Emerson Electric Co. (NYSE:EMR) Q4 2023 Earnings Call Transcript

Emerson Electric Co. (NYSE:EMR) Q4 2023 Earnings Call Transcript November 7, 2023

Emerson Electric Co. misses on earnings expectations. Reported EPS is $1.29 EPS, expectations were $1.3.

Operator: Good day and welcome to the Emerson Fourth Quarter 2023 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 Colleen Mettler, Vice President of Investor Relations. Please go ahead.

Colleen Mettler: 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.

Lal Karsanbhai: 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.

Second, 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, near assuring, 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 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. And 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. Turning to Slide 5. Our 2023 performance caps three strong years of execution, demonstrating the power of our Emerson management system and its ability to create value for our shareholders. We embarked on a transformational journey of Emerson in 2021 and remained focused on execution. Underlying sales growth of 7% and 10% in 2022 and 2023, respectively, shows the leadership position of our automation technology and our world-class sales organization. It is also indicative of our market share expansion within the $160 billion served automation market.

Our ability to both leverage our $150 billion installed base as evidenced by our MRO sales in 2023 of 65%, and win new projects are strengths of this company and critical to the long-term success of this business. As we invest more in digital technology and software, we are also seeing the benefits to gross margins, which have expanded 470 basis points to 49% since 2021. Strong price discipline and differentiated technology have also provided positive contributions, and the addition of NI will further expand our gross margins. This enabled strong operational leverage across the business. Over 50% leverage for 2022 and 2023 is distinguished amongst industrials. Cost discipline remains part of the DNA at Emerson, driving further cost productivity and margin expansion.

Put all this together and Emerson has delivered back-to-back years of 20-plus-percent EPS growth. Please turn to Slide 6. I want to provide a couple strategic updates on our business. In October, we hosted Emerson Exchange Immerse in Anaheim, California. The event showcased our control systems and software technology and highlighted our integration with AspenTech throughout different solutions and industries. Featuring over 1,400 attendees and over 100 customer presentations, the week was spent discussing the exciting roadmap of our Delta V, Ovation, and AspenTech products and working with customers to solve their toughest challenges. This was all reflected in our keynote presentations from three important customers, Syzygy, a provider of electric catalyst reactor technology, Biogen, and Tesla, who discussed their automation challenges in partnership with Emerson.

These types of engagements not only help our users understanding of our current products, but also provide important inputs into our next generation products and innovation. Throughout this event, we highlighted our boundless automation vision, the next generation automation architecture that Emerson is uniquely positioned to deliver based on our leadership position in intelligent devices, control systems, and software. This vision empowers our customers to unlock and access all their operational data, enabling better decisions through analytics and optimization. It also enables customers to balance their production and sustainability goals through enterprise management and a unified software platform. On Slide 7, as part of this vision, we continue to accelerate innovation across four priority domains, disruptive measurement technologies, software defined automation systems, self-optimizing asset software, and our sustainability portfolio.

Each of these areas provide stepping stones to enable the boundless automation vision. At Immerse, we introduced many significant new products to our leading DeltaV portfolio. First, DeltaV Version 15 Feature Pack 1 is one of our biggest rollouts in recent history. The package includes enhancements to software like DeltaV Live, the most advanced DeltaV HMI ever developed, and the introduction of a subscription controller, PK Flex. It also includes the DeltaV Edge Environment, a first-of-its-kind edge solution, allowing users to securely move data into their enterprise environments. As we look at the next generation of software solutions and automation platforms, this is a key enabler to unlocking data that users previously discarded. Throughout the rest of the organization, we are also making focused investments in strategic areas.

This includes next-generation intelligent devices to further cement our leadership position in our measurement and analytical portfolio, and relevant additions to our sustainability portfolio. At AspenTech, many of the new releases are focused on enabling sustainability and energy transition segments, in addition to further building out capabilities like AI and DataWorks to enable self-optimizing asset management. Please turn to Slide 8. On October 11, we closed the acquisition of NI and announced we will report the business as a new test and measurement segment in 2024. We are very pleased with the progress already in the first month with NI and are excited about the opportunities in this business. We remain committed to the $165 million of synergies by the end of year five, resulting in approximately 31% adjusted segment EBITDA when moving stock comp to corporate.

As we have openly stated, NI completes the significant portion of our portfolio transformation, and we are excited to execute as a new company. We will, however, continue to be active with bolt-on acquisitions that fill technology gaps in our business, and we have the balance sheet flexibility to do so. These will be prioritized in four segments we introduced a year ago, industrial software, test and measurement, factory automation, and smart grid solutions. In the fourth quarter, we completed two of these bolt-on acquisitions. Flexim is a global leader for clamp-on ultrasonic technology measuring liquids, gases, and steam. The business is highly complementary to our existing leading flow portfolio consisting of Coriolis, DP Flow, Mag & Vortex, and will also serve attractive growth markets in the energy transition.

