Emerson Electric Co. (NYSE:EMR) Q1 2024 Earnings Call Transcript

Emerson Electric Co. (NYSE:EMR) Q1 2024 Earnings Call Transcript February 7, 2024

Emerson Electric Co. misses on earnings expectations. Reported EPS is $0.2302 EPS, expectations were $1.04. EMR isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning and welcome to the Emerson First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to our host, Colleen Mettler, Vice President of Investor Relations at Emerson. Please go ahead.

Colleen Mettler: Good morning, and thank you for joining us for Emerson’s first quarter 2024 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.

Lal Karsanbhai: Thank you, Colleen and good morning. I’d like to begin by thanking the Emerson team for delivering a strong start to 2024. I’d also like to extend my appreciation to the Emerson Board of Directors and to our customers for your continued confidence in us. Our first quarter results demonstrate, the underlying strength of the markets we serve, the meaningfulness of our differentiated technology and the relentless execution of our global teams. Please turn to Slide 3. Q1 was a strong start for Emerson. As we continued our focus on executing and driving value creation for our shareholders. The demand environment remains healthy for process and hybrid markets. We continue to see projects moving forward at a healthy pace in markets like chemical, LNG, life sciences, metals and mining and sustainability and decarbonization.

Even in the face of higher interest rates, ongoing geopolitical challenges, and upcoming elections in key global markets, including the U.S. Our customers 2024 CapEx budgets are shaping up constructively, and are largely supportive of the demand environment we are experiencing. This robust environment, along with continued execution by our teams is a key contributor to the Q1 performance. Q1 orders, sales, operating leverage and adjusted earnings, all exceeded expectations, providing confidence to increase our full year guidance. This performance reflects our ability to win with a focused approach to our growth platforms and through continued investments in innovation. It is also a testament to our new differentiated portfolio with leading technology, strong profit margins, and exposure to the important global secular growth markets.

This is exhibited by our gross margin and adjusted EBITDA expansion since 2021. Our business is well positioned to capture investments in areas like energy security and affordability, sustainability and decarbonization, digital transformation, and nearshoring. Regarding our portfolio, we continue to reiterate that the large parts of our portfolio transformation are complete, and we do not expect any sizable transactions in 2024. This is a portfolio we designed from the beginning, and we are excited to be executing with this set of businesses. On that note, test and measurement is executing well and had a strong first quarter ahead of our expectations. The quarter performance and an acceleration of synergies provide more confidence, for our full year expectations from the business.

Please turn to Slide 4. Emerson’s Q1 exceeded all expectations. Underlying orders continued to grow in the mid-single digit range, with 4% growth in Q1. Processing hybrid markets were strong and discrete orders remain down as expected. Multiple LNG projects booked in the quarter, specifically in Europe and the Middle East. Life sciences activity was also strong across the globe, with large project wins in the U.S., Canada, Europe and Asia. The Q1 growth was also supported by some project activity shifting from Q2 to Q1. As you all know, orders can move around quarter to quarter, but we still expect low single digit order growth in the first half of 2024 and mid-single digit order growth for the full year, as discrete demand improves in the second half.

Underlying sales for the quarter grew 10%. Again, led by process and hybrid markets, exceeding our expectations. Energy transition markets and metals and mining will both bright spots in the quarter, as we executed numerous projects across Europe, Latin America and Australia. This volume combined with favorable price cost and a strong operational execution resulted in 41% operating leverage in Q1, ahead of our mid 30s expectations. Adjusted EPS was $1.22 up 56% versus 2023. And free cash flow was $367 million, up 51%. Mike Baughman, will go through this specific shortly, but we are excited about our first quarter performance. On Slide 5, our current strategic project funnel grew by approximately $200 million to $10.4 billion, and our growth programs continue to represent nearly two-thirds of this funnel.

The continued expansion of the funnel is promising, with existing customers and new entrants continuing to plan and budget for capital projects in the coming years. In the first quarter, Emerson was awarded approximately $400 million of project content, with a little more than half from our growth programs, including three noteworthy deals in energy transition. First, Emerson was selected by DG Fuels in Louisiana, to provide our comprehensive automated automation portfolio, including advanced sensing, control systems, and optimization software for the production of sustainable aviation fuels. These fuels can be used in existing aviation and vehicle engines, and DG Fuels has previously announced agreements with aviation leaders, including Air France, KLM, Delta, and Airbus.

