Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness
Emerson continues to see a very healthy order/project environment for process automation, with ongoing potential in oil & gas, refining, chemicals, and mining, as business shifts from MRO to projects.
Acquiring GE’s Intelligent Platform business adds important PLC/PAC assets for hybrid and discrete markets, but GE’s share has been falling from a low level due to underinvestment.
Emerson remains highly-leveraged to the still very attractive process and hybrid automation markets; valuation is not low, but beat-and-raise potential remains above average.
The good times keep rolling for Emerson (EMR), as the company is enjoying a strong recovery/expansion phase in its core process markets, as catch-up spending on MRO, brownfield investments, and greenfield projects all combine for strong near-term revenue and margin improvements and a healthy outlook over the next year or two. At the same time, Emerson continues to reinvest in its business to better-position it for less cyclicality and better competitiveness in hybrid automation markets.
As was the case a few months ago, I see Emerson as a so-so value proposition, but a stronger near-term growth/momentum story. The shares don’t seem unreasonably priced on forward EBITDA, but it’s a little harder to see strong FCF-based undervaluation, and I think the share price performance is very much tied to ongoing momentum in orders, revenue, and margin leverage.
Strong Process Markets The Key To The Story
With 8% order growth in the trailing three months through August, Emerson’s automation business remains very healthy and like Honeywell (HON) (and to a lesser extent Rockwell (ROK)), the company is benefiting from widespread strength in multiple markets, including oil & gas, refining, mining, life sciences, and food/beverage.
A lot of the strength in process automation has been driven by deferred/catch-up MRO spending, and this remains a meaningful ongoing opportunity for Emerson. Importantly, though, the company’s project funnel has grown to nearly $7 billion, with management expecting to win around 30% of those opportunities. Emerson has pointed to studies suggesting potential five-fold increases in oil & gas project investments on the way, not to mention meaningful capacity expansions at refineries and ongoing greenfield chemical projects. LNG is also a significant potential source of upside, highlighted by LNG Canada’s $30 billion potential project.
Investing In A Strong Full-Cycle Business
MRO is a key component of the process automation industry, and what Emerson calls KOB3 activity now accounts for around 55% of the company’s automation revenue. This number moves around through the cycle and will decline as new project activity picks up, but Emerson is looking to increase its KOB3 product and service offerings, including displacing rival systems and components, with an eye toward at least partially reducing some of its full-cycle cyclicality. While I discussed it previously, I’d note again that the acquisition of Aventics and its fluid control/pneumatics assets will help the company’s positioning in certain automation markets.
Emerson is also trying to improve its stack of offerings in what it calls Data Management (basically a combination of above-control software and system offerings including PLM and manufacturing execution systems). Emerson does have some presence today in MES, but relative to companies like Siemens (OTCPK:SIEGY), Schneider (OTCPK:SBGSY), and Rockwell, you can’t really say that Emerson is a leader here. That said, the company has been investing in its PlanetWeb digital ecosystem, which includes connectivity and analytics capabilities.
Adding Assets In Discrete/Hybrid
Just the other day, Emerson announced the acquisition of General Electric’s (GE) Intelligent Platform business. The key assets here, I believe, are GE’s PLC and PAC platforms. PLCs (and PACs) are used to control machines, most often in discrete automation settings but also in hybrid automation systems and certain process automation subsections.
Emerson’s Delta DCS platform is a strong contender in the process automation space, but Emerson had very little in the way of discrete controls. That, I believe, was one of the key attractions of the company’s aggressive but fruitless bid for Rockwell. By no means is GE an equivalent substitute, as GE’s roughly 2% to 3% share in PLCs/PACs, which has been falling due to under-investment, is nowhere near the high-teens to 20% share enjoyed by Rockwell.
Even so, it’s a business with around $200 million in revenue, leading me to think it’s at least close in scale to the B+R PLC business that ABB (ABB) acquired, though B+R is/was a company on its way up. Perhaps more encouraging to Emerson, GE has been making investments in cloud-connected controllers (industrial IoT was a priority of the now-former CEO of GE) and these products should fit in with Emerson’s PlanetWeb system and vision.
GE’s Intelligent Platform business does not immediately make Emerson a credible threat in discrete automation, and I don’t think Siemens is going to lose any sleep over this. That said, it does fit very logically with Emerson’s stated goals of improving its competitiveness and product offerings in hybrid automation markets – markets like food/beverage and life sciences that combine aspects and elements of both process automation and discrete automation.
I like the GE Intelligent Platform acquisition, and although a purchase price was not discussed, I don’t believe Emerson had to pay all that much to get it. The business will need ongoing investment to really move the needle for the company, but I believe management is prepared to do that, and I get a sense that there are other acquisitions in controls and sensors for hybrid/discrete automation that Emerson would like to pursue at the right price. As is, this deal is too small to really move the needle on valuation, and I continue to expect mid-single-digit long-term revenue growth from Emerson and low double-digit FCF growth as it leverages this cycle and integrates major acquisitions.
The Bottom Line
It’s tough for me to argue that Emerson is undervalued on cash flow, though the “fair” EBITDA multiple supported by its margins and returns on capital still argue that the shares aren’t worrisomely overpriced. Moreover, I think Emerson is well-placed to continue delivering strong quarters given its leverage to a very healthy process automation cycle. Valuation makes it tough for me to call this a “buy” for value investors, but those who are more momentum-driven and/or focus more on the “guh” part of GARP investing might still find them attractive.