We also completed the acquisition of Afag in the fourth quarter, a highly strategic asset in the factory automation market. Afag’s electric linear motion solutions, combined with our existing pneumatic motion offering creates a leading motion portfolio for discrete industries in a $9 billion TAM. Please turn to Slide 9. As I mentioned, the large pieces of our portfolio transformation are behind us. And this slide shows that we were able to accomplish what we were able to accomplish over the last few years. We have three main objectives that I communicated when we started this journey. First, cohesiveness, which we now have with an unmatched technology stack. Second, diversification. Discrete is now our second largest end market with further opportunities to expand into attractive diversified industries.

And third, our growth is aligned to secular growth drivers. This alignment to energy security and affordability, sustainability and decarbonization, near-shoring, and digital transformation will allow Emerson to move to a more secular and less cyclical business profile. $36 billion worth of transactions. Disposing of assets with low single digit growth profiles and adding businesses we expect to grow cumulatively in the high single-digits to low double-digits. The profitability improvement is also remarkable. Trading 30% GP businesses for those that operate 70% plus gross profits, which are already seeing — which we are seeing the benefits of today. We are all energized by the opportunity we have with this new Emerson. Please turn to Slide 10.

Our current strategic funnel is now over $10 billion in opportunity, with nearly two-thirds residing in our growth platforms. We’re also encouraged by the activity of projects already in the funnel, considering the interest rate environment and global uncertainty. In the fourth quarter, Emerson was awarded over $500 million of project content, with over 60% of those in our growth platforms. This includes strategic wins in LNG, carbon capture, hydrogen, life sciences, and metals and mining. These successes are indicative of our team’s focus and our technology’s relevance within these markets. As we look at further diversifying our portfolio into hybrid and energy transition markets, 2023 was a fundamental foundational year. Specifically, there were three highly strategic projects to highlight.

First, Emerson was selected to automate five different plants for Samsung Biologics as it standardizes on our DeltaV automation platform. The Emerson solution provides control for both production skids and for plant-wide operations. We are also currently engaging with a customer on the potential to leverage AspenTech software for future expansion. Secondly, in the third quarter, we highlighted Emerson’s selection for the Port Arthur LNG project with Bechtel Energy and Sempra. This quarter, we are pleased to announce we were also selected for another large-scale world-class LNG facility in the United States. The Rio Grande LNG project from Bechtel Energy and NextDecade, located in Texas, will be capable of producing 17.6 million metric tons per annum of LNG across three liquefaction trains.

Emerson is providing much of our leading technology, including analytical and measurement technology, and control, pressure relief, and isolation valves. And finally, AspenTech was awarded a Synergy win in the most recent quarter with a world-leading pulp and paper producer. Emerson’s DeltaV system is already installed at the site, and through this relationship with the customer, Emerson was able to bring AspenTech to the table. Through this engagement, the customer chose to displace the current incumbent provider of adaptive process control software and instead move to AspenTech. This example demonstrates the power of our Emerson AspenTech integrated solutions and the opportunity to expand AspenTech utilizing our global sales channel. These wins and the continued evolution of the funnel provide a strong foundation as we head into 2024.

With that, I will now turn the call over to Mike Baughman.

Mike Baughman: 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. Please turn to Slide 12. 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. Slide 13 details the drivers of adjusted EPS growth from the prior year. Operational performance was exceptional. 10% underlying sales growth and 53% segment level operating leverage contributed $0.77 of year-over-year EPS growth. FX was a $0.12 headwind. Stock comp was a $0.16 headwind versus the prior year, due primarily to the mark-to-market accounting for the company’s old stock compensation plan, which was mostly offset by pension and other corporate items.

The reduced share count resulting from the $2 billion share repurchase contributed $0.14, and the Copeland note receivable interest contributed $0.05 to adjusted EPS for the year. Overall, adjusted EPS grew 22% year-over-year to $4.44. Please turn to Slide 14. We believe 2024 is shaping up to be another good year of financial performance. Our end markets remain generally resilient, evidenced by 5% underlying orders growth in Q4 and for all of 2023. This has resulted in healthy backlog levels, which were up 12% versus where we entered 2023, giving us good visibility into 2024 sales. We also have good visibility through our MRO business, which was 65% of 2023 sales. This day-to-day replacement business gives us good perspective on pace of business and remains constructive.

Lastly, we are entering 2024 with a $10 billion-plus funnel, up $3 billion from where we entered 2023. This all feeds our 2024 outlook. Process and hybrid end markets remain strong, driven by secular trends like energy security, sustainability and decarbonization, nearshoring and digital transformation. We expect process and hybrid sales growth of mid to high single-digits in 2024. We continue to see investments moving forward in energy transition markets like LNG, nuclear, hydrogen, carbon capture and renewables. We continue to see nearshoring investments here in the US and around the world in life sciences and metals and mining, especially midstream metals processing and refining, which is being expanded to the United States and Europe. These secular trends in process hybrid end markets and our ability to help customers be successful give us confidence in our 2024 outlook.

Discrete markets are obviously in a different part of the cycle, which impacts both our discrete automation and test and measurement businesses. Orders have been negative for two to three quarters but we expect this to begin to turn positive in the second half of 2024. We expect underlying sales to be flat to up low single-digits in 2024 for our discrete businesses — for our discrete business. From a world areas perspective, it should continue to be a balance, and we expect each world area to grow in the mid-single-digit range. 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.

