Investors in industrial equipment company Emerson Electric Co. (NYSE:EMR) have watched their stock underperform the S&P 500 by around 15% year to date. The stock sold off after a disappointing set of third-quarter results, and readers may be wondering whether this is the trough in Emerson Electric Co.'s stock price for this year. In this context, management had plenty of things to say about the company's prospects. Let's look at five key takeaways from their commentary.
Orders better than sales
The first takeaway is that underlying sales--those that exclude acquisitions and divestitures-- came in at 3% and are trending at the low end of full-year guidance of underlying growth of 3%-5%. Underlying sales are important because they are a better gauge of the company's performance and future prospects. However, underlying order growth is a lot stronger; coming in at 5% in the third quarter. Moreover, Director of Investor Relations Patrick Fitzgerald said on the conference call:
Orders growth is expected to accelerate increasing to between 5% and 7% in the fourth quarter. On a [preliminary] basis, July trailing three-month orders are approaching 7% growth, with the stand-alone month of double digit."
Indeed, a few weeks later Emerson Electric reported that three-month average order growth had increased to 7% in July, from only 5% in June. Increasing orders are usually a strong precursor of stronger sales.
Backlog good, indicating future growth
Another sign that Emerson Electric's sales will increase in the future comes from the large increase in its backlog this year. Year to date, Emerson Electric's backlog, excluding divestitures, is up 20%, and when questioned on the call, Chief Financial Officer Frank Dellaquila disclosed that it was up "11% year on year." Clearly, there is an opportunity to reduce the backlog in the fourth quarter -- something the company has traditionally done -- and this will help give a boost to sales in the current quarter.
Cautious customers; unstable geopolitical environment
According to the presentation, management generally feels that "global economic momentum continues to improve." However, that's not the complete story, and management took the time to explain to shareholders that customers continued to take a cautious stance on current spending. As discussed above, orders are increasing well. However, current customer deliveries (which are booked as revenue) are relatively weaker, which means that the backlog is increasing. Going forward, the company needs to increase the rate that it converts backlog into deliveries.
When asked a question on conversion rates, CEO David Farr replied:
The conversion is the uncertainty around the world ... from a geopolitical situation and the fact that the underlying growth of the world ... substantially below what people thought they were going to be just six months ago,
Clearly, there is no guarantee that customer sentiment will change in the future, and investors should be mindful of that.
Emerson Electric Co. outlines its aims
The first three takeaways -- orders, backlog, and customer sentiment -- come together to influence the fourth takeaway, which is management's objectives going forward. In a nutshell, management acknowledged that growth was trending below what it had expected, and going forward, Farr said the focus will be on trying to increase sales growth:
[W]e've got to convert, we've got to get the orders, we've got to reduce the backlog and then deliver profitability, which I believe we're set up to do for the remainder part of this year
In other words, management has pretty much said that it's in a race to hit its full-year targets, and investors can expect an emphasis on accelerating its sales growth in the fourth quarter.
Returning cash to shareholders
The company has long been known for being shareholder friendly. For example, its dividends have increased for the past 58 years, and the yield currently stands at around 2.7%. Its management wants you to know that its policy of share buybacks and dividend increases is likely to continue. That's good news for dividend hunters.
This is what Farr touched on when questioned about the company's capital allocation strategy for 2015:
- Spending on acquisitions is likely to be between $1 billion and $1.5 billion.
- Share buybacks are at a similar level to 2014 -- i.e., $1 billion -- although this could be more if its power transmission solutions business is sold.
- The dividend is expected to increase next year,
- Capital investments will come in at $800 million to $850 million next year.
To put these figures into context, the company's market cap is around $44.9 billion, and its free cash flow (from which the buybacks and dividend will be paid) last year was nearly $3 billion.
Putting these points together, it's clear that Emerson Electric Co. has the potential to improve its sales and earnings in the coming quarters. Orders have improved, and the backlog is big enough to spur growth in the near term -- something the company is focused on doing. Question marks still exist over its customers' ongoing caution, but Emerson's commitment to enhancing shareholder value is likely to find it plenty of friends in the value investing community.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Emerson Electric. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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