Emerson Electric Company (EMR) — Q3 2019 Earnings Call Transcript

Thank you, Allison. I am joined today by David Farr, Chairman and Chief Executive Officer; and Frank Dellaquila, Senior Executive Vice President and Chief Financial Officer. Welcome to Emerson’s Third Quarter 2019 Earnings Conference Call. Please follow along in the slide presentation, which is available on our website. I’ll start with the third quarter summary on Slide 3. Sales in the quarter of $4.7 billion increased 5%, and underlying sales were up 2%. Growth was below our guidance across both businesses. Underlying orders were up 2% in June, also below the 5% to 7% expectation we discussed during the second quarter earnings conference call on May 7. Automation Solutions’ underlying sales were up 3% and orders up 4% in the quarter. We had expected global discrete channel inventories to clear and demand to recover, but instead, discrete end markets further decelerated in the quarter. North American upstream oil and gas demand have yet to improve. Demand in process and hybrid end markets, however, was stable in North America and continued to be robust elsewhere. Commercial & Residential Solutions underlying sales and orders were down 1% in the quarter, primarily driven by cooler wet weather conditions in North America. GAAP EPS was $0.97 and was $0.94 up 7%, excluding discrete tax items in the current and prior year. Through the third quarter, we’ve returned $1.9 billion to shareholders and completed our $1 billion 2019 share repurchase target. Today, we announced an additional $250 million of share repurchases that we will target to complete in the fourth quarter. Turning to Slide 4, third quarter gross margin was down 90 basis points and EBIT margin was down 80 basis points. EBIT margin was up 50 basis points excluding the Aventics, Tools & Test and GE Intelligent Platforms acquisitions. Tax rate in both years benefited from several favorable discrete items in the quarter. Turning to Slide 5, third quarter underlying sales growth was led by Asia, Middle East and Africa, which accelerated from flat in Q2 to up 3% in Q3, primarily driven by sequential improvement in the Commercial & Residential Solutions business. However, the Automation Solutions business also ticked up sequentially. The Americas was up 1% and remained positive across both businesses but with slower compared to the second quarter growth of 7%. Europe was up 1% and remained positive across both platforms. Turning now to Slide 6, total segment margin was down 160 basis points and was down 30 basis points excluding recent acquisitions. Segment margin of 18.1% was approximately in line with our expectations as our business executed well to deliver strong profitability on lower sales growth. We guided sequential core leverage in the mid-40s and our businesses together delivered over 70% on $120 million higher sales. As we discussed last year, we’ve accelerated certain restructuring programs in the second half of 2019 to position the business for a slower near-term growth environment. In Q2, we identified approximately $10 million of restructuring investments to accelerate in this fiscal year. And this quarter, we’ve added another $20 million. Our total expected restructuring spend and other actions is now $100 million for 2019, which is up from approximately $70 million at our February Investor Conference. These investments will help position the company for improving profitability in early 2020. Operating cash flow performance was solid, up 2% and free cash flow conversion was 135% in the quarter. Our year-to-date free cash flow conversion is 88% and we continue to expect strong cash flow performance in the fourth quarter and greater than 100% full year cash flow conversion. Trade working capital is an opportunity for us in the fourth quarter. TWC performance was worse by 80 basis points driven entirely by inventory, which was higher in June, as sales softened late in the quarter. We expect to recover this in the fourth quarter, which will benefit cash performance. Turning onto Slide 7, Automation Solutions’ underlying sales were up 3% and orders were up 4% in the quarter. The underlying sales trend in the quarter remained broadly stable as follows. We saw continued strong demand across our three kinds of business; MRO spending, brownfield, and greenfield projects. All world areas remained positive. And we continue to see healthy progress in our long cycle project outlook, a strong project funnel, systems orders growth, and a growing backlog. There were few areas that missed our expectations. First, North America