Why I Sold Emerson Electric
In this weeks post, I want to discuss my selling of my Emerson Electric (EMR) stock, which was one of my largest positions in my portfolio. The reason why I want to discuss selling this stock is because I thought Emerson was a high quality company that I could hold for many years. While I did hold the stock for about 3.5 years, I cut my holding period short not because something bad happened per se, I just felt the company’s capital allocation was moving into a direction that may cause problems. Also, I bought EMR during the COVID crash and the stock price had recovered to something close to fair value, leaving me with a nice capital gain. In this post I want to provide the context for me buying Emerson in March 2020, subsequent developments, and discuss their recent capital allocation moves that made me feel uneasy.
For some context, Emerson Electric an industrial conglomerate that operates under two business platforms: Automation Solutions, and Commercial and Residential Solutions. The latter is further subdivided into two operating segments: climate technologies, which sells HVAC and refrigeration products and services, as well as tools and home products. Commercial and residential solutions boast several household brands, including InSinkErator garbage disposals. Automation solutions is most known for its process manufacturing solutions, which consists of measurement instrumentation, as well as valves and actuators, industrial control software, among other products and services.
The reason I was initially interested in Emerson was because it was a diversified industrial company, with slower growth Commercial and Residential Solutions segment, as well has higher growth Automation segment. The company had a long time CEO, and appeared to be a quality company with growing earnings and high return on equity.
Traveling back in time, at the end of fiscal 2019 EMR generated $18.37B in revenue, $2.31B in net income, which ended up being $3.74 in earnings per share. The stock peaked right around the start of 2020, around $77 a share. Based on this stock price and earnings, Emerson had a price to earnings ratio of 20.6x, which is probably around the fair value for the company at the time.
As COVID started to cause a panic in the stock market, Emerson dramatically fell along with the market. I bought my shares of EMR on March 18th, for $41 a share. Over the next couple of days the price dipped down to $38. Shortly after the low price, the market reversed course, and Emerson’s stock price gradually increased through out 2022 ending the year at $81 a share. Emerson continued to rise in 2021, peaking in September around $105. Since then, the stock has bounced between $70 and $100 a couple of times.
These figures show how crazy it is that the value of a $50B company can swing so wildly in such a short period of time. Using the 2019 earnings and my cost basis means that I bought EMR at a price to earnings ratio of 11x. This is a pretty low multiple for a high quality company, which is the value investors dream.
Not too long after I bought the stock, Emerson’s long time CEO retired. David Farr was the CEO from 2000-2021, and was replaced by Lal Karsanbhai. If you plan on holding a stock for a long period of time, the company better have good capital allocation, which is primarily decided by the CEO. David had a long tenure and a solid track record. Nothing against Lal, but a new CEO presents an unknown when it comes to future capital allocation.
After Lal became CEO, Emerson started to make some big capital allocation moves. In late 2021, Emerson announced that they would merge a couple of their industrial software subsidiaries, in addition to contributing $6B, with AspenTech. This merger would create a “new” AspenTech that Emerson would have 55% ownership in. Next Emerson announced they were selling off 55% of their climate control business for proceeds of $9B. Then Emerson decided to acquire National Instruments in an all cash deal amounting to $8.3B.
I am not opposed to smaller acquisitions, but often times large acquisitions end up losing money for shareholders. CEOs often want to build empires, and investment bankers advise them to make deals with overly optimistic synergies once the companies are integrated. Emerson’s recent deals made me feel uneasy because they do not seem straightforward in structure, and it seems like the company is making too many big moves over the course of a year and a half. I am not saying these were bad deals, it will take some time to reveal that, but I feel like it increases the probability that shareholders will be burned.
Another reason why I became disillusioned with Emerson is that I realized that I did not understand the business as well as I would have liked. I can visualize HVAC systems and InSinkErator’s, but it is hard for me to understand industrial control software or process automation solutions. When I think of automation, I think of robots assembling cars. However Emerson version of automation is gas flow sensors, smart valves and such for a chemical plant or something. These software tools and the installed environment are not tangible to me so it is not within my circle of competence. Then to top it off, Emerson goes on to sell the easier to understand HVAC business. Emerson’s stated goal is to seek higher growth by focusing on becoming an industrial software company.
The final reason I decided to sell my Emerson stock is simply because I had a sizable gain. I bought the stock at $41 and sold it at $100, an 144% gain. At the end of 2022, Emerson had revenue of $19.63B, net income of $3.23B, and $5.44 in earnings per share. Emerson’s fiscal year is almost over at the time of this writing, and so far indications are that the company will have an even better year in financial results. Based on the 2022 results, I sold EMR at a price to earnings ratio of 18.4x, probably close to fair value.
The stock could continue to do well in the near term, but based on my lack of understanding of industrial software, its capital allocation, and the seeming reversion to fair value, I felt it was reasonable to sell out of my largest position.