Emerson Electric Company (EMR) — Q4 2023 Earnings Call Transcript

Good morning, and thank you for joining us for Emerson's fourth quarter and full year 2023 earnings conference call. Today I am joined by President and Chief Executive Officer, Lal Karsanbhai; Chief Financial Officer, Mike Baughman; and Chief Operating Officer, Ram Krishnan. As always, I encourage everyone to follow along with the slide presentation, which is available on our website. Please join me on Slide 2. This presentation may include forward-looking statements which contain a degree of business risk and uncertainty. Please take time to read the safe harbor statement and note on the non-GAAP measures. I will now pass the call over to Emerson's President and CEO, Lal Karsanbhai, for his opening remarks.

Thank you, Colleen. Good morning. 2023 was an exceptional year for Emerson. The management team, alongside the Board of Directors, boldly delivered across the three dimensions of our value creation strategy. Firstly, culture. Our management team just completed a trip around the world where we had the opportunity to engage with our customers and our teams. It was an energizing trip and it was evident to me that the changes we are driving in the culture of Emerson are embraced, as evidenced by our engagement survey. 2023 was an important year. We made significant progress across multiple dimensions of culture. We rolled out an employee value proposition, advanced our diversity and inclusion metrics, and made significant strides in our sustainability targets, as well as launching a differentiated talent engine program. Secondly, our portfolio transformation is largely complete. The Copeland divestiture and, more importantly, the acquisition of NI have enabled us to create an Emerson focused on automation with a cohesive, higher growth, higher profit margin, diversified portfolio aligned to the critical macro secular drivers: energy security and affordability, sustainability and decarbonization, and digital transformation. I would like to welcome Ritu Favre and the NI family to Emerson. This is an exciting time. With NI, our technology stack is unequaled, and we are in a position to continue to push the boundaries of automation to meet our customers' needs. Thirdly, execution. The Emerson management system is delivering differentiated results. Underlying sales for 2023 grew 10%. GPE expanded 330 basis points to 49%. And adjusted Segment EBITDA expanded 220 basis points to 25% after delivering yet another year of over 50% leverage. Adjusted earnings per share in 2023 grew 22% to $4.44 and free cash flow was $2.4 billion. Orders growth exited the year at 5% and we grew across all world areas. We had strong price realization in the business at 4% for the year. And MRO represents 65% of our revenue, with now a $150 billion installed base around the world. We exited the year with $6.6 billion of backlog, up 12% year-over-year. We delivered on innovation in 2023. It was a year of significant releases in our DeltaV platform, Aspen models, and intelligent devices. Our R&D spend as a percent of sales rose to 7% in 2023. Cost management is the way of life at Emerson. The differentiated leverage of 53% is reflective of aggressive cost actions across our business. We also delivered on commitments of no stranded costs related to the Copeland transaction and will be delivering on the $100 million corporate cost takeout by the end of 2024 through significant transformational activities, driving certain functional activities to centralization and best cost locations. I am humbled by the exactness of our performance and I'm certainly optimistic about the future of our company. I'd like to express my appreciation to our customers who increasingly place their trust in Emerson to solve the world's most challenging problems. And lastly, in my opening remarks, I'd like to say I am but one of over 70,000 Emerson team members around the world. I'd like to thank our global employees for your passion, hard work, and energy that you bring to Emerson every single day. Please turn to Slide 3. As I said earlier, and it bears repeating, 2023 was an exceptional year. We are excited to run this cohesive high growth and diversified portfolio. The financial performance was differentiated with double-digit underlying sales growth, 53% operating leverage, and 22% adjusted EPS growth. As we look ahead, 2024 is expected to be another strong year. Operating leverage, excluding NI, is expected to be in the mid to high 40s, and adjusted EPS is expected to be $5.15 to $5.35, including roughly $0.35 to $0.40 contribution from NI. We hit the ground running on October 11, as soon as we closed the transaction, to begin executing the synergy plan, and we expect it to provide early benefits in 2024. We are expecting 4% to 6% underlying sales growth, driven by our focus and commitment to winning in our growth platforms and leveraging our innovation. Energy transition, industrial software, life sciences, and metals and mining are expected to remain resilient parts of our portfolio and we are utilizing our leading technology, customer relationships, installed base, and expertise to capture investments in these markets. While discrete markets are down in both our factory automation business and test and measurement, we are expecting recovery in the second half of the year. Turning to Slide 4 for some additional details on how we finished the year. 2023 was a remarkable operational year for Emerson. Starting with the orders performance, our teams executed exceptionally throughout the year. We won in the marketplace. We won in markets like LNG, hydrogen, renewables, life sciences, and metals and mining, resulting in 5% orders growth for the year. This shows our portfolio relevance and leadership position for our customers. Orders were also up 5% in Q4, led by double-digit order growth in China and the rest of Asia. Underlying sales were up double digits for the year, exceeding our initial expectation of 6.5% to 8.5% last November and in line with our August guidance. The strength was widespread across the organization with all world areas growing 9% to 10% and both business groups growing 10%. I am most proud of our performance around operating leverage this year. 53% is differentiated. It is a testament to our Emerson management system and our operational talent, which drove strong performance. Adjusted EPS ended the year at $4.44, beating the midpoint of our original November guidance by $0.37 and near the top of our August guidance. Lastly, free cash flow of $2.4 billion was up 35% year-over-year and above our August guidance.