upstream oil and gas did not recover as we expected. Customers in the Permian and other key regions continue to focus their CapEx budgets and maximize free cash flow, and limited pipeline capacity continued to constrain investment activity. Second, global discrete manufacturing end markets decelerated. The short cycle weakness was particularly evident in automotive and semiconductor end markets. And finally, although our project funnel remains healthy, our customers are more cautious around capital spending. Geopolitical and trade tensions have created a more cautious business investment climate. As a result, we’ve seen some projects push out of the year. This has impacted our orders and sales growth expectations in 2019. However, we’ve not had any project cancellations and we continue to have confidence that projects in the funnel will be executed. For the full year, we expect underlying sales growth of approximately 5%, which is at the low end of our prior guidance. This implies a fourth-quarter underlying sales growth rate of approximately 5%, a bit stronger than Q3, which is supported by steady orders growth and backlog conversion. Segment margin decreased 150 basis points and was down 10 basis points excluding the Aventics and GE Intelligent Platforms acquisitions. The business delivered sequential leverage above our guidance as the management team executed well on lower growth. As mentioned, we have pulled in additional restructuring actions that we are targeting to complete this year. Including the full year, segment margin is expected to be approximately 15%. Turning to Slide 8, Commercial & Residential Solutions underlying sales and orders were down 1% in the quarter. Growth in the Americas decelerated from 4% in Q2 to 1% this quarter, due mainly to unfavorable weather conditions, cooler, wet weather in key regions late in the quarter that affected residential air conditioning and construction markets. Europe also decelerated late in the quarter due to weather, but preliminary July orders trended positively. The Asia, Middle East, and Africa region improved from down 15% in Q2 to down 6% this quarter. We expect improvement to continue with underlying sales growth turning positive as we head into 2020, and the preliminary trailing three months underlying orders in July were up slightly, a good sign. For the full year, we expect Commercial & Residential Solutions underlying growth to be approximately flat, compared to the up 2% in our prior guidance. This implies a slightly positive Q4 growth rate, which is supported by expected improvement in North America air conditioning markets and continued improvement in the Asia, Middle East, and Africa region. Margin decreased 70 basis points excluding the Tools & Test acquisition. The business delivered over 40% sequential leverage on incremental sales, which was in line with our guidance. We expect full-year segment margins to be approximately 21%, including additional restructuring actions pulled into the fourth quarter. Let’s turn now to Slide 9. Our 2019 guidance framework is updated to reflect underlying sales growth of approximately 3%, including lower than expected third quarter growth and a reduced near-term growth outlook for global discrete markets. The fourth-quarter underlying growth is expected to be approximately 3.5%. The EPS guidance range is maintained at $3.360 to $3.70, and we expect fourth-quarter earnings per share of approximately $1.10, which is the midpoint of the full-year range. Updated full-year segment margin targets reflect reduced growth and increased restructuring spend. The fourth-quarter total reported segment leverage is expected to be approximately 30% year-over-year and almost 40% sequentially, compared with the third quarter. Reduced segment profit contribution is offset by lower corporate costs and a lower full-year tax rate to hold the prior 2019 EPS guidance range. We expect fourth-quarter corporate costs to be approximately $150 million. The fourth-quarter tax rate is expected to be approximately 21%, including a $0.05 discrete tax benefits. The 2019 full-year tax rate is also expected to be approximately 21%. We’ve updated our estimated ongoing operational tax rate, which includes improvements from platform reorganization actions. We now expect our operational tax rate to be approximately 23.5% going forward, as we continue to optimize our global two-platform operating structure. Expected operating cash flow is $3.1 billion and free cash flow is unchanged at $2.5 billion. Please turn now to Slide 10, and I will hand the call over to Mr. David Farr.

