Emerson Electric Co. (EMR) Earnings Call Transcript & Summary

Great. Well, thanks, everyone, for being here. It's my pleasure to have up next Emerson. We have Lal Karsanbhai, President and CEO; Mike Baughman, CFO. So thanks very much, both of you for being here.

Maybe start off with -- you had a very strong end to the calendar year on order intake. Maybe help us understand some of the main drivers of that. Are you optimistic that order strength broadly at least can continue kind of into the first half of this year?

Yes. Why don't I start, and I'll pass it on to Mike here on this. Yes. So trailing 3-month orders 9%, trailing 12-month orders at 6%, backlog increased 9% in the Q, and it certainly gave us a lot of confidence in executing the plan that we have and that we shared with you, particularly in the second half of our year. And really, as it starts to look into 2027 as well. The strength came predominantly across the 5 growth vectors that we've identified with significant strength in our power generation business, in the energy markets driven by LNG, semiconductor growth, life science growth and, of course, aerospace and defense. And from a geographic perspective, the growth was heavily concentrated in the United States, in the Arabian Peninsula and then a few countries like Brazil, Japan and other parts of Southeast Asia.

Yes, I would just add that the -- we're really pleased with 9% rates, the trailing 12 months of 6% is also very supportive of what we see as we go into the year. When we came into the year, we had a backlog that had a certain phasing to it that sort of favored the back half of the year. And so that is still there. If you peel back the 9% a little bit, as you know, orders can be lumpy. We don't expect to print 9% going forward. But if we look at the underlying MRO type of order rates that we're seeing, they're in that mid-single-digit range, which is very supportive of the ongoing business, which is very important to our growth algorithm. So really pleased with it. We also were assuming a strong test and measurement and we're seeing that. So no news there, but confirming that the rebound in the markets for T&M that we were expecting, we're seeing, which is great. And as Lal said, the growth vertical is doing very well, both in orders and in revenues for the quarter. So really pleased with the start. Nothing there that says the year is going to be any better, but it's one quarter down right in line with our expectation around the core run rate in orders.

The one thing that's also embedded in our forecast, Julian, which is important to note is that we do not expect a recovery in China, and we do expect a weak Europe. So we're not counting on that to deliver the forecast and the guidance that we've shared with the Street. And we're continuing to see weakness in both of those markets.

And so I suppose it's fair to say the organic sales guide, yes, you have that acceleration in the back half, but it's assuming that order rate underlying hold pretty steady. You don't need a big pickup in the orders versus the pattern you've seen.

I'm not going to -- not in a place to forecast orders, but which I did, if you recall, as we came out of Liberation Day, and I felt compelled that I needed to because of all the uncertainty in the market. But we certainly expect to -- orders to moderate into the mid-single-digit range as we continue through the year, which will then support the forecast that we have.

Yes. And you, I think, said it right as an acceleration. I'll just briefly remind everybody that we do have the software renewal dynamic. So the 2% underlying that we'll be showing has 2% -- in the first half has a 2% drag in it from that software renewal dynamic. So it's really a 4% to 6%. And again, it was backlog phasing that we knew coming into the year, and we knew we needed the steady MRO-type orders to continue which we're seeing. So we feel good about the year despite the optics of this acceleration and the optics gets even more acceleration when you don't consider that software renewal dynamic in the first half of the year.

Perfect. And you mentioned now at the beginning the U.S. has been an area of order strength. A lot of that was coming in the power gen business and some of the other priority verticals for you. How are you seeing the health of kind of the overall U.S. industrial economy right now? People get excited about the PMI bounce 3 weeks ago. What are you seeing kind of bottom up?

Yes. So bottom up, certainly strength across those 5 growth factors, continued investment in liquefied natural gas that I haven't seen. There's been 1 or 2 odd things that have slowed, but other than that, it continues to be relatively robust with awards which will continue well into -- through the year. Power generation, look, Ovation was up 74% in the quarter. Our total power business was up 20%. That's inclusive of our sensors and our valves. And a lot -- there were a few greenfields in there, in the United States, but the majority of the power awards that we won were modernizations or behind-the-meter work at data centers. So we're yet to see the vast acceleration of the new combined cycle power plants, the next generation of coal plants or the evolution of nuclear in the United States come in. So that's good news for the future, but there's a lot of modernization work going on and a ton of behind-the-meter work at places like Google, Meta and Elon's data centers, and those have been really good for us. Semiconductor recovery, that's been a cyclical recovery in the business that continues to be strong for us, particularly in the United States. And then aerospace and defense markets, not just the traditional suppliers, but also the new space economy continues to grow. And then lastly, a life science expansion, which, again, whether it's GLP-1, near-shoring of plants, new drug conjugates, gene therapies that are coming on the market are very, very strong. Weaknesses, I'd say automotive in the United States is weak. That's probably a global comment, Julian, to be honest with you. across Europe and China as well. Chemicals, weak, particularly bulk chemicals, still in a situation of overcapacity. And that's going to take some time, perhaps another 6 to 12 months to correct, we'll see. Again, not counting on that in any recovery in our forecast. Beyond that, it's -- the U.S. economy, particularly is really good. And I would lastly say, Julian, that the industrial policy of this administration lies very well to our 5 growth verticals. It falls in very well to where the investments are coming in and call it dumb luck or call it good strategy, but we feel really good about where the United States is going and how our technology is positioned to serve those industries.