Thanks, Lal, and good morning, everyone. Please turn to Slide 11 that summarizes our fourth quarter financial results, which were in line with our expectations. Underlying sales growth was 5%, growing off a tough comp in 2022 when sales shifted from the third quarter into the fourth quarter due to China shutdowns and electronic component shortages. Price contributed approximately 4 points of growth. As expected with our typical seasonality, backlog declined sequentially about $300 million to $6.6 billion, up 12% versus where we entered 2023. Software and control sales grew 2% on an underlying basis, which now includes AspenTech as we lapped a year of ownership. The control systems and software business came in largely as expected and it was comparing against a very strong prior year Q4. AspenTech tends to see lower sales volume in our fiscal Q4 due to the timing of renewals and its sales can be more variable due to ASC 606 accounting. The sales were on forecast and importantly ACV showed strong growth at 10.9% year-over-year. Intelligent devices grew 6%, led by process and hybrid exposed businesses, mainly measurement and analytical and final control. Our discrete automation business was down in the quarter with softer-than-expected demand and Europe and China weakness impacting this business. Emerson adjusted segment EBITDA margin improved 80 basis points to 25.5%. Operating leverage excluding AspenTech was 45%. Volume, margin accretive price cost, which included net material deflation and ongoing productivity programs contributed to the margin improvement. Adjusted EPS grew 21% to $1.29. Lastly, free cash flow for the quarter of $838 million was up 17% versus the prior year.

As Lal summarized, 2023 was an exceptional year for Emerson. Underlying sales growth was 10% with 4 points of price contribution. Software and control and intelligent devices both finished with underlying sales growth of 10%. All geographies reported strong sales growth with Americas up 10%, Europe up 10%, and Asia, Middle East, and Africa up 9%. Emerson adjusted segment EBITDA margin improved 220 basis points to 25%. Operating leverage excluding AspenTech was 53%. As we've talked about throughout the year, this was driven by leverage on double-digit sales growth, strong execution by our operations teams, margin accretive price cost, and favorable product and project mix. Adjusted EPS grew 22% to $4.44 with $0.27 of contribution from AspenTech. Lastly, free cash flow of $2.4 billion was up 35% versus the prior year. This includes approximately $100 million from the interest on undeployed proceeds from the Copeland transaction. For the year, free cash flow conversion of adjusted earnings was 88%, slightly ahead of our expectations. This also represents a 15.6% free cash flow margin, a metric we plan to utilize moving forward.

As Lal summarized, 2023 was an exceptional year for Emerson. Underlying sales growth was 10% with 4 points of price contribution. Software and control and intelligent devices both finished with underlying sales growth of 10%. All geographies reported strong sales growth with Americas up 10%, Europe up 10%, and Asia, Middle East, and Africa up 9%. Emerson adjusted segment EBITDA margin improved 220 basis points to 25%. Operating leverage excluding AspenTech was 53%. As we've talked about throughout the year, this was driven by leverage on double-digit sales growth, strong execution by our operations teams, margin accretive price cost, and favorable product and project mix. Adjusted EPS grew 22% to $4.44 with $0.27 of contribution from AspenTech. Lastly, free cash flow of $2.4 billion was up 35% versus the prior year. This includes approximately $100 million from the interest on undeployed proceeds from the Copeland transaction.

Please turn to Slide 15, where we have outlined our 2024 guidance. Our later cycle exposure, robust backlog, and continued orders resiliency support our 2024 guidance for underlying sales growth of 4% to 6%. We expect both intelligent devices and software and control to be within this guidance range for underlying sales. Test and measurement is excluded from 2024 underlying sales and is expected to add another 10 to 10.5 points to reported growth or approximately $1.6 billion of sales. FX is expected to be a 1 point tailwind. We remain committed to driving differentiated incremental margins through our operational execution. Operating leverage, which now includes AspenTech but excludes test and measurement, is expected to be in the mid to high 40s in 2024, which includes cost savings from our corporate and platform rightsizing. Price/cost will continue to be margin accretive in 2024 and ongoing productivity and cost savings will drive further benefits. We expect adjusted EPS to increase from $4.44 in 2023 to between $5.15 and $5.35 in 2024, an 18% increase at the midpoint.