Next, Emerson was chosen to automate a lithium ion recycling process based on our metals and mining expertise and experience throughout the lithium value chain. Emerson will provide SungEel HiTech, a specialist in lithium battery recycling in Korea, with advanced automation solutions, for safe and reliable operations at its newest facility that is capable of supplying materials for approximately 400,000 electrical vehicle — electric vehicles each year. Lastly, Emerson and AspenTech were jointly selected for a large scale LNG liquefaction facility in the Middle East. The project will win represents Emerson’s strong presence in the region, including an already sizable LNG installed base. The win is also recognition of the collaboration in synergies between Emerson and AspenTech.

As Emerson’s DeltaV was selected, along with AspenTech’s high simulation, showing the power and differentiation of our combined portfolio. As we look at the continued needs of Europe, and its reliance on gas imports, the Middle East and Africa will play a pivotal role in gas exports. Emerson is uniquely positioned with our local expertise, manufacturing and installed base to serve the region in its LNG growth. These are just three examples of Emerson’s continued leadership position in energy transition markets, spanning from established markets like LNG to newer markets, like sustainable aviation fuels. Turning to Slide 6. We remain focused on accelerating innovation for profitable growth. Our recent innovations and our continued technology leadership were recognized by IoT Breakthrough, who named Emerson its 2024 Industrial IoT Company of the Year.

IoT Breakthrough received over 4,300 nominations for the 2024 competition, and Emerson was selected based on our unique ability to effectively leverage decades of expertise in digitalization and automation to help the industry transform operations. Among the innovations recognized were Emerson’s Ovation green portfolio for manning renewable power assets, Florida cloud solutions to continuously monitor critical production and energy efficiency data in factories, one-click transfer software capable of accelerating the life sciences drug development process, and numerous releases focused on enabling the boundless automation vision, including the DeltaV edge environment. As you recall, boundless automation is Emerson’s vision for a cohesive automation ecosystem from device to enterprise.

Integrating operations with a flexible automation architecture allows users to have access to all their data, enabling analytics and performance improvements across numerous domains like production, safety, reliability and sustainability. All these innovations will be on display at Emerson’s upcoming Users Exchange at the end of February. Emerson Exchange in Dusseldorf, Germany will feature customer case studies, industry sessions and a technology exhibit demonstrating Emerson’s leading automation portfolio for process and hybrid industries. New this year are industry-focused exhibits showcasing Emerson’s complete solutions for emerging industries like hydrogen, biofuels and carbon capture in addition to growth markets like life sciences and metals and mining.

Please turn to Slide 7 for an update on our synergy progress in test and measurement. We effectively use the time between signing and closing to plan all integration and synergy activities, utilizing a world-class M&A methodology as part of our Emerson Management System. Given the strong team collaboration in current market environment, we have accelerated those synergy activities. In the first quarter, we worked closely with the new test and measurement leadership team to aggressively address public company and corporate costs while rapidly implementing Phase 1 of our sales and marketing and research and development transformations. We are also leveraging our Emerson Management System and best practices to progress operational execution and commercial excellence at test and measurement.

This includes trade working capital, price realization and procurement efficiencies in logistics and direct materials. These efforts put test and measurement ahead of schedule and give us the confidence to increase the cost synergy target to $185 million, which we now expect to achieve by the end of 2026, two years faster than originally expected. This includes approximately $80 million expected to be realized in 2024. Our planned cost to achieve these synergies increases slightly to $165 million with the majority of the spend expected in the first two years. We still expect adjusted segment EBITDA to reach approximately 31% by year five, as sales grow on the reset cost base. I’ll now turn the call over to Mike Baughman to go through more detail on the quarter performance, including test and measurement and our updated 2024 guide.

Mike Baughman: Thanks, Lal, and good morning, everyone. Please turn to Slide 8, where we have summarized our first quarter financial results. Underlying sales growth was 10%, led by our process and hybrid businesses. Intelligent devices and software and control grew 11% and 9%, respectively. Discrete automation was down low single digits as expected. All world areas were strong with Asia, Middle East and Africa up 15%, Europe up 10% and the Americas up 8%. Price contributed approximately 2 points of growth. Test and measurement, which is outside of the underlying sales measure, contributed $382 million, exceeding expectations for the quarter. I will discuss test and measurement performance in more detail on the next slide. Backlog is now $7.6 billion, which is up $500 million versus September 30, when excluding test and measurement.

Emerson adjusted segment EBITDA margin improved 190 basis points to 24.6%. Volume, margin-accretive price-cost, which included net material deflation, ongoing productivity programs and the test and measurement performance, all contributed to the margin improvement. Operating leverage excluding test and measurement was 41%. Adjusted EPS grew 56% to $1.22, up $0.44 and is a strong start to the year. Double-digit sales growth and 41% operating leverage contributed to the $0.33 of operational improvement year-over-year. Non-operating items contributed $0.11 year-on-year, mainly due to lower stock compensation, which contributed $0.08 versus Q1 of 2023. As a reminder, all legacy mark-to-market stock compensation plans are now complete. Also contributing to the non-operating items were interest income of 4% and share count, which contributed $0.02.

