.67
2013
2.76
2014
3.03
2015 (adjusted)
3.161

While the company forecasts annual growth of 3-5% of underlying net sales annually, 2015 is the first year that the company forecasts a drop of net sales by 6-8% for 2016. Given the time at which the 10K is filed, oil prices have went further south and a gloomier forecast might be in place. However, given the highly diversified holdings under Emerson, it would not be impossible for them to shift their earning capacity further away from O&G industries. They also have a rich history of acquisition and divestitures depending on profitability of certain sectors. Given the fact that Emerson managed to cling onto the lifeline in the several oil crisis in 2003 and 2008 where prices are around current levels, I think EMR is well experienced in dwindling oil prices and this would not hit them as hard. 

Furthermore, in FY2015 oil prices are a steep drop - nearly 50% - off FY2014 prices, and yet EMR managed to report strong EPS, displaying their resilience and strong footing as a large corporation. The decent EPS might also be caused by large share buybacks of EMR, which will be discussed later on.

Un-adjusted EPS is actually $3.99, a steep growth from 2014, but given that it is a one time gain I took that out, but one should still not completely ignore it. EPS doesn't look that bad here, taking the rocky economy into consideration.

3) Cash and CE
year
Cash and CE
2011
2,052
2012
2,367
2013
3,275
2014
3,149
2015
3,054
 

While they are constantly buying and selling businesses, EMR is stocking up on a healthy amount of cash in case of economy downturns (ding ding ding its happening right now). Its always good to see a company which doesn't squander away all their money in pursuit of heated expansion during good years and always be ready for the rainy season. It is also not to say that they are cash hoarders as proven on their massive share buybacks. Pretty good money usage.

4) Assets & Liabilities
A bigger group that cash and CE is in, assets paint a much bigger picture of what the company has and what the company owes. Its rather self-explanatory.
year
Total Current assets
Total non-current assets (less PPE)
Total assets
Current Ratio
2011
9,345
11,079
23,861
1.445475638
2012
10,126
10,183
23,818
1.419599047
2013
10,999
10,107
24,711
1.442491803
2014
10,867
9,508
24,177
1.285427017
2015
10,049
8,454
22,088
1.288333333


year
Total current liabilities
Long-term debt
Total non-current liabilities
Total liabilities
2010
 -
 -
 -
 -
2011
6,465
4,324
6,845
13,310
2012
7,133
3,787
6,243
13,376
2013
7,625
4,055
2,313
13,993
2014
8,454
3,559
5,556
14,010
2015
7,800
4,289
6,160
13,960


While there isn't much growth to speak of, their current liabilities are increasing at a pretty quick pace, this seems like non-current liabilities are reaching maturity as their total liabilities are pretty much maintained. The current ratio is still steady at 1.28, while their debt ratio is decent at 0.63. So long as the company doesn't take on increasing debt in a falling economy they should be able to service them and tide the crisis over.

Since investors are very cautious about buying into a debt-laden company (or one that could be), debt ratios are important to us as we do not want a seemingly bustling company fall into bankruptcy because of excessive leverages. For a manufacturing corporation like EMR, a debt ratio of 0.63 indicates that for each dollar of asset they have, 63 cents of it is financed by debt. The industry average for manufacturing companies is 0.7 - so EMR is doing fairly well.

Taking a look at how strong are they at servicing debts, the 10-K shows a good ratio of 21.8X, giving us a interest payment of only about 4.5% of sales, even in event where sales dropped by half, they are still more than capable of handling their debt payments. For FY2015, 23% of their net earnings is paid as interest, it is high but still very manageable.
Operating Cash Flow-to-Debt Ratio  37.0%
Interest Coverage Ratio 21.8X

Interest paid / net earnings : 23.08%
I believe that the company wouldn't buckle anytime soon, we can instead take falling assets/increasing debts as a chance to acquire some bargain shares as other investors are spooked away by it.


5) Return on Equity

year
shares issued ( 0 pref)
Return on Equity
Shareholder Equity
2011
738.87777
24.33%
10,399
2012
724.11329
19.38%
10,442
2013
706.66026
19.28%
10,718
2014
696.60522
21.58%
10,119
2015
654.60852
27.03%
8081


Personally I am a great fan of share buybacks, admittedly I might have placed a much larger emphasis on share buybacks for a company than many others, but that's just by bias. Why?
For a company issuing dividends as a way of rewarding shareholders, it has been so taken for granted that shareholders throw a tantrum and start a selloff should payments be interrupted or even reduced. Therefore companies which have a long history of dividends are unable to increase payouts in a good year, lest they invoke the wrath of the market during bad years where they have to reduce it. In a way, for most companies dividends distribution is on a 'no choice' basis.