Thank you. Good morning, everyone. Just a couple of specific questions if I could. Some noise with the bolt-ons. So could you just clarify for NI revenues in 2024? And also, if you could provide any color on how their orders progressed in the fourth quarter? And finally, maybe a little bit about how much of that synergy target happens in the first year?

Hi, Jeff. Lal here. Good morning. So on the revenue, as Mike stated, $1.6 billion is the assumption. It's not in the underlying sales as we reported. Orders in the environment, as I expressed in my presentation, are still challenging in the business, exiting the quarter at down 16% NI, which is very much aligned to the plan that we had in place. We do expect, much like in our core discrete markets, orders to flatten out as we get into the second half of the year. So feel very much that they're under in plan from an orders perspective, although still in a challenging environment. And then lastly on synergies. Look, we got off to a really good start, day one. The team's executing very, very well. We haven't given guidance on year one, but what I will say is that about half the synergies will be delivered in the first two years.

Right. And just as an unrelated question, maybe it's for Mike. But just thinking about the organic guide for 2024, you're exiting here at 4% price with 5% order growth, right? It feels like there's a little bit of room in those organic numbers. Maybe just share how much price is embedded in that 4% to 6% for 2024?

Yeah. Jeff, the 2024 price assumption is 2%.

Hi, good morning.

Good morning, Steve.

Can you just talk about within the cash guidance, what you're assuming on working capital? And then that $250 million that's kind of running through this year, how does all that trend into ‘25?

I'll address the second part of the question first. The $250 million is a one-time figure associated with the acquisitions and some of the increased capital expenditures we have.

Great. And then just working capital?

Working capital for the year exited at about 20.5%, and we expect to see a reduction of about 50 basis points from that percentage of revenue. Therefore, we anticipate some improvement in our balance sheet for 2024.

Great. And then just one last one, just on orders. How do you guys kind of see the funnel stepped up a bit, the backlog, you had in the backlog seasonally, but how do you guys see orders and backlog trending over the course of the year here?

I'll comment, Steve. We exited at 5%, so there is optimism and momentum out there. We encountered some challenges in the discrete segment, as we mentioned in our discussions. Looking at the beginning of the year, I expect performance to be flat to low single digits. However, as we move into the second half of the year, I anticipate exiting in the mid-single-digit range. For the full year, I expect results to be in the low single to mid-single-digit range.

Great. And, thanks a lot.

And then Steve, just on backlog. That pattern holds, there shouldn't be a meaningful change in backlog as we exit 2024. So the backlog should remain healthy.

Hi, good morning. Maybe first off, just looking at Slide 15, I wanted to understand why the operating leverage steps up after Q1 when the organic sales growth steps down? Is there any one segment or subsegment or something happening with mix that's driving that? And should we assume that that organic sales growth just steadily decelerates through the year?

Hey, Julian, yeah there is a little bit of mix and I would say the discrete automation softness that we are expecting in the first half of the year plays in on that. We've been ramping up our spend around growth platforms and innovation. And so as you come into the first quarter, there's a little bit of a year-over-year comparable that plays into that first quarter leverage as well.

I see. So it's really discrete, sort of getting better, and that pushes up the op leverage balance of the year.

That's correct. Again, obviously we're driving restructuring in the discrete business given the trend in the orders and you will see that margin expansion come through in the second half which would drive up the leverage rates.

That's helpful, thank you. And then just a quick follow-up would be around, I suppose, historically process cycles in automation followed discrete by around 12 months, and we see discrete is soft now. Are there any sort of specific reasons why process should hold up differently this time versus history instead of following discrete lower later this year?

It's a good question, Julian. We have given it considerable thought and are closely monitoring the situation. Currently, there are some unusual long-term trends affecting the world. I believe that much of our process activity is driven by three key factors: near-shoring activity, which influences life sciences and the metals and mining value chain; energy affordability and security, leading to ongoing investments in liquefied natural gas and nuclear; and sustainability, which is equally important. We have reached a point where our customers are fully committed to sustainability, and we are witnessing ongoing investments in this area. Therefore, we need to consider whether these factors will endure through various economic cycles and how they might affect the stability of our processes as we move into 2024.

Yeah, and the other point I'd make, Julian, is the capital spend in the process hybrid industries has been pretty disciplined. There hasn't been a boom in capital to cause a correction as we move forward as opposed to the prior cycles we saw. So I think that disciplined capital spend plus obviously the trends that Lal identified, where the sustainability investments provide that tailwind, we expect process to continue to run for a lot longer.

I see, so you…

Process and hybrid, yeah.

Got it. So the process and hybrid orders growth should stay fairly steady through 2024.

That is our expectation, yes sir.