Thank you very much, Tim. I want to welcome everybody. Thanks for joining us. I’d also want to let you know that this is Tim’s next to last earnings call. I go through this process of training semi-professional Investor Relations people. They never quite get there. But Tim has a unique opportunity that we can’t talk about, but he’s going to be going to it later this year. And I have breaking in another person, by the time we get into the November timeframe. But Tim most likely will join us for that call. And I want to thank everybody for joining us today and I want to give you an update on what we see. I want to thank the employees for joining us today. I also want to remind everybody, we actually have an extensive number of people in the queue, close to 20 people in the queue to ask questions. So I definitely need to keep you to holding to the two questions rule; we’ll extend the call a little bit maybe a minute or an hour, 15:20 to try to get as many questions as possible. Clearly, as you can tell from my communications that we put out our communications we put out last Monday and the communications today, I have sensed a continuous sense of change in the underlying business environment, which I’m sure we’ll be talking about here for a few minutes. And then you’ll be asking a lot of questions around it. I also want to thank all the employees for their support over the last three months in this challenging third quarter we just went through and for the year-to-date numbers as we drive to finish out this fiscal year in 2019 and moving into 2020. As I look at the year, it’s a good year. We have good growth in sales, we have good growth in earnings, we have good growth in cash flow, but it’s happened on a fold much differently than we thought going back 9 months or 10 months ago. And that’s what we’re having to deal with right now. But as you can see in the orders chart on Page 10, two things. First, we have new pop called Doon, after Doon bag, one of our favorite golf places in Ireland and Doon is a black and tan. Next to rocket, Rocket’s birthday is today. You can see the order trend improved slightly for automation solutions. It ticked up a little bit, pulled us up a little bit. On the Commercial & Residential Solutions for the month of July, orders were a little bit better, but still slightly negative overall in a specific turn positive and ends – the month of July, which is good. We’re now three or four months behind what we said, more or less four months behind what we said, but it’s good to see that happening. You could see the industries we see – we’ve been seeing pretty good strength in the third quarter, between the midstream, downstream, lots of caution around the upstream area right now. Chemical, we’ve got a very good quarter, and power our orders in the PWS power business is close to 40% up for the quarter around the world as we continue to upgrade the power facilities around the world. Automotive and semiconductor and discrete really had a tough quarter. But overall, a softening in key marketplaces, the trend lines are still positive overall, but definitely slowed to way below we thought when we started this year. Going forward, we’ve updated our large project pipeline funnel, including, we actually did an upgrade the total size of the funnel, when we give this funnel out two, three times a year. In February, it was around $7.6 billion, 195 projects, today it’s 221 projects, $8.3 billion, it did increase a little bit. Clearly, another sign of things slowing down a little bit of push out is that are committed one, but not booked is now slightly over $1 billion in projects. Projects that are basically sitting out there that we’ve won, and there we’re still waiting for the final documentation in order to be placed. So we can start booking and then obviously, start doing some shipments against it. The other key thing you’ll see in this is that, down the bottom, we talk about what’s been shifted out of 2019 and 2020, based on what we’ve seen about $350 million of projects we’re working on for the last couple of – 6 to 8, 12 months has been shifted from 2019 to 2020 and we basically have seen about $450 million other pipeline shifted out of 2020 into 2021. Clearly, this tells you we have, what I call, a dynamic pipe and some things moving in, some things moving out, but clearly a slow down. I fundamentally believe in discussions with our customer base, our organization around the world, we’ve been spending a lot of time on this last couple of months is, this cycle is not ended. This cycle is in a pause mode, because of the disruption that’s going on relative to the trade negotiations, the trade discussions and it’s clearly causing a slowdown in some key markets, primarily the USA, a little bit of Europe; and we’ve seen some pushback in a couple of places around the world. But our international markets have continued to hold up from an automation standpoint, US markets pushed out a little bit. The Canada market pushed out a little bit and a little bit of push out and actually sales are going out in the Middle East, but overall, still going in. And I firmly believe, if we do get resolution to the trade discussions at some point in time here between now and the next 12, 18 months, the cycle will move back up. There’s not been an excessive amount of capital spent in build out in the cycle yet. It’s way too early. I just look at what’s going on inside our company as we reallocate. But I’m sure we’ll have a lot of questions around this issue. As I look at what’s going on, I am a little concerned from the standpoint of how long the slowdown will happen. Hence, the OCE got together over the last 30 days and looked at some incremental restructuring. We’ve looked at where we need to slow down investments, where we need to pull back investments. We’ve looked at where we can accelerate restructuring that we had planned in 2021 and to deal with protecting and improving our profitability in a slower growth environment. Clearly, we laid in a structure of costs from a people standpoint organization back in 2018 and at the end of 2018 running through 2019, looked at much faster growth. This year, for instance, we had thought we’d grow around the 6% to 6.5%, we’re now growing around that 3% to 3.5% range. You look at what we see going next year. I look at a very gradual growth environment at this point in time, but I also want to build in the flexibility if that doesn’t happen that we could still protect our profitability and our cash flow and deliver some results for our shareholders. At this point in time, I see the slow down lasting well into 2020. And so I see some resolution on around what’s going to happen with the trade discussions that we all face. And from my perspective, that could last easily well past the election at the end of November 2020. So that’s how we’re looking at it. It is a different perspective than I did discuss, say, electrical products group in May and even when the phone call in early May, but I’ve come to the realization and watching our customer base and talking to our customer base is they’re going to be cautious. And therefore from my perspective, we’re going to continue to invest strategically where we can gain market share or market penetration. And then we’re going to back down and protect our profitability and cash flow where necessary. We’re also going through a whole prioritization of our capital projects. From this year, we’ve pulled it back a little bit as we go through this process. Next year, we’re prioritizing where we need to spend capital. I have commitments that we have to do in capital over the next couple years. And I’m trying to set priorities with Frank and you’ll see those priorities of where we need to spend money. I have some actions, I have to take some additional manufacturing capacity in the best cost locations that we have around the world. But I need to prioritize those to make sure we’re dealing the right way as we go forward here in 2020 and as we come back into 2021. Again, we’re being proactive, we’re trying to be a little bit more aggressive and hence our restructuring. And we’ll be looking at that pretty hard between now and year end. And if we see we have other opportunities, we will take those opportunities on. It’s all about getting our cost structure in line for slower growth, improve our profitability, deliver the incremental margins that we’ve been committing in a different growth environment and also positioning ourselves for one of recovery does happen in our capital base, which I believe will happen. So overall, again, I want to say it’s been a good year from my perspective. It’s not happened like we thought would happen. We totally happy about it. No. We’ve been dealt a hand in a little bit more challenging environment relative to trade and relative to the investment environment. My customer base is being cautious, but we’re not rolling up the tent and going home. We’re going to be attacking and aggressive going after things. But we’re also bringing our cost structure line to be able to serve ourselves and also serve our customers and also build the profitability that we want to deal with. So I want to thank everybody from the Emerson team as we wrap up this year. We’ve got a couple more months left. And I want to thank the team as we get ready for 2020 and 2021. With that, we’ll open the line, again I want to remind everybody we have a lot of people in line, close to 20 or maybe more than 20 people now. And so I need to hold you to the two questions, and we’ll take as much time up to about an hour, 15:20 to get through the questions. So with that, Tim, let’s open it up.

