Emerson Electric Company (EMR) — Q4 2020 Earnings Call Transcript

Thank you, and welcome, everyone, to Emerson's Fourth Quarter and Full Year 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 welcoming Jamie Froedge, our New Executive President of Emerson Commercial & Residential Solutions. As usual, I encourage everyone to follow along in the slide presentation, which is available on our website. Starting with the cover slide. Despite the overarching challenges of COVID-19, Emerson has continued to invest in key technologies and solutions for future growth and value creation. We are excited to welcome OSI Inc. to the Emerson family, a leading provider of software-based technology for advanced grid management. Additionally, we also welcome Progea Group to Emerson, a leader in software-based HMI, SCADA, and analytics solutions. We will also review other important strategic 2020 acquisitions later in the call. Now please turn to Slide 3. Similar to last quarter, I'd like to briefly highlight the Emerson Corporate Social Responsibility report, which is available on our website, emerson.com. This document reviews in detail many of Emerson's aspirations and accomplishments within the environmental, social, and governance realms. Many of these important topics remain at the forefront of the national and international conversation. As problem solvers at our core, Emerson strives to advance the discussion, share our own progress and strategies, and also be a valued resource for our customers as they embark on their own individual sustainability journey. Emerson takes very seriously our role as a critical enabler and partner for digital monitoring, measurement, control, optimization, and efficiency management across our broad customer base. Fundamentally, we believe that this role and responsibility align very well with the broader purpose and goals of the sustainability movement. I encourage everyone to read the CSR report if you have not yet had a chance to do so. Please turn with me to Slide 4, and we will review some highlights of the quarter and the fiscal year. First, Emerson remains steadfast in our commitment to health and safety for our employees, customers, and communities. Business continuity, serving our customers in critical industries, disciplined cost control, and positioning to outperform as we emerge from COVID-19 remain our key thematic priorities. Next, we continue to work hard to ensure that our localized supply chains and operations remain stable, safe, and productive. Turning to performance. Emerson executed well in a challenging but stabilizing demand environment. The organization was able to deliver adjusted earnings per share of $1.10 in the quarter and $3.46 for the full year, a strong finish driven by our ongoing aggressive cost reset actions, which totaled $73 million in restructuring actions in the quarter and over $300 million for the full year. Cash flow in the quarter was very strong, representing 128% conversion of net earnings and 6% growth year-over-year. It is important to highlight that the balance and market diversity and stability of our two platform business portfolio were critical to enabling a strong operational and cash flow outcome. Savings for the year on both restructuring and COVID-related cost actions totaled approximately $370 million. And we were able to manage decremental margins to 21% at adjusted EBITDA. Despite all the uncertainty and demand challenges, sales and orders finished in line with guidance given in August. Commercial & Residential Solutions orders turned sharply in the quarter, finishing up 6% on a trailing three-month basis. We now expect this business platform will turn positive to sales growth earlier than previously expected. Overall, as we look towards 2021, management has adopted a conservative view given the uncertainty in the marketplace but continues to expect sales to turn positive in Q3. Now please turn to Slide 6, which summarizes results for the year. Both net and underlying sales growth finished towards the higher end of their guidance ranges at down 9% and 8%, respectively. Commercial & Residential Solutions came in slightly ahead of expectations at down 7% underlying. Adjusted EPS of $3.46 was above the guidance range of $3.20 to $3.35, and restructuring actions finished slightly above guidance of $300 million. Despite lower sales, both platforms executed well on profitability with the COVID-19-related cost control measures, in addition to the ongoing aggressive restructuring reset actions. Finally, cash flow performance for the year was strong with both operating and free cash flow finishing above guidance.

Thank you very much, Pete. And Jamie, welcome to the group here. And Frank, and obviously, Lal. But Chart 21 outlines the underlying orders forecast, and I'll talk about that in a second. But first, I want to welcome everybody from the investor world, the shareholder world, and our employees, thanks for joining us today. Thank you for your continued support and engagement over this quarter and the total fiscal year. As we all know, it's been a truly unusual fiscal year for this company, but I think this team has risen to the challenge. I want to make a special call out to the global Emerson employees, the leadership team, and our new members from acquisitions this year and thank them for their commitment to safety, our customers, our fellow employees, shareholders, and the community as we return to work beginning in March and throughout the year. I appreciate everything you've done. Thank you for the job you did over the last eight months as we got back into our offices and manufacturing plants. As we know, 2020 was an exceptional year in sales, profit margins, earnings, and cash flow. Our free cash flow to earnings conversion was close to 140% this year. We achieved our 64th year of dividend increase. Our dividend free cash flow came in at 47.5%. As many of you know, we did not cut our dividend during the major repositioning back in 2016, and we've worked our way back to under 50% in free cash flow to dividend ratio. We returned over $2.1 billion to our shareholders this year in 2020. We kept our dividend going like many companies did not and returned capital to our shareholders through share repurchase. Given what I see right now in underlying margin improvement, strong cash flow generation, and growth returning in the Commercial & Residential Solutions business, along with a business in Automation Solutions that will return in the second half of the year, we are going to increase our capital allocation back to shareholders to get to $2 billion this year, as Pete talked about. This reflects our strong confidence in the company, how we position from a cost standpoint, the new products, and investments we've made in acquisitions. Clearly, we have a very uncertain political environment right now. But with the investments we've made, we have a lot of confidence that we will be able to grow and outperform this marketplace while returning more cash back to our shareholders. It's very important to show that confidence to our shareholders that we will find our way through this. As you know, we sat here in April, gave a forecast for quarters, for the year, and the first half of '20 and 2021. Very few companies did that. We delivered and actually beat those forecasts as we moved through that quarter. We are two quarters ahead, and Commercial & Residential has returned to growth, which is a tremendous performance by that group. The market is coming back. It's great to see. They're leveraging, and their margins are significantly improving based on all the restructuring that occurred from 2019 throughout 2020. And they're ready to grow and expand those margins. We believe the Auto Solutions cycle we laid out back in August is about 1.5 quarters behind that cycle. There are still some tough things ahead of us, but we are quite confident that business will return to growth in the second half of the year. Lal and his team are confident in delivering improved profitability and cash flow in 2021. They've decided to increase the restructuring in the first half of this year, primarily to drive higher margins even though sales are expected to continue to decline in the first half of the year. This is not easy to do given all the things they've been doing over the last 12 to 18 months, but I feel strongly they will deliver. The company is stronger, and the balance sheet is stronger. I believe the underlying growth momentum will return. Our aggressive cost actions are self-help, and we're on track to deliver the peak margin plan we laid out in February of 2020 despite sales being approximately $2 billion lower than before the pandemic and recession. The hard work on cost actions, restructuring, new product investments, and all the necessary actions taken to make this company stronger for our shareholders and customers have been completed. We have confidence in 2021. Yes, there are still challenges ahead of us, and we do have an election going on today. Who knows what will happen? Yes, the COVID virus is still present. However, we have confidence in the vaccine and our ability to move back into a more normal business environment as we progress through the year. We feel good about our ability to return more cash to our shareholders as we move into 2021. But before I delve into the charts, I want to make a special call out to our Emerson employees around the world, the leadership team, the corporate employees, and those who stood by me through the OCE live in St. Louis. I want to thank you all for making that happen. Clearly, we have some challenges ahead, but I feel that the company is in a much stronger position than it was back in April when we last spoke, and I feel very optimistic about the future prospects as we enter 2021.