Yes. Julian, I would just add, as we talked about on the earnings call, we did have $450 million of wins coming out of the funnel. We didn't win them all. Some projects were taken out of the funnel that nobody won, just the project didn't move forward, and we managed to backfill all of that and the funnel stayed flat. So that's a pretty good indicator to us that there's still some great activity out there in capital formation. You mentioned PMI. We don't -- the only business that we've got that is sort of PMI linked would be the Pro Tools business, and they did see an uptick in orders in the quarter. So we're seeing some of that read through, but obviously, that's relatively small and not going to move the needle.

Yes. And I think, as you said, sort of aerospace and defense, an area that people haven't historically associated Emerson with semiconductor as well. What are you doing there to kind of make sure you have an advantage. A lot of your presence there came from acquisition. So how are you kind of making sure that you keep eating on those businesses keep taking share in those industries?

Correct. You're absolutely right, particularly when it comes to aerospace and defense, that business, which represents nearly 5% of the company's revenues today sits entirely in the Test & Measurement vertical. And again, the innovation there is very customer-driven around requirements for circuit testing for new space delivery vehicles or defense systems. There's a lot of work being done there. That is customer design specifics. So staying ahead of that is important. And we have the leading position in the Test & Measurement market in the aerospace industry. So we want to make sure that, that is accentuated at the time. Semiconductor is a little bit of a different story. Yes, led by our position in Test & Measurement. But interestingly enough, as you know, Julian, underneath every fab is a water plant and a chemical plant. And that's an environment that moves gases around and water around, cooling around, and that is an environment that's full of valves, instruments and control systems. So that's an area of opportunity for us that will continue. We've always had that business, but that's also a critical element for us on a forward basis.

Yes. I think well said an important thing there around innovation, and we've been talking about innovation more particularly in that -- the areas you speak of because of the LabVIEW and the importance of LabVIEW and the development of Nigel as a virtual adviser and then continuing to develop tools like that as we're doing across the suite of software offerings and then moving that up the curve to where, as we talked about on the call, you have Nigel actually beginning to do some simple authoring to help test engineers. So we have to keep innovating to continue to be leading and that's what we're doing.

Perfect. And then in some of the softer areas, perhaps chemicals, kind of what's the strategy there? Are you seeing the MRO business still holding up despite CapEx being softer?

Yes. MRO is still in that mid-single-digit range for us. And -- but we're not seeing any kind of expansion or modernization efforts in that bulk chemical space. Specialty is a little bit different, but certainly in the bulk space.

Which is certainly part of the story in China for us. That's an important chemical market for us, and it's been soft.

And oil and gas, I think the sensitivity is much lower now. How do investors think about kind of oil and gas CapEx, the effects on Emerson's overall top line today?

It's a good question, Julian. We've been very focused on winning in liquefied natural gas. It was a -- what appeared to be a niche 15 years ago that turned out to be a very viable strategy for our company as we took DeltaV into those applications. And today, we have over 50% of every liquefied natural gas installation on the planet is run by DeltaV. Our valve position is also very strong and our sensing position as well. So we found ourselves a great place to play in the energy space, which not just to where the bulk of capital investment exists in energy today, but I think as a viable energy source well into the future. So that's really the focus for us. We have MRO business, of course, that we sell into the upstream space and into refining. But the bulk of the growth and the dependency and we will continue to watch very carefully is the investments in additional capacity in liquefied natural gas. And we believe, as we've talked about at Capital Markets Day that we are in the middle of the current wave, and we have about half of that wave yet to be awarded and that size of 1 million tons per annum to be awarded is larger than the first in the second wave of LNG investment in the world combined. So we feel really good, and we're seeing that developing now in -- continue to develop now in Qatar and in the United States.

