Emerson Electric Company (EMR) — Q3 2020 Earnings Call Transcript

Good afternoon. Thank you, and welcome, everyone, to Emerson's Third Quarter 2020 Earnings Conference Call. I hope everyone is staying safe and healthy. Today, I am joined by David Farr, Chairman and Chief Executive Officer; Frank Dellaquila, Senior Executive Vice President and Chief Financial Officer; Lal Karsanbhai, Executive President of Emerson Automation Solutions; and Bob Sharp, Executive President of Emerson Commercial & Residential Solutions. As usual, I encourage you to follow along in the slide presentation, which is available on our website. Starting with the cover slide. In the era of COVID-19, safety and health have been rightfully brought to the forefront of the global conversation. At Emerson, safety is a core value. And in June, our employees celebrated Global Safety Day to reflect on the importance and personal responsibility of each individual to foster healthy and safe behavior. Additionally, Emerson has a passion for STEM education and innovative thinking as critical enablers for the needs of business and society both today and in the future. Emerson recently hosted a virtual STEM competition in cooperation with our Impact Partner here in North America, Spartan Controls. The winners designed wearable devices that gave alerts when within a 6-foot social distance barrier. Congrats to the winners, Kaiden and Caleb Manji. Please join me in turning to Slide 3. I'd like to briefly highlight the Emerson Corporate Social Responsibility Report, which is also available on our website. This document highlights in detail all of Emerson's aspirations and accomplishments within the environmental, social and governance realms. COVID-19 and the ongoing social discussions are catapulting many of these important ESG topics to the forefront. As problem solvers at our core, Emerson strives to advance the discussion, share our own progress and strategies and also to be a valued resource for our customers as they embark on their own ESG journeys. Emerson takes very seriously our role as a critical enabler and partner for digital monitoring, measurement, optimization and efficiency management across our broad customer base. Please turn with me to Slide 4. Despite the challenges presented by COVID-19 in the quarter, there were also many reasons for cautious optimism. I'd like to briefly share a few. First, Emerson remains steadfast in our commitment to health and safety for our employees, customers and communities. Business continuity, disciplined cost control and positioning to outperform as we emerge from COVID-19 remain our additional key thematic priorities. Our regionalized supply chain and operations remain resilient and stable in the current environment, and we continue to work hard to ensure we can serve our customers and their essential industries. In the quarter, the team was able to exceed adjusted EPS guidance by $0.20, with $0.16 being attributable to strong operational execution. A lower effective tax rate also contributed to the overall adjusted EPS beat. Cash flow was strong in the quarter, representing 181% conversion of net earnings. Additionally, the team was able to manage decremental margins to the mid-20s level at adjusted EBITDA. Despite the uncertainty and continuing challenged demand environment, sales and orders finished in line with guidance given in April. As expected, China is leading the emergence from the downturn with positive sales growth of 3%. Additionally, we are seeing trailing 3-month orders starting to stabilize, highlighted by Commercial & Residential Solutions' month of June year-over-year orders turning positive. Finally, based on current recovery trends, we expect sales to turn positive in either Q2 or Q3 of next year.

Thank you very much, Pete. I appreciate your inputs. Pete wants to be called Commander Pete, and he's got a new name, come with a military background. I didn't have to deal with this with Tim. But Pete, I do. By the way, I did see Tim today. We had a Board call, and Tim was in Germany with my German Director, and his family has arrived in Germany. He's the President of Professional Tools in Germany. He's doing well, and his family are now there. And his kids will be going to school live. And so it's good to see Tim. He seems to be pretty happy today. Overall, month by month, we saw the quarter unfold exactly like we thought it was going to unfold relative to orders and sales. Margins came in much better as you've seen from the cost reset actions and what we call the COVID-related savings. Therefore, cash flow came in better too. Overall, execution was extremely good. And I really want to thank the global leaders relative to their strength of operations throughout the quarter. We are acting and running this company live, in person, in our offices as best that we can, not everywhere but as much as we can. I really thank them for what they have done because it's been a very challenging quarter. As you know, we laid out our forecast in mid-April. We went out early. We executed around the plans from an order standpoint, sales, manufacturing. We really did a great job around the cost reductions both from the reset actions, which we started last June, which we have accelerated. We're in a different phase right now. We're in the phase of actual consolidation of facilities, shutdown facilities, new facilities. We're moving stuff at this point in time versus the initial phase, a tougher phase. Both of the businesses are on track and doing extremely well. We have raised the year. We have confidence in the year. Our profitability will continue to do well. Overall, the trends for orders were pretty much in line with what we thought would happen in the quarter from a month-by-month basis. I think you'll see that, that improve again in the month of July. I'll let Bob talk about that. Lal continues to stabilize around this bottom. But really, from the execution on operations, we really did a great job. And I just was pleased to see that.

Okay. Thanks, Dave. As Pete mentioned earlier, the front end of the quarter was very much unlike the back end of the quarter. April really dropped severely everywhere, especially North America A/C, with a lot of plant spending down. Of course, we ended with June swinging up positive. So quite a dramatic change. The 3 months through June was down 19, and that will bring the July 3 months into the 5 to 10 range. So definitely going in the right direction. Coming out of it, as going in was broad, coming out of it is really quite broad too. But again, North America A/C, you all follow a lot of the HVAC producers in North America, clearly, when the heat hit in late June, that made a dramatic difference, and we felt it very quickly. The DIY space continues to be very strong. We have relationships with some OEMs and are enjoying some very strong growth right now.