Okay. The line is live, but I'm not, so sorry for that. So National Instruments, I think that the 4Q fiscal sales were down, I think, high single-digit organic. Is that the right number? Is my math correct? And it looks like the guide implies flattish to maybe slightly down organic. Just wondering what the profile is on that and anything on orders there would be helpful.

Yeah. So, Ram here, Nigel. From an orders perspective, as Lal indicated, last quarter, which is our fourth quarter, down 16% in orders. We expect orders to remain down for the first half and turn positive in the second half. And you are right, the $1.6 billion that we're guiding will translate to down 5% to 6% for the year from a sales perspective. And sales should turn positive in the fourth quarter. So we'll have down sales for the first three quarters and positive in the fourth quarter.

Okay, great. I'm sorry I missed the order number. Thanks for clarifying that. And then on the backlog, backlog down from $6.9 billion to $6.6 billion QoverQ, maybe just clarify, I don't think that's unusual from a seasonal perspective. I think it's normal to see 4Q backlog consumption. Was there any FX revaluation impacts there? I just want to make sure that I understand the organic movement there.

No, that's on a consistent GAAP basis.

Hey, good morning, everybody. Congrats on all the stuff done.

Good morning, Scott. Lal, it sounds like you were just in China, if you were around the world, and it seems pretty topical to get an update from what maybe you saw there. I'll just leave it there. Yeah, I actually, on this particular trip, did not hit China. We'll do that later in the year. I was there in May. But having said that, look, we had a very good year in China. We exited orders at 11% in China. So feel good about the momentum there again. The investments there really around energy security and nearshoring are very significant. Sales were in the mid-single-digits for the year, and we continue to see robustness in our core process and hybrid spaces. And not unlike what Europe and the United States are struggling with on the discrete side, but certainly the process hybrid strength will continue as we expect into 2024.

And then the discrete in China is negative I'd assume this quarter?

Yes, it is negative in the quarter. Yes, sir.

Hi, good morning. Thanks for taking my questions. One, just on the NI earnings contribution for the year, $0.05 in the first quarter would be kind of running, I guess, $0.10 a quarter or a little better for the rest of the year. But any more detail on that cadence? Anything that's sort of cost heavy up front and then the progression through the course of the year as you're thinking about that earnings contribution?

I don’t have anything else to add, Joe. As Ram mentioned, there will be an increase in volume during the second half of the year that will lead to leverage and additional profits, but that really sums it up.

Okay, and then on the R&D side and the step up to 7%, it sounds like it goes even higher in ‘24. Any context on that? And then sort of an additional insight on sort of the products and verticals that are getting outsized investments, as well as what your returns focus is on R&D, the prioritization around share gain or sort of the revenue dollars that you want, returns on R&D investment, any sort of context around that?

From a dollar perspective, yeah, we get the benefit of Aspen coming in, that mixes us up, and then NI comes in, and that also mixes us up. So you'll continue to see that commitment to growth, innovation, accelerate and increase as we move on. And in terms of where the investment is going, a lot of the investment really is across the four technology areas we've consistently showed you guys. It's disruptive measurement which is the sensing technology in our measurement technologies business, our automation system, the next generation automation system that Lal referenced in the presentation, and also collaborative technology development with Aspen around asset performance management. So those are the areas where we see lots of opportunity in terms of new-to-the-world type innovation that we can drive as an automation company and that's where the investment is going.

Thank you. Good morning. I was curious about the funnel conversion comments. I think last quarter you indicated that the conversion rates of those are picking up as the size of the projects ramps and some of the newer technologies and applications. So, just curious, trend line if you see in further acceleration and how much of that notion is baked into the fiscal ‘24 guidance or could that be an opportunity?

No, Chris, it's Lal here. We continue to see the funnel expand organically, which is why we thought it was important to share that it grew from quarter to quarter. What's particularly interesting is that it's growing in the right areas for us. This growth aligns with our focus on key platforms and currently represents about $6.6 billion of the funnel, with energy security and transition being significant parts of it, along with sustainability and decarbonization. If you look at our wins, they closely match the funnel's alignment with the growth platforms, and energy transition plays a major role in our conversions. We are monitoring this carefully as it progresses through the FID process and other elements, but for now, we remain optimistic, especially regarding products linked to national security, nearshoring, and energy affordability. Overall, we feel encouraged by what lies ahead.

From a channel perspective, I mean, if you're referencing destocking, we're not seeing that. The discrete slowness is purely market driven, certainly European machine builders, China is an end market, and an overall slowdown in the factory automation segment in North America. And you see that with obviously a lot of our peers that have a lot more exposure and discreet. Frankly, versus our peers, we're holding our own in terms of the order rate decline in discreet, and we do expect to see a second half ‘24 positive orders for the business.