Thanks, David. I was in Asia, working with Lal as we navigated the depths of the COVID impact, and it's great to be back here to see the tremendous number of investments put in place to improve our operational capabilities and transform our structures and our business for improved profitability as we move forward. Looking at Chart 27, we saw a return to growth in underlying sales in the fourth quarter of 2020 across many of our product lines, driven by strength in the North America residential markets. We also experienced sequential improvement across our businesses as the quarter unfolded. Trailing three-month orders in September were up 6.4% and are expected to improve to be double-digit as we finalize the October numbers. The residential markets globally typically represent between 40% to 50% of our mix in any given quarter, and North America is by far the largest portion of that. Inventory restocking across residential segments is providing additional order sales growth opportunities beyond the demand being driven by home sales and home improvement. We are very well positioned for 5% to 6% underlying sales growth in the first quarter. The second quarter outlook in growth percentage is slightly lower than Q1 as we believe the inventory rebuild restocking activities will start to level out a bit. The North America A/C strength could continue potentially into the fiscal third quarter, given seasonal trends. We anticipate growth occurring in the Europe heating and A/C technologies group businesses throughout the year and overall growth for the broader European portfolio returning in the second quarter. Asia is on track to return to growth late Q1 or early Q2.

Thank you, David, for those words. It's very meaningful for all of us in the business. 2020 was an extraordinary year as you described, and I'm so grateful and humbled by the results delivered by our team. A few words regarding 2020: the second half of 2020 was weaker than we expected when we first talked back in April during our reset, and we did not see the acceleration in orders in the latter half of the year. However, the team did an exceptional job in several areas, including restructuring programs, converting $400 million of backlog in the second half, growing our life science and medical segment by over $100 million, and ensuring a strong focus on digital transformation and diversifying our business. As a result, we achieved 26% quarterly adjusted EBITDA leverage and 23% annual adjusted EBITDA leverage despite almost $1.5 billion of down sales. Looking toward 2021, we expect two additional challenging quarters in the first half, prior to turning positive in the second half of the year on three key indicators: first, discrete industry orders and inventory levels in distribution channels; second, manpower presence at customer sites; and third, acceleration in the core market spending for KOB 3 in North America. Additionally, we had significant growth in our life science, medical, and clean fuels business segments, with impressive growth driven by vaccine development and clean fuels technology innovation.

Before we turn it over to Jamie, I just want to thank Lal and the team for their major contributions to restructuring cost reductions aimed at driving the margins back up despite sales struggles in the first half of the year. They have also made sure to make the right investments. We've had extensive discussions about new products and next-generation technologies, ensuring we did not jeopardize our future franchises. So, Jamie, welcome to your first call. I hate to say Bob Sharp set it up for you, but you've got a growth opportunity that you just need to execute on. Let's discuss it.

Yes. Thank you, David. As we've been working through the issues created by COVID, our team has put in tremendous effort in terms of improving operational capability and performance. In the fourth quarter of 2020, we saw a substantial increase in underlying sales across many product lines driven by strength in North America residential markets. We experienced robust order growth as the quarter progressed, and we anticipate North America A/C growth to be up over 20% in Q1 due to successful execution and our technology investments. Our partnerships with customers have been critical as we capitalize on these opportunities with a focus on driving innovation in our product offerings.

Thank you very much, Jamie. Again, I want to thank the commercial and residential organization for their efforts, as we have progressed towards growth following a difficult restructuring period. Bob, in 2018 and 2019 and the first half of 2020 laid a strong foundation for this growth trajectory. We are now in a position where we are getting ready to exploit the market potential that's returning. However, many of our plants are operating at full capacity, which has been a significant challenge. At the same time, we have been able to create a more efficient organization. I believe we are well-positioned for success.