Yes. I think, Bob, one of the key issues we've talked about is the demand coming back globally, and what we want to make sure is we deliver on that demand and not miss this bounce. I've been to a couple of the sites, and they're all getting ready for a sequential bounce this quarter, and that's going to be a key milestone for us from that perspective.

Thank you, David. Good afternoon, everyone. Yes, clearly, operating around the bottom of this order cycle, as we feel it through June. And actually, July came in, on a daily basis, about 4% above the month of June as we saw broad stabilization particularly in Europe and driven by some growth in China and stabilization in North America.

Thanks. As we expected, we would expect Lal to lag in the cycle. He went down slower. But I feel very good about where they sit. We go on the next chart. From our perspective, we were dead-on from the underlying number that we talked about for the quarter. I think Bob's business was slightly better. I think Lal's business is going to be the key issue for him, but we expect to see sales start turning positive in the second quarter next year. Overall, the direction and the trend lines of this cycle feel pretty well understood at this point in time, and we're managing around that. We're allocating resources because we have businesses that are performing well. We feel good about it.

I do feel very good about what's happening in China. We had a good quarter in China, positive orders and sales, and we're seeing that broader stabilization across Europe and, hopefully, North America here as we go through July as well.

Our June orders for HVAC in North America were double what they were in April. On the commercial side, there are numerous stimulus programs in progress, but on the consumer side, especially regarding housing purchases, people are being very cautious, similar to the situation in the U.S. Overall, I believe there’s no reason this trend won’t remain strong throughout the season, and we are also looking to engage the channel effectively.

So Steve, right now, we see a couple of quarters of pretty good demand here. The big issue for us is, clearly, if all of a sudden you had an outbreak in where our plants are located, a supply chain disruption, right now, we are able to keep up with them. But I'm always concerned that one break could cause issues. I feel the demand is there, and we're going to see it for the next couple of quarters, and we'll keep going at it. So I think the one thing I'd be worried about is the supply chain. We have been working on it for the last couple of months because we knew this was coming at us, and so we've prepared for it. I feel good about our outlook as we progress.

Can you hear me, David?

Good to hear from you.

I just bought one of your InSinkErators. There's a shortage of those things out there, by the way. I'm sure you know that.

Yes, we do know that. Thank you very much, Scott, nice comment there. We're working on that issue.

Dave, just to think about your own business, the guidance on the restructuring is great. But what else changes as you think about when you get into 2021? I mean your own capital spending, cash flow probably isn't quite as easy. I mean how do you think about ramping up your own spend?

I think that as we look at it right now, to be honest, I think we'll probably spend a little less this year. I would expect capital to be coming up as we go in to automate the facilities. I would expect that next year we'll have a number in the sixes. But overall, betting man right now, slightly less than $550 million capital this year.

Okay. Helpful. And then, Dave, I think I know the answer to this, but I want to hear your view. I mean, what is your lowest visibility end market? Is it still oil and gas? Is there any hope at all in finding a bottom there?

Yes, I think the toughest visible market is North America oil and gas. And I think we're starting to see some formation of the bottom here a little bit. The key issue for us right now is when will they start doing some work around the fields, around the facilities. And that will be the tough decision. We're not seeing it yet.

No, I couldn't agree more, David. I think you've said it. We're going to be through '21, but clearly, there are traditional roles in the oil and gas market that are being impacted and some are disappearing as a result of it. Interestingly enough, this virus has been a catalyst for adoption of automation in the oil and gas industry, which poses an opportunity for us as people come back and as spending occurs.

Yes. So we have a lot of remote automation software equipment, and we see that being in great demand as they automate there. So there's an upside to this. We just got to get through it.

Dave, first question for you. Just thinking about your guidance for the fourth quarter, specifically as it relates to Commercial & Residential Solutions. It seems like you guys are implying like a mid-single-digit down quarter. Yet the trends seem pretty good, right, like towards the end of June and early July. So maybe talk a little bit about what's kind of dragging the growth there?

The key issue for us is manufacturing output. You're taking the facility that historically would not be doing this much sequentially from quarter-to-quarter. We're being cautious relative to the recovery. Things have hit pretty well, the heat wave. So residential HVAC has taken off, and Bob can talk further about that. But the main challenge is keeping the plants up and running, especially in a COVID environment.

There's a lot of bullwhipping or whipsawing kind of stuff going on right now, and commercial is still being difficult. But overall, the June and July orders are very encouraging.

Yes, that was a great observation.

We did it in the third quarter. I feel very good that we'll do it again in the fourth quarter. The only thing that would be a problem would be a supply chain shock. I know that right now, our cost controls and reset programs have been working well.

We did hit those low 20 decrementals in Q3 already. So we're there, and I think we've got no reason to believe that won't hold us into Q4.

Just thinking about that $140 million net. Is there anything related to price cost or productivity net of inflation that you see as a detractor to that number?

Not right now, John. The big issue for us right now will be the balance of price relative to material inflation. We're trying to get through this year basically neutral.

Great. And then as a follow-up, maybe digging a little bit more into the margin performance at Automation. Can you actually talk a little bit about the mix of KOB 3 year-on-year if that was a good thing?

KOB 3 has continued to increase relative to where we finished the last fiscal year as we've navigated through this year. We're sitting north of 60% as we close the quarter.

One of the key issues here that we are tracking is the order intake on a daily basis. This is important to us, particularly in North America because that's where we're going to see the KOB 3 pop back up first. And that's what we're watching because when that rate comes up, it tells us that the short-term stuff has started kicking in. I want to thank everyone for joining us today. We delivered a quarter we laid out. We did a better job execution around the cash flow and the earnings. I feel confident that we are well structured to go through this final quarter. I appreciate everyone joining us today.