This includes approximately $0.35 to $0.40 from NI, inclusive of stock compensation and approximately $0.32 to $0.34 from AspenTech. There are some movements below the line in stock compensation, pension and other corporate items, which roughly offset year-over-year. This detail can be found in the appendix. As a reminder, stock compensation from NI is now reported in our corporate stock compensation line item. Net interest expense is expected to be approximately $105 million. Lastly, free cash flow is expected to be $2.6 billion to $2.7 billion, which we will discuss in more detail on the next slide. For the first quarter, we expect underlying sales to increase 6.5% to 8.5% with leverage in the mid-30s. Adjusted EPS is expected to be between $1 and $1.05, a 31% increase at the midpoint.

NI is expected to contribute approximately $0.05. As I mentioned, we will discuss some additional details on Slide 16 regarding our free cash flow. We ended 2023 with free cash flow of $2.4 billion or 15.6% of sales. This included just over $100 million of after-tax cash from interest on the undeployed proceeds from the Copeland transaction, which will not repeat in 2024. Taking this into consideration and starting from a foundation of approximately $2.3 billion of free cash flow, we expect approximately $300 million of contribution from NI operations and another $350 million increase from base operations. This would have resulted in a free cash flow margin of approximately 16.8% or $2.9 billion of free cash flow. However, we have two headwinds in 2024.

First, we expect approximately $200 million of acquisition-related cash payments associated with the NI and bolt-on acquisitions. Second, we are expecting an elevated CapEx spend related to facility expansions, which will increase our CapEx to approximately 2.5% of sales, up from our historical and future expected rate of approximately 2% of sales. Including these two headwinds bring us to our guidance of $2.6 billion to $2.7 billion of free cash flow or 15.2% to 15.4% free cash flow margin. Before we turn the call over to Q&A, I will quickly discuss capital allocation on Slide 17. We remain committed to disciplined capital allocation. Internal development and organic growth investments remain a high priority. This accelerated in 2023 with R&D spend now representing 7% of revenue and NI will further mix this up in 2024.

This increase was driven by increased innovation in our four priority breakthrough domains, disruptive technologies and measurement, sustainability, software-defined automation systems, and self-optimizing asset software. We also remain committed to the dividend and announced today, we are beginning our 68th year of consecutive increased dividends with our $0.525 per share declared dividend this quarter. The right side of this chart is where we have flexibility. We will continue to be active in pursuit of strategic bolt-on acquisitions to strengthen our portfolio in targeted areas and we will remain committed to strong returns on these investments. Finally, we plan to have approximately $500 million of share repurchases in 2024. We are energized as we enter the new fiscal year, and we are focused on the execution of our plans.

Thanks for your attention. I will turn it back to the operator to open the call for questions.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jeff Sprague with Vertical Research. Please go ahead.

Jeff Sprague: Thank you. Good morning, everyone. Just a couple specific NATI questions if I could. Some noise with the bolt-ons. So could you just be clear for NATI 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 of around how much of that synergy target happens in the first year.

Lal Karsanbhai: Yeah. 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. And 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. What I did, I will say is that about half the synergies will be delivered in the first two years.

Jeff Sprague: 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?

Mike Baughman: Yeah. Jeff, the 2024 price assumption is 2%.

Jeff Sprague: Great. Thank you.

Operator: Our next question comes from Steve Tusa with JPMorgan. Please go ahead.

Steve Tusa: Hi, good morning.

Lal Karsanbhai: Good morning, Steve.

Steve Tusa: 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 kind of into ’25?

Mike Baughman: Yeah, I’ll start with the second half — or the second part of the question first. The $250 million is really one-time and in the year related to the acquisitions and some of the higher CapEx that we’ve got.

Steve Tusa: Great. And then just working capital?

Mike Baughman: Working capital for the year. Yeah, we exited working capital, trade working capital at about 20.5%, and we’re expecting about 50 basis points coming off — 20.5% of revenue. So we do expect to have a little bit of balance sheet goodness in 2024.

Steve Tusa: 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] (ph) backlog seasonally, but how do you guys going to see orders and backlog trending over the course of the year here?

Lal Karsanbhai: Yeah, I’ll comment, Steve. Obviously, we exit at 5%. So we have optimism, and we have momentum out there. Obviously, we have some challenges in discrete, as we talked about in the business. I think as you think about the start of the year, my expectations are flat to low single digits. But as we get into the second half of the year, my expectation is exiting at — in the mid-single-digit range. And for the full year, somewhere in the low single to mid-single-digit orders.

Steve Tusa: Great. And, thanks a lot.

Mike Baughman: And then Steve, just on backlog. There — that pattern holds, there shouldn’t be a meaningful change in backlog as we exit 2024. So the backlog should remain healthy.

Steve Tusa: Great. Thank you.

Operator: The next question comes from Julian Mitchell with Barclays. Please go ahead.

Julian Mitchell: Hi, good morning. Maybe first off, just looking at Slide 15, so 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?