Okay.

Good afternoon, guys.

Good afternoon, Andrew.

This – so how do we think about the longer-term roadmap for you guys in the more difficult macro and particularly as we go into Slide 20, it might be difficult obviously to achieve the target in 2021 of $450 million. But if we are in this longer prolonged slowdown, can you still grow double-digits in EPS off the 2019 base? If not, that stabilizes a bit here, given a high level of restructuring and repurchases, how should we think about that?

From the perspective, our underlying growth rate based on the model we presented in February, it was close to 5%, $4.5% to 5%, I believe the cycle here. If that number is going to be closer to 2% to 3% because of the slowdown, we’re going to have to have a lot more bolt-on acquisitions to allow us to be able to get that tougher earnings growth. It’ll be very – it’ll be challenging for us. But that the key issue for me is, can we drive to make amount of roll through penetration. If that’s possible, we’ll try to do that while also going to have to be a little aggressive on the bolt-on acquisitions that allow us to integrate some more sales and profits to get that number up. But that’s the game plan is going to have to be is where do we get that top line growth. If we lose about a point or two from underlying from this core business, then the acquisition gains can be even more important to us from the bolt-on standpoint. And then we’re going to have to be aggressive on integrating those acquisitions. That will be the key issue for us as we look in the next couple of years and that target we laid out in February because of, as you said, it’s a much different macro environment. Let something happen relative the trade early on in 2020, we spend what would accelerate growth potentially in 2021 that would be another scenario, but I’m not banking on that right now. We’re looking at an environment that’s going to be a little bit less growth in rapid deal with that.

Yes, that’s helpful. And then obviously, in Automation Solutions, you’ve talked about 30% incremental as the target. How should we think about underlying instrumentals? If we do have this slower growth environment, given all the restructuring you’re doing, could we still do 30% plus on lower growth?

