Emerson Electric Company – Priced for Long Term Buy

Emerson Electric Company (EMR) is a diversified global manufacturing and technology company. It offers wide range of products and services in the areas of process management, climate technologies, network power, storage solutions, professional tools, appliance solutions, motor technologies, and industrial automation. It is recognized for engineering capabilities and management excellence, Emerson has more than 140,000 employees and approximately 255 manufacturing locations worldwide.

EMR is a Dividend Aristocrat and member of Broad Dividend Achiever and has been raising dividends for last 52 years. The most recent dividend increase was in November 2008. It remains to be seen if it will increase dividends later this year. My objective here is to analyze if EMR still continues to be a good dividend growth stock and how does it rate on my scale of risk-to-dividends.

Trend Analysis
Here I am looking at trends for past 10 years of corporation’s revenue and profitability. These parameters should show consistently growth trends. The trend charts and data summary are shown in images below.

• Revenue: In general, a growing trend since 2002. The average revenue growth for last 10 years has been approximately 6.8%. Year 2009 is likely to show the weakness and dip in revenue.
• Cash Flows: Overall, an increasing trend of free cash flow and operating cash flow. It is good indicator that FCF is always greater than income.
• EPS from continuing operation: In general, it had an increasing trend from 2003 onwards. It is likely to take a dip in 2009.
• Dividends per share: Slow but increasing trend.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 1.43. This is a low risk category as per my 3-point risk scale. The ability to maintain its margins, low payout factor, and low leverage makes it a low risk to dividends equity.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past five years.

• Dividend growth rate: The average dividend growth of 7.1% (stdev. 6%) is little less than average EPS growth rate of 9.3% (stdev. 18%). Dividends are more or less growing along with the earnings.
• Duration of dividend growth: 52 years.
• 4 year rolling dividend growth rate for past ten years: Less than 10%.
• Payout factor: It is 38.6% and has been trending downwards from high of 65% in 2003. It is likely to be higher for year 2009. However, there seems to be sufficient room to sustain and/or grow dividends.
• Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 3.21%; and (b) MMA yield is 3.4%. With my projected dividend growth of 6.6%, the dividend cash flow is 1.24 times the MMA income in 10 years time period. For dividend cash flow to be twice the MMA income, the pricing has to be $27.00 (i.e. yield 4.89%)

Fair Value Calculation
This section determines what price I should pay to buy a given stock.

• Net present value (NPV) price based on 15 year DCF: $46.7
• Average high yield price calculated based on past 10 years: $58.2
• Pricing based on past 10 year relative price-to-earnings ratio. $38.5
• Pricing based on price-to-earnings ratio of 12: $32.0
• Graham number: $12.6

The range of fair value is calculated as $28.7 to $37.4.

Qualitative Analysis
Emerson Electric Co. was founded in 1890, based out of Missouri, and has been paying and growing dividends since last 52 years. What surprised me was EMR’s evolution, its ability to sustain margins and grow, and worldwide reach.

• Its revenue is pretty diversified in eight product sectors and four global regions. Approximately 23% of its revenue comes from Asia and Latin America.
• It continues to have stable gross and operating margins. It generates relatively consistent operating and free cash flows. 2009 FCF is expected to be higher than last year.
• It expects 2009 EPS in the range of $2.20 to $2.30, which leaves room for dividend growth (presently at $1.32).
• In the most recent quarterly results, CEO mentioned, quote “even under difficult market conditions, Emerson is generating strong cash flow to support our objectives for acquisitions, new technology development, share repurchases and dividends to shareholders”. We have seen many CEOs making such proclamations and then cutting or suspending dividends. However, the key difference here is that the statement is backed by results in company performance.
• It faces short-to-intermediate term challenge of soft global markets and weaker demand. I believe its strong balance sheet will allow it to wither it and position for next phase of growth.

Conclusion
I like EMR’s diversified revenue stream and geographical presence. Overall, it is a US based company that will provide hedge against dollar fluctuation and proxy for foreign developed/emerging markets. It has been raising dividends for last 52 years. EMR’s end-markets are cyclic and it appears that it knows how to wither such business environments. It has a strong balance sheet and competitive market positioning. The stock’s current risk-to-dividend rating is 1.43 (low risk). The current pricing of $41.17 is tad above my buy range. I recently added new position, and would continue to add as per my allocation whenever it goes near in my buy range.

Full Disclosure: Long on EMR.

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