Tax was a $0.03 headwind. Lastly, free cash flow for the quarter of $367 million was up 51% versus the prior year. This was in line with our expectations for the quarter as we saw modest improvement in work capital year-on-year. Headwinds related to acquisition fees and restructuring impacted the quarter by approximately $100 million, and CapEx was up $18 million year-on-year. AspenTech sales and ACV were slightly weaker than our expectations for Q1 driven mainly by a delay in renewal from one customer. This slight miss, however, did not have a material impact on total Emerson results versus our expectations. For the quarter, ACV grew close to 10%. And the AspenTech team continues to see strong market dynamics in power transmission and distribution and sustainability and decarbonization while at the same time utilizing Emerson relationships to win in LNG, life sciences and power generation.

Turning to Slide 9, we will dive deeper into the first quarter performance of test and measurement. Orders were in line with our expectations, down 17% year-over-year but showed high single-digit sequential improvement led by the strength in aerospace. There was continued softness in semiconductor and automotive markets and ongoing weakness in China. We continue to launch orders as a key indicator and still expect to turn in the second half on easier comps. Sales for the quarter were $382 million, beating initial expectations. This was driven by stronger backlog conversion, lower-than-expected sales during the 11-day stub period prior to closing and a little conservatism in the guide given the timing of the close. Sales were $401 million, including the sales in the stub period.

Test and measurement adjusted segment EBITDA margins was 26.5% in the quarter, beating expectations due to higher sales, better-than-expected gross margins and slightly higher cost synergies. The Q1 adjusted segment EBITDA margin benefited from lower-than-expected sales in the stub period against ratable fixed costs. Test and measurement contributed $0.13 in the first quarter, including stock compensation expense and using the test and measurement tax rate, which is in the mid-teens. The stub period dynamic discussed earlier benefited the adjusted EPS contribution by approximately $0.02. Test and measurement’s March quarter end sales volume has typically stepped down from its December quarter end. We expect similar seasonality with second quarter sales of approximately $350 million.

Second quarter adjusted EPS contribution is expected to be $0.07 driven by leverage on the lower seasonal sales volume, partially offset by synergy savings. Turning to the full year. We have increased our expected adjusted EPS contribution from test and measurement to $0.40 to $0.45 to account for some of the Q1 upside. We still expect sales to be $1.5 billion to $1.6 billion as we continue to watch for the orders turn. Sales volumes are expected to ramp from Q2 to Q4, turning positive in Q4, consistent with our prior expectations. While we expect to sales to be down versus 2023, we expect modest adjusted EBITDA expansion as we recognize the cost synergies. Finally, I would like to thank the test and measurement team for an excellent quarter.

The integration work has been performed exceedingly well, and your embrace of the Emerson Management System is very much appreciated. Thank you again to the entire test and measurement team. Please turn to Slide 10, for details of our Q2 and full year 2024 guidance. After our strong Q1 performance, we are increasing our full year 2024 sales and adjusted EPS guidance. We now expect underlying sales growth of 4.5% to 6.5% driven by our process and hybrid businesses. We expect both intelligent devices and software and control, to be within this guidance range for underlying sales. We continue to watch the discrete automation recovery closely, and we now expect sales to turn positive in Q4 consistent with test and measurement. Full year discrete automation underlying sales are now expected to be down in the low single-digit range.

FX is expected to be approximately flat versus 2023 compared to a 1-point headwind embedded in our November guidance. Operating leverage, excluding test and measurement, is now expected to be in the low to mid-40s in 2024 versus the mid-to high 40s guidance from November. A modest reduction in our full year target is solely attributed to the move in FX as the 1% increase in sales volume comes in at a lower margin. Our adjusted EPS range increases from $5.30 to $5.45 driven by our Q1 performance. AspenTech is still expected to contribute approximately $0.32 to $0.34. Lastly, we are maintaining our free cash flow guidance of $2.6 billion to $2.7 billion. Share repurchase is expected to be approximately $500 million, of which $175 million was completed in Q1.

For the second quarter, we expect underlying sales to increase 3.5% to 5.5% with leverage in the low to mid-40s. Tougher comps in discrete automation are expected to have an impact on reported sales growth for the quarter. However, volumes are expected to improve sequentially from Q1. Adjusted EPS is expected to be between $1.22 and $1.26. And with that, we will now turn the call back to the operator for Q&A.