That’s the game plan. That’s why we’re going after the incremental restructuring now, Andrew. We've made a commitment to get that profit margin back up. These are quality assets. We’ve made a lot of acquisitions within this asset space and we need to make sure from our shareholder standpoint that we get those margins back up to eyesight or that reasonable range. It might take us a little longer to get back to what I think the appropriate number is now in this combination of companies that run 19% even, but we’re not backing off that number incrementally, that’s our number for next year, and Lal and his team understand that.

Thanks, Dave. Appreciate it.

All the best, Andrew. Thank you.

Hey guys, good afternoon.

Good afternoon, Steve.

Congrats to Tim, unless you’re like sending them to some godforsaken part of the world like, I don’t know where you send these people, but hopefully, it’s going more nice.

Tusa, I can willing to – I’m open for suggestions. I mean, you might have to talk to his wife a little bit about this. She is the St. Louis girl. But you might – if you've got an idea, it’s not going to be gut to Georgia. I can tell you that right now.

No, I’m just going to say that you stole that one. I’m just going to say that.

Not going to be to Georgia. Most likely, it could be like, so what the tough place in Nevada? We get some valley or something like this. Now he is going to be going, most likely in the Northeast somewhere.

Got it, got it. I love the red exclamation points on the order trends. I think that really pops, stands out. But how bad was your discrete business on order rate or revenues either one like are those down double-digit. And then as a follow-up to that, within power specifically and then a little bit less in LNG, how do you think you’re doing share-wise, because power, I would assume that’s more kind of attacking competitor installed base and selling digital and that kind of stuff. So it seems like there’s a bit of a share gain there in power.

So on the discrete side, we’re not down double-digit. I mean it’s a solid single-digit, but I mean I would say, Tim and I are going back for the somewhere between 5% to 8% mid-single digit down in the discrete side. The inventory has not come out of the system at all.

Okay.

I mean I would say, Tim and I are going back for the somewhere between 5% to 8% mid-single digit down in the discrete side. The inventory has not come out of the system at all. Obviously, the demand slowed down as you’ve seen Steve, and therefore it’s going to take a little longer. It could last all the way to the calendar year now to get that out. But that’s where we see at that point in time. The process side where it’s been pretty good within the channel, but just right now its oil and gas related down around Texas and the Permian has been pretty tough. On the power side, we are very committed to this space. And we’ve continued to bring out the next generation control system ovation. We’ve continued to bring out new services. We’ve continued to be highly committed to supporting the power generation both renewable, primary power, all different types of power, particularly around colder gas. So based on what we’re seeing right now, I would say we are winning against our key competitors out there. But obviously, we’re not going to back down. I think there’s a unique window of opportunity as we look at this. And overall this year, year-to-date, we’re up a solid single-digit in orders. And I think we’re going to have a good fourth quarter and good start to next year. The industry needs to go through some reinvestments and upgrading systems, taking old systems down and bringing out the new power plants, bringing up new gas, get rid of coal. These are all opportunities for us and we’re out there fighting for it.

Right. But that’s the OEM installed base, correct, that you’re going after?

Correct.

Yes. And then one last one just on the macro, you seemed confident that this isn’t getting worse, but then you said things extend. I mean how are your customers and you guys going to not at least pause a little bit before all the uncertainty around the election and let you just have, I’m sure you have confidence in the outcome, but like how are you going to integrate that into your kind of plans and your thinking?

From our perspective, we’re going to work multiple plans here from my perspective. I think we’re going to look at an environment where there’s very little growth in environment. There’s some moderate growth. Clearly, we still see our international business doing better than the U.S. at this point in time. And that’s going to allow us to see a little bit better growth. But we’re going to factor in that. We could be in a slugfest with real low-single digit growth for the next 12 months and therefore you got to get that cost line in line and really prioritize where we’re going to spend money. It’s not going to be – in my opinion, I’m being very, very, let’s say cautious or negative, but I’m very concerned about businesses, like you said, keep pausing and they keep reevaluating their investment and that’s going to drag the business investment to a weaker environment. If it doesn’t happen that way and things get better, we’ll be okay. But I’m more worried about that it will happen and they’re fine, we’re structuring the company to be in that environment.