Share buybacks on the other hand, can be triggered as and when the company feels suitable to do so. These are often regarded as a positive move by the company to increase shareholders value, by buying back shares from the market during bad years, the company can also increase profitability by having to share profits with lesser investors in the future. For a company to be giving money back to shareholders on their own will is something I regard very highly in. As we can see above, even in a falling economy, EMR used their funds to increase RoE from a would-be 20% to 27% by massive share buybacks.

It could also signal that the management knows in a bad year, monies should not be used for expansion as there is no need to increase production with falling demand. They are also not just mindlessly hoarding more and more money with no plans on what to do with it. IMO, signs signifying good decisions by management always outweighs any current numerical data or technicals.

6) Dividends
The factor where EMR has built a solid reputation on. One aspect where the company performed admirably is that they managed to maintain solid dividends payout even in bad years, something badly managed companies could never achieve. Maintaining a decent amount of leveraging also helps towards this. EMR has a 59 year of consecutive dividend payout increment, that's a really impressive record. Adding to the fact that this 59 years is riddled with several worldwide shocking financial events:
https://en.wikipedia.org/wiki/1970s_energy_crisis [1970s]
https://en.wikipedia.org/wiki/Black_Monday_%281987%29 [1987]
aaaaaaaand.............
pardon me but I am too lazy to properly format the entire list, but among it , even for those who aren't following the finance industry, know about the 2000s and 2008 financial crisis, where the world economy turned to sh**. You get my point about Emerson staying strong with their dividends throughout.

Paying dividends is one thing, but paying it sustain-ably and reasonably is another. It's pointless for a company to continue paying dividends if they are increasingly getting in debt or having no profit in order to do so (although in that case it would be impossible to do for over 50 years, but still). Regarding that we can take a look at their dividend payout margin. During the bad years:

Year
EPS
Dividends paid
payout margin
2007
2.66
1.05
39.47%
2008
3.06
1.2
39.22%
2009
2.27
1.32
58.15%


It's a good thing that EMR is keeping their margin relatively low in bustling years, thus giving them ample cushion to handle economic downturns. As we can see above, their payout margin increased nearly 20% after the 2008 crisis, although I do not understand why they chose to still increase the payout. This move is like their management throwing out a poster to the entire corporate world saying 'that's how we roll'. Anyway they are cool.

After increasing payout margin in bad years, it would only make sense for management to bring the margin lower in better times to prepare for the next crisis, which brings us to now.

year
Dividends paid
payout margin
yield
2010
1.35
47.54%
2.56%
2011
1.435
43.88%
3.47%
2012
1.61
60.30%
3.34%
2013
1.64
59.42%
2.53%
2014
1.72
56.77%
2.75%
2015
1.88
59.47%
4.26%


We can see a evident effort of lowering the margin in 2010-2011, but with the stark decline in earnings post-2011 ..
year
Net earnings
2010
2,217
2011
2,530
2012
2,024
2013
2,066
2014
2,184
2015 (adjusted)
2,184

 
..the margin went back up again to 60%. Still not that bad, seeing that they have been through it before, in even worse times. I would believe that they can continue their dividend streak a long time in the future. However, their rather stubborn habit of increasing payouts is slightly irking me as it is starting to look like they are giving more than they can afford to. I wouldn't mind if they only started to increase payouts after lowering their margin back to the 40% area, but I am sure with their entire group of management their reasoning behind these actions would be infinitely better than my simple opinions.

The yield of the stock in recent years has been fluctuating very widely, from 2.53% in 2013 to 4.26% this year. This is mainly due to investors sentiment pushing the prices of the share up high when the market is good, and having a massive sell-off now. I believe the situation right now nicely displays Graham's Mr. Market, and a yield of over 4% with a strong dividend history company does seem to be a good time to enter.

Taking into account that once oil prices and investors sentiment improves, share price appreciation could net some decent profit into the future. Even if that doesn't happen soon, so long as EMR continues with its tradition of distribution, the risk margin is not that deep.

Fin. *********************
 
I may post a part 2 describing more qualitative analyses of the company but given that most of them I did is rather subjective and existing only in my head, this article highlights the important factors that I can refer to next time after buying the stock.

Note: Non-US citizens are liable for a 30% income tax by the federal government of the USA. That includes dividends.

 
 





 



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