Dividend Aristocrat Emerson Electric's (EMR +6.94%) payout of around 3.4% makes it a favorite of yield hunters, but for long-term income seekers, is the stock really worth buying ? The answer is likely to be shaped by events in the coming year, particularly as the company is undergoing significant restructuring.
Let's take a look at five things you need to know about Emerson Electric as an income investment, and why 2017 is such an important year for it.
EMERSON ELECTRIC NEEDS THE PROCESSING INDUSTRY TO MAKE CAPITAL INVESTMENTS. IMAGE SOURCE: GETTY IMAGES.
Restructuring
CEO David Farr is in the process of restructuring the company from five business segments into two, namely automation solutions (the process management segment and the remaining industrial automation businesses) and commercial and residential solutions (combining the existing business with the climate technologies segment).
As part of the plan, the company has sold its network power segment and is close to completing the sales of Leroy-Somer and of Control Techniques (industrial automation). Ultimately, management expects to receive $4.3 billion from these sales after taxes and fees are paid.
The divestitures will have a significant impact on revenue and free cash flow generation, making it hard for Emerson Electric to increase its dividend. For example, the company's fiscal 2016 revenue including the discontinued businesses (Leroy-Somer, Control Techniques, and Emerson Network Power) was $20.2 billion, but analysts are forecasting around $15 billion in revenue for 2017.
Free cash flow and dividend outlook
The impact on free cash flow and dividends will be significant in the next five years. At the Morgan Stanley Laguna Conference in September, management gave its free cash flow and dividends-paid outlook for the next five years. As outlined at the conference, free cash flow supports a $0.02 increase in dividend per share for the next five years:
| Metric | 2016 | 2017 Estimated | 2019 Estimated | 2021 Estimated |
|---|---|---|---|---|
|
Free cash flow* | $2.434 billion | $2.050 billion | $2.225 billion | $2.550 billion |
|
Dividends paid | $1.227 billion | $1.230 billion | $1.240 billion | $1.260 billion |
|
Percentage of free cash flow | 50.4% | 60% | 55.7% | 49.4% |
| Potential dividend | 1.92 | 1.94 | 1.98 | 2.04 |
| Potential dividend yield | 3.33% | 3.37% | 3.47% | 3.54% |
DATA SOURCE: EMERSON ELECTRIC PRESENTATIONS. *REPRESENTS MIDPOINT OF THE RANGE.
There are two points of note for dividend investors:
- In five years' time, Emerson Electric's yield, based on the current stock price of around of $57.6, could be around 3.54%.
- Management's desired range for dividends paid -- 40% to 50% of free cash flow -- means that after 2021, dividends might only rise in line with free cash flow growth -- as in 2021, the ratio is forecast to be 49.4%.
In other words, the outlook for dividend growth in the next five to seven years is moderate at best.
Margin pressure building
There is no guarantee that Emerson Electric will hit its earnings and free cash flow targets in the future. In common with other industrial stalwarts like General Electric Company (GE +6.68%) and Rockwell Automation Inc. (ROK +5.37%), Emerson has seen its oil-and-gas-related revenue disappoint in 2016. All three are hoping that energy capital spending will bottom in 2017, but it's obviously contingent on energy prices to a large extent.
In addition, on the fourth-quarter earnings call in November, Farr talked of rising cost pressure and said: "[I]n order to hold our margins and improve our profitability next year, we're going to have to come up with more stronger discretionary cost savings, because I think price-cost will be working against us."
Acquisitions can help
On a positive note, the divestitures will give management more financial firepower to make acquisitions. The acquisition of Pentair PLC's (PNR +2.66%) valves and controls business for $3.15 billion is a demonstration of management's confidence in capital spending in resources industries -- General Electric Company is doing a similar thing by merging its oil and gas business with Baker Hughes -- and it may prove the right time to invest in core end markets.
Moreover, Farr plans to make more acquisitions, and given that the figures in the table above don't include anything other than the Pentair deal, Emerson's potential acquisitions could lead to more free cash flow and dividends in the future.
EMERSON ELECTRIC HOPES OIL AND GAS CAPITAL SPENDING WILL BOTTOM IN 2017. IMAGE SOURCE: EMERSON ELECTRIC.
Positive orders needed
In the end, Emerson, General Electric, and Rockwell Automation are looking forward to when heavy industries start increasing spending again. Farr laid down a marker for investors to look out for regarding Emerson's automation solutions segment: "[W]e're saying it's going to start getting better in the early calendar year of 2017 but will not go positive until late -- on the Automation Solutions standpoint, until late 2017."
Is Emerson Electric a buy for dividend investors?
All told, the decision boils down to your level of confidence in energy and heavy-industries capital spending; if you believe in the former, then a stock like Rockwell Automation or General Electric arguably gives you more upside.
However, for pure dividend investors, the potential yield of 3.3% to 3.5% during the next five years might be enough to stay in the stock, particularly if Farr -- a CEO who is highly regarded, not least by this author -- manages to successfully restructure the company toward growth.