Operator: [Operator Instructions] The first question comes from Andy Kaplowitz of Citigroup. Please go ahead.

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Q&A Session

Andy Kaplowitz: Good morning, everyone. Lal, I think your backlog at $7.6 billion, it was up relatively significantly, even excluding test and measurement addition with the orders, as you said, a plus 4%. Can you talk about organic order visibility going forward? It seems like process/hybrid has been relatively strong as you thought. Can you sustain that mid-single-digit kind of order growth going forward? And then have you seen an inflection yet in NATI-related orders?

Lal Karsanbhai: Hi, Andy, no, happy to give you some color on the orders. So obviously, as you know about our business, orders can fluctuate on a quarter-to-quarter basis, which is why we guided in that lower single-digit range in the first half of the year, but finishing the year in the mid-single-digit range, as we are now. We have a high degree of confidence about that based on two factors, Andy, the first being our MRO business continues to be relatively strong. It represented approximately 65% of the revenue in Q1, and we expect that to remain robust as we go through the remainder of the year. And that provides us a strong base of order activity. Secondly, the conversion in the funnel. We booked approximately $400 million that represented almost a little over 90 projects that we won out of the funnel in the first quarter.

The funnel grew despite that. And we continue to see activity, particularly in energy transition driven by the Middle East and Africa, in the sustainability area, life sciences, and of course, a tremendous amount of activity in metals and mining. So from an underlying Emerson perspective, the focus really is process and hybrid to continue to provide that underlying strength through the year. Now what we will see is a recovery in discrete in the second half, and that’s what we’ve got baked in here. We are still in the lower single digits negative right now in our discrete markets. It’s really demand-driven, as we’ve been talking about for the last couple of quarters. We do expect a recovery in orders into the second half, of course, between comps and obviously some demand elements there.

As far as NI is concerned, it’s very much on plan to what we expect in terms of orders. We do also believe that there’s a second half positive return on the order activity. And we’re starting to see early signs in markets, particularly like semiconductor, as you see these companies come out and report. So very much on plan on both ends and which gives us confidence in the underlying strength of the order activity, Andy.

Andy Kaplowitz: Helpful. You obviously had a good quarter and raised the outlook. But maybe just on free cash flow, you didn’t change your guidance despite the better quarter and outlook. Did you raise your acquisition-related costs? Is CapEx going up? Anything that you could talk about on that side or on the working capital side?

Mike Baughman: Andy, it’s Mike. I’ll take that one. Yes, the guide was maintained at $2.6 billion to $2.7 billion. And with respect to the $250 million that we called out in November, that’s tracking right on plan. About $100 million in the quarter plus the cap, that’s on the operating cash flow items, mostly integration-related. And then we did see a little bit elevated CapEx, again, very much in line with expectations. We thought a lot about the guide, obviously. And just to go through a little bit of the math, we — while we took up the earnings, we took up the sales, the net of that is about $50 million in cash flow, still within the $2.6 billion to $2.7 billion. So we elected not to take it up given where we set first quarter. But certainly sitting here today, I can tell you we feel better about the cash flow guide than we did three months ago, and it’s all going to plan.

Andy Kaplowitz: That’s great. Appreciate the color guys.

Operator: The next question comes from Steve Tusa of JPMorgan. Please go ahead.

Steve Tusa: Hi, good morning. Can you just talk about the — just maybe the bridge, a little more clarity there from the $0.13 you did for NATI to the $0.07? It doesn’t look like all of that account was accounted for by a $30 million sales decline. And then, I guess, on a — just when you look out to this $1.55 billion guidance, going from what you’ve done in the first half, do we expect that to be kind of linear from the $350 million in Q2 in sales? Or is it kind of heavily loaded in the fourth quarter?

Mike Baughman: Yes. Steve, it’s Mike. I’ll talk a little bit about the test and measurement performance and the EPS performance in the quarter. We talked a little bit about this stub dynamic, which really was simply the early 11-day period that we didn’t own them the first part of the quarter. The sales were much lower than we expected. We expected something more ratable. They were not ratable. And that drove about $0.02 of improvement from what we expected. And the business leverages, as you know, really nicely. So pushing those sales out into the quarter drove part of that $0.13 performance. Now of that, there was also some Q1 sales that we were expecting in Q2. And so when we thought about the guide, we took that $0.08 beat and we rolled $0.05 forward, and that’s where we landed. So great performance on test and measurement, and we’re really off to a great start there. Ram, do you want to talk about the…