Great. And then more structurally, I suppose, investor questions around sort of AI potential threats to industrial software and all kinds of software business models. I'm sure it's an area that you spent a lot of time thinking about as well as this kind of discussion has got bigger and bigger in the last few months. Any kind of perspectives on that today?

Yes, I'll share it, and I'll let Mike chime in as well. When we did place an infographic on our website, our investment website for reference, so to your point, I think a large part of the concerns come from AI agents replacing humans in executing workflows and the impact that, that has, particularly as it relates to horizontal software offerings, point of use and seat-based licensing. So perhaps what I should do is contrast our software offering and to that environment. So we have a $1.6 billion ACV valued software business, okay? And we have 3 very important moats that will protect us on the threat of AI. The first moat is that our software is vertical in nature, is deterministic and is based on deep domain expertise, fast customer libraries and understanding of process conditions. If you contrast that with AI, AI is generic. It's -- it makes -- comes up with solutions on an inference basis. And so moat number one is really thinking about our software is being deterministic and having deep domain expertise. Moat number two is the fact that we serve mission-critical applications in industries that are heavily regulated. And heavy regulated industries require 2 things. Number one is real-time compute and traceability. You have to understand what you did moments ago because you have to technically either report that forward or have a great understanding of it. So traceability is important. Real-time compute is important. So 2 features of AI, latency and hallucinations are not very good in the industries and these industries that we serve. And over 75% of our software is sold into the energy space, pharmaceuticals and power, and those are heavily regulated industries. The third, Julian, the third moat is around the pricing model. There is no seat-based pricing for Emerson software. The entirety of our software offering is sold either as a perpetual license, which is the bulk of DeltaV innovation or as a token on a usage basis. So if you're a seat-based license and you remove x number of humans from the equation, you get to sell x number of less seat licenses. If you're using a usage-based token, it doesn't matter whether it's a human or machine, you're selling it into an enterprise and you're monetizing that token. So that's how we are positioned. And then the last thing I would say is our customers are demanding AI applications within our product, but they're demanding it from people like us and our peers who have deep domain expertise. They want it embedded in the software offerings that we currently have in the marketplace. We've released 3 products in the marketplace. Of course, Nigel, we've talked about. We did not name it after your peer, just so you know. The Ovation Virtual Adviser and the Aspen Virtual Adviser. We have over $100 million of quotations on the Ovation Virtual Adviser alone outstanding, and that's embedded in the Ovation system that we're selling in the marketplace.

Yes, I would only add, there's a strong linkage to product in the LabVIEW Test & Measurement offering that we've got. And as Lal said, this really becomes a force multiplier for us as we move forward and we begin to continue -- we've already put AI into our software products. We're going to continue that journey with our clients, and they're asking us for that. And certainly, we have customers that are looking at their landscape, getting their road maps together and they're coming to us and saying, "you're going to be an important partner here as we move forward." So this is really, I think, ultimately going to be a good opportunity for us. Make no mistake, we are terribly paranoid about everything going on and monitoring all that very closely, but we're also really focused on how this can be an advantage to us as we move forward with our software offerings.

And then the last thing I'll say just ultimately, the results is where the rubber meets the road. We grew ACV 9% in the first quarter. We expect high single digit, not a similar growth in the second quarter. And that's with a 2-point headwind from a total order that we had last year. So -- and then we expect 10% plus ACV growth in 2026. And that hasn't changed despite everything that's going on out there.

If you were to see some kind of risk like how -- where do you think it would show up? It would be in the course of what customer conversations, I suppose, and something changing around that?

Yes. No, I was -- I referenced in the earlier meetings, I was in -- Ram and I were in Saudi Arabia, South Africa, Angola, Nigeria last week. And we met with vast number of customers, inclusive of Aramco, of course. Everyone is investing in AI. Everyone should figure out how to replace human activity and workflows with agents. But everybody is very dependent on the fidelity of our control systems and the value that an optimization and what drives in performance that AspenTech brings. None of that has changed. As a matter of fact, they're asking more of us to embed those tools within the software pathogens, and it comes back to the domain expertise that we have, which is incredibly difficult to replicate and is built over decades of deep customer libraries of knowledge.

Perfect. And away from the software side of things, maybe on hardware, there's a lot of cost inflation around. We've been saying that in a way for sort of 4 years, 5 years now. Do you find it relatively easy still to pass those on to customers in terms of price? Or do you get kind of more resistance today?

