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Will Emerson's Organizational Reset Help Right the Ship?

By Howard Smith – Feb 25, 2020 at 9:06AM

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With an outlook for zero sales growth ahead, management has announced a three-year plan to accelerate profit margins and cash flow.

Many investors in Emerson Electric (EMR 3.59%) closely follow, and rely on, the dividend. After 63 annual increases, this Dividend King is on the short list of companies that have increased dividends for more than 50 straight years. But share price returns have caused long-term shareholders to trail the general market since the Great Recession, as this 10-year chart shows.

EMR Chart

EMR data by YCharts.

Now management has unveiled a strategic plan through 2023 to give investors confidence for future returns.

Planning for slowing growth

At Emerson's investor conference earlier this month, management said that it is planning for no organic sales growth in 2020, and revealed it has finalized a plan to begin "aggressive cost resets" and to "expect some major changes in senior leadership" this year. This comes in the face of what it considers deteriorating macroeconomic conditions in its businesses, though it stressed that some 2019 goals were still achieved.

Income investors should be relieved to see that the company still intends to increase its dividend in both 2020 and 2021 at a higher rate than it did in 2019. The business should continue to support this as the plan is to return approximately 70% of operating cash flow to shareholders in the forms of the dividend and share repurchases, with its ratio of dividends paid to free cash flow at approximately 50%. Emerson looks to be taking a proactive approach and laid out its plan that will carry through to 2023.


Image Source: Getty Images

Building long-term value

As the near-future low-growth environment became apparent, Emerson brought in a third-party consultant to help create cost saving initiatives in both its automation solutions and commercial and residential solutions platforms, as well as at the corporate level.

It believes that even with minimal sales growth, this plan of $1.4 billion in actionable items will deliver $425 million of additional profit, resulting in 2 percentage points of margin expansion, and a new high for peak margins in 2022-2023. If sales growth exceeds expectations, as well as when the macro environment allows it to resume growth, the new cost structure will leverage higher profits. Contribution to these actions will come from product pricing, operational efficiency and cost reduction, footprint reduction, and corporate restructuring including lower general and administrative (G&A) costs.

Also announced is the plan for an orderly management transition during this period. Current Chairman and CEO David Farr, CFO Frank Dellaquila, and Systems and Solutions President Jim Nyquist will be retiring through 2021.

Good news or bad news?

Restructuring during down markets isn't new to Emerson management. Plans were also implemented in 2001-2003, 2009-2010, and 2015-2016. This experience is helpful, but investors might look at the above 10-year chart versus the S&P 500 as bad news and wonder if these plans were successful.

The good news is that the goal of the current plan is for improved cash flow and margins. As the chart below shows, since the 2001-2003 restructuring, operating cash flow has been strong, allowing investors' dividend payouts to continue to increase. 

EMR Cash from Operations (Annual) Chart

EMR Cash from Operations (Annual) data by YCharts.

A look at the business

About two-thirds of revenue comes from automation solutions, with the balance from commercial and residential, and the company intends to keep the businesses growing. Included in the restructure plan is $4 billion intended for acquisitions through 2023. 

Organic investments are also intended to grow the business. These focus on areas including artificial intelligence (AI) and machine learning, device diagnostics, and field analytics in automation solutions, as well as energy efficiency, connectivity, food quality and safety, and e-commerce within the commercial and residential platform.

Different investing goals

By proactively looking at its business during down cycles, and making concrete plans to improve cash flow and margins, Emerson has maintained steady returns to shareholders for years.

Not every portion of an investor's portfolio needs to be geared to outpace the general market. Even with a near-term outlook for no sales growth, Emerson has detailed plans to continue generating plenty of cash, as well as investing for future growth. Investors looking for income and a reliable business should look into whether Emerson has a place in their portfolio.

Howard Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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