Got it, okay. Thanks a lot.

Thank you.

Thanks, Steve. All the best. If you’ve got ideas, we’re going to send Tim, send him to me.

Thank you. Good afternoon, everyone.

Good afternoon, Jeff. How are you doing?

I'm doing well. Thank you. Fighting through it all so.

Good. It’s always fun at slugfest system. You get to meet, it gets boring.

No, exactly. Well, hey, I want to just to pick up on your last point. You’re – you kind of indicated you didn’t use the term, but maybe kind of the risk of just stall speed. And if we get there, what really kind of keeps us from kind of tipping lower?

The key issue there is, I think there’s a good chance of the economy, next year it gets the global economy gets real close to that stall speed. And I think that as we finish the rest of this calendar year, which I think will be okay relative to investment then people then really start reevaluating in 2020. We have to – if we sense we’re going to get pretty close that stall speed which we’ve seen the economy before, then we got to think about, okay, do we have the right things done relative to our restructuring and our position in the company. Right now, I mean I think we’re going to get close to that stall speed, but I don’t think it’s going to go all that way. We also, as you understand around the world, we have the every Federal Reserve around the world really pushing accommodation to make sure the economies do not get to that stall speed. So I think that’s one thing we have going for us.

Yes. And then just separately, just thinking about the automation margins, right, so it actually ended up being a kind of peculiar looking quarter, right. Your actual OP dollars are down, right.

Yes, that’s right. We’ve got a solid single-digit down pressure on the discrete now. I mean, you can see the revenues with the all. So we have lowered the discretionary investments that we had planned for some of that, which is impacting the margin.

So now as we look into Q4, right, we need to see a pretty significant step up in the OP dollars to get to that forecast. You had talked on the last call about some of the sweet things on price cost and other levers. Could you just give us a little bit more visibility on how we bridge to that Q4 automation margin number?

Yes. I think there’s a couple of things going on from the perspective we have, obviously the price cost continues to move our way in that fourth quarter in a positive way. They did have a pretty good sequential margins improvement in the third quarter. The other thing is the restructuring actions that we took back a couple months ago. I believe in April and April, May and also some of the core restructuring that we started in the beginning of year are starting to flow through. So the automation business, as things slowed down, as you remember, we started taking actions earlier on with that business, so some of those benefits are coming true. In the last couple months close and even June, which was a tough month for Automation Solutions from a sales standpoint, they did very well with leverage and in profitability. The month of July, which we’re starting to see right now, the same things flowing through again. So my gut tells me right now, I feel pretty good about where they flow.

Great. Thanks, Dave. I’ll pass it.

All the best Jeff. Thank you very much. Have a good rest of it.

Thanks. Good afternoon, everyone.

Good afternoon, Deane.

Hey, maybe a good place to start, Dave, would be the game plan where you would augment slowing growth with bolt-on acquisitions. And when I hear you say that, it kind of suggests that you’re still willing to play offense here and which is a good sign.

But just how do you marry the idea of going after acquisitions during a period of high uncertainty and clearly a pause and closer to stall speed? From the perspective of some of the bolt-on acquisitions, which we worked pretty aggressively all the time, fundamentally we believe as we go into this time period, as we move into 2020, early 2021. Some of the companies that we’re interested in, we’ll want to – we’ll want to get out and we’ll have the opportunity to do those bolt-on acquisitions. Historically and times that things like this slowdown, things get kind of sloppy, near that sloppy, we see some of these product lines pop out. And so we’re bank yet, we’re going to try and push the pressure point up on this thing and see if we can get a couple of these pop and give us some incremental growth, the top line.

Got it. And then as a follow-up, but just to continue along the lines of this pause versus an end of a cycle, can you comment on the power or the influence of this negative feedback loop, because you’re saying right now you’re slowing down your investments, you’re pulling back, you’re seeing customers push out projects.

How does that not feed on itself and become a more of a power slower, faster? From our perspective, we’re going to work multiple plans here from my perspective. I think we’re going to look at an environment where there’s very little growth in environment. There’s some moderate growth. Clearly, we still see our international business doing better than the U.S. at this point in time. And that’s going to allow us to see a little bit better growth.

Thank you.

Thank you very much.