I mean, we've got about 2.5 points of price in our plan. No, look, I think this business, our automation business, Julian, you've been following it for a long time, has been price cost positive as far back as I could go, and I've been in the company for 31 years. So we feel really good about our ability. It differentiates based on the value of the technology. Our GP is, of course, touching that 52-plus percent are strong indicators of the value of the technology in the marketplace. So no, we feel very confident in our ability to continue to manage price work humbly with our customers, which is important. We're not in we're not -- we're being very -- we have great conversations with our teams, and we do value-based pricing, and we do very strategic pricing based on where we have opportunities in the marketplace with strength of technology. And so it's not a uniform 2.5% across the entire portfolio.

Yes. And it's, as you know, a large customer base, 125,000 customers. And some of those are very strategic big accounts -- bigger accounts and -- but many are MRO-type accounts where they're buying periodically. And obviously, given the stickiness of the product, particularly around the MRO business, that there's some pricing power there. I think everybody has also gotten used to, if you will, some of these price increases. And as we went through tariffs, I think customers' initial expectations were that price increases would be much bigger than they actually turned out to be. So while there's been a lot of price coming out of the supply chain issues a few years ago, that has moderated. We had 2.5% last year, 2.5% this year. We still see 2 points of pricing power per year as we move forward.

Great. And you mentioned the gross margins got to a very, very high level. When we think about kind of operating leverage for the company, I think it's guided in the sort of 40% in the second half of this year. What's the confidence level in that given that cost backdrop and everything else? You can speak to it.

I think we have a lot of confidence, and you're absolutely right, 40% is the value creation framework for leverage as we move forward. And we've got -- we feel like we have a nice path on the expected 240 basis points of margin improvement as well. Look, it certainly shows in our adjusted segment EBITDA margins that we've been at this a long time. And that's one of the things that we feel very comfortable about that we do at a world-class level, which is drive profitability. The opportunities, as we move forward certainly are in footprint. We have more to do there and then productivity. We talked about it in terms of our solutions, but we have lots of opportunities for productivity using AI. We've launched several initiatives. We have all the same challenges that our customers do around data and getting data lined up to really make those tools work like an agent. But we've got those initiatives going. We're using copilots ourselves and seeing some efficiencies there, and we expect some profitability improvement. So yes, you're right, this year is not going to be 40%. We've got the software renewal dynamic, which, as we talked about, reverses. So it comes down to getting about 80 basis points per year an improvement in profitability and then driving the leverage and 40%, we feel very comfortable now.

Great. And on capital deployment, it was a very successful acquisitions since COVID. But I suppose at the Investor Day, sort of guarded on future M&A. Maybe help us understand kind of why, particularly in those 5 growth verticals that you have prioritized.

Yes. No, I will. Certainly, you hit on the head. The last 5 years have been highly transformative for us. And that was by design. That was the vision that we had of the company we wanted to create. And I was fortunate that our Board supported division and that we were able to execute it to create this company. On a forward basis, the capital allocation story for us is really centered around returning cash to our shareholders through the dividend, accelerated dividend payments and share repurchase as we talked about at our Capital Markets Day. Now having said that, there's ample firepower to look at bolt-on acquisitions in key vertical opportunities. And we'll continue to do that, Julian. We have ample that comes in front of us, and we evaluate, but we also want to be smart. We have -- we've created a great, highly differentiated company that we can believe -- that we believe can grow 4 to 7 through cycles, and we don't do anything that deters from that in a negative way. So we're looking at assets that obviously would support that growth, which I think ultimately is what leads to -- for our company and multiple expansion, which is really the opportunity.

Fantastic. Well, with that, we'll turn now to the audience response questions, please. So the first one is around current ownership of Emerson.

Absolutely. Interesting.

I'm overweight.

Yes, me too.

That's reassuring.

Okay. So there's a lot of opportunity left in the broader group. Second question is really around sort of general bias, even if you don't own it.

It's like getting a performance review real-time, Julian.

Yes.

You put every CEO through this.

Okay. So neutral-ish. It's around kind of earnings growth potential. If we move to question 3, it's around, yes, EPS growth for Emerson versus say the multi-industry average.

Doug is voting 5 or 6x times for question.

Okay. So in line-ish on the whole. The next question is around capital deployment, uses of excess cash. So it's fairly even sort of small M&A and buybacks. Next question is on valuation, kind of what's the appropriate year 1 PE multiple? Average of [indiscernible]. And then last question is kind of why what's the biggest kind of anchor on the multiple right now?

So organic growth, the biggest question mark.

Great. So with that, Lal and Mike. Thank you so much for being here. Thanks.

Thank you.

Great to see you. Thank you very much.