Investors in Emerson Electric (EMR +2.92%) already know the company had a difficult 2015, with a combination of negative trends forcing management to lower revenue and earnings estimates throughout its fiscal year. The last earnings report wasn't pretty, and as of this writing, the stock has declined around 20% year to date. However, no stock goes down forever, and the stock's forward annual yield of 3.8% is obviously going to attract dividend hunters. With that said, let's look at the five things management wants you to know about its current trading and future prospects.
1. China's slowdown is hurting
It's rare that a CEO gives such detailed perspective on its trading in one country, so it pays to look closely at David Farr's commentary on the third-quarter earnings call. Regarding current trading, Farr outlined how conditions deteriorated in the quarter:
It got tougher as the quarter went on, as we got into June. The big negative surprise for us in the month of June was the extreme weakness in China. We saw China drop over $100 million from prior year, down 14%-plus versus the prior year.
When questioned on the specific issues in China, Farr said the state-owned enterprises had "really cut back on spending." He also argued that there was a political cause: "The major state-owned enterprises, there has been a lot of continued crackdown on the ethical issues, the arresting and replacement of management team. A lot of people are afraid to make decisions." Farr went on to predict that the next couple of quarters would be tough in China.
On one hand, the problems in China may prove temporary as the crackdowns may be relaxed in the future. However, there is no guarantee that China's economy will increase its growth rate in the near future, or that the type of spending Emerson Electric needs will recover.
2. Oil and gas is getting worse
Emerson Electric investors have been hoping for the price of oil to rise, because the longer it stays at relatively low levels, the more pressure will build up on the company's oil and gas customers to curtail capital spending plans. But the price of oil has continued to remain below $60 in 2015. Farr now expects "pretty weak orders in this space for at least the next 12 months to 15 months."
In addition, Farr served notice that customers' spending cuts could extend beyond capital spending cutbacks and move into cuts in spending on maintenance, repair, and operations, or MRO. His "gut feel" is that "they're going to start cutting into the MRO base, which has held up until now."
3. There are two tough quarters to come
Investors already know the company is headed for a difficult couple of quarters, because analyst estimates are for EPS to decline by 23% and 15% in the fourth quarter of 2015 and first quarter of 2016. However, if you think that's bad, consider that when asked on the earnings call about future growth, Farr said, "Visibility right now is very challenging, because I know I've got that big hill I've got to climb sitting right out in front of me."
In other words, conditions are getting tougher for the company, and if Farr's visibility (over orders and bookings) is challenging, then don't be surprised if the company faces further difficulty in the next two quarters.
4. A Network Power spinoff is coming
In June, the company announced plans to spin off its Network Power segment in an attempt to refocus on its core strengths. However, there are some question marks over the intended spinoff. For example, the segment has been weak for some time, amply demonstrated by the 11% decline in underlying sales growth in the third quarter.
Moreover, Craig Rossman, director of investor relations, described how "the third quarter reflected continued weakness in the global demand for data center infrastructure and telecommunication investments, with North America and Asia telecommunications spending down significantly."
With conditions deteriorating in the segment, Deutsche Bank analyst John Inch asked if there was anything that might derail the spinoff plan, Farr promptly replied that he didn't see anything "stopping us now."
5. Adjusting to down markets is taking some time
Clearly, the emphasis for management is on firefighting within its declining end markets. As a consequence, the company is undergoing substantive restructuring, with around $160 million to $180 million worth of restructuring costs planned for 2015.
Indeed, Farr disclosed that when the restructuring is finished "sometime in early 2016, you're going to see SG&A personnel headcount down 8% to 10%." That's a pretty significant measure, intended to improve profitability while revenue declines.
What next for Emerson Electric?
Putting all of this together, it's clear that management is making significant cost-cutting efforts while continuing its plans to spin off the ailing Network Power segment. Conditions are looking very difficult for the next few quarters, and unless China's growth and/or energy prices start to perk up, then it's hard to see that the company's end markets will improve anytime soon.
With that said, if China and/or energy prices do pick up, then the company's combination of a 3.8% dividend yield, plus the opportunity to surprise on the upside, could create a compelling case for the stock.
