Emerson Electric Co. (EMR) Morgan Stanley's 11th Annual Laguna Conference (Transcript)

Emerson Electric Co. (NYSE:EMR) Morgan Stanley's 11th Annual Laguna Conference September 13, 2023 12:20 PM ET

Company Participants

Surendralal Karsanbhai - President and Chief Executive Officer

Michael Baughman - Chief Financial Officer

Conference Call Participants

Joshua Pokrzywinski - Morgan Stanley

Joshua Pokrzywinski

Good morning, everybody. Thanks for staying with us this morning on day two. I'm joined on stage by the team from Emerson CEO, Lal Karsanbhai; Emerson's new CFO, Mike Baughman; and from Investor Relations, we have Colleen Mettler. Team, thanks for joining us. Looking forward to the discussion here. Certainly a lot to talk about.

Question-and-Answer Session

Q - Joshua Pokrzywinski

While, maybe just launch us off here with what you guys are seeing, what you're focused on. Obviously, a ton of moving pieces in the organization, in the macro, but what's rising the -- to the eye line right now? What are you spending your time on?

Surendralal Karsanbhai

Yes. First of all, Josh, thanks for having us. Great to be here and great to see everybody. I can't see you because of the light, but I assume you're out there. No, look, a positive momentum in our business at this point in time; we've undergone, over two and a half years, a fundamental transformation at Emerson, disposing the Copeland business, the InSinkErator business, TOD, a few oil-centric assets and replacing those with AspenTech, National Instruments and creating a cohesive automation portfolio with that.

It's well aligned to the global macros that we've talked about, near-shoring, energy security, affordability, sustainability and digital transformation, which are the underlying drivers for the business today. And it's one that, combined with the Emerson Management System, which has delivered over time even with -- as we've made some changes to it, differentiated performance, incrementals, cash. And we're really excited about the opportunity now to run the Company that we created over two and a half years on a go-forward basis.

Joshua Pokrzywinski

Excellent. Maybe just diving into what you're seeing on the macro side. It feels like we're right on the precipice of these major mega-projects kicking off that you guys are seeing, a lot of other folks on the stage this week talk about as well.

In the meantime, we're kind of in this lull period, maybe not a lull period but a period where supply chains are normalizing, folks are kind of waiting for the bigger stuff to kick up. How do you characterize what's going on, on that front now as we kind of transition through the last phases of the supply chain whips off?

Surendralal Karsanbhai

No, I'd be happy to. Why don't I give you a little bit of an industry perspective, and I'll let Mike walk you across the world and give you the geographic view? So from an industry perspective, I would suggest that there are four or five very important trends to be aware of.

The first is energy. In energy, we're not talking about oil. We're talking about gas, liquefied natural gas, which is in a period of investment, an investment wave that is unprecedented. It's driven in three key geographies around the world. It's the Gulf Shore of the Gulf of Mexico here in the United States, it's Qatar and it's Mozambique. That's where the core investments will occur over the next three to seven years.

About $1 billion of automation alone, across those projects. We highlighted one last quarter, Port Arthur with Bechtel, which is a very important first win here in the United States in this wave. We are hopeful to announce the second one when we announced earnings here in November, also in the United States., so very excited about the momentums there across LNG.

The other part of energy security is nuclear. We are in the early innings of a resurgence in nuclear power. And that comes in two ways, the first being, of course, the smaller reactors, the SMRs. These are basically your nuclear sub-reactor used in a commercial way. But the second is the extension of life of nuclear power plants.

Putting Germany aside and Japan to some extent, you're seeing that across the world, and then there's a wave of new builds in Eastern Europe, in the Middle East and of course, in India and China. So, very important perspective there around energy.

The other two industries that I'll highlight that are very relevant to us but are tied into the theme of nearshoring, life sciences and metals and mining. Life sciences, the perspective there is that just about every country, industrialized country on the planet is bringing the life science capacity onto their shores. It's not just an American phenomena. It's an Australian phenomena. It's a European phenomena.

On a recent trip to Australia, where nine out of 10 meetings that I hold with customers are related to the mining industry, the first set of meetings were with Moderna and BioNTech, who are replicating their capacity from the Northeast and in Belgium into Melbourne for vaccine manufacturing.

Those are replications of plants with DeltaV, of course, and the equipment that they use already with our 3200-odd system. So, nearshoring is very important for us as it relates to the life science industry and then metals and mining. We have quietly put together a $450 million, $500 million metals and mining business, but very relevant as it moves today for us from what was traditional production into the processing and now into the packaging, particularly as it relates to batteries and EVs.

So it's not just about the production in copper, where we've been particularly strong, lithium, cobalt and other rare Earths but also into the packaging, we won a very significant project in Texas, which we announced with we believe a Company that is one of the clear winners in the EV space.

First application of DeltaV in such an environment, which has been traditionally a PLC environment. So we're very excited about what we can do with that partner. And then into the actual production of the battery itself, where we won a major project in Europe there with another automotive manufacturer. So that value chain as it relates to nearshoring is really important for us as well, Josh.

Michael Baughman

Reading through in the geographies. I mean, start in North America, our biggest business is about 50%. We'll exit the year, with about 10% growth driven by a lot of what Lal talked about with LNG, energy, metals and mining, life science is all strong.

Moving to Europe, we'll exit that business in the high single digits. Liquid natural gas, re-gasification, renewables driving in that area. A lot of discussion around China, the headline discussion around commercial residential doesn't really read through in our business, though we're seeing some discrete softness. Chemical is very strong.

That's a nearshoring effort as well. Rest of Asia, high single digits as we exit the year. And then Middle East, Africa, a region that's just been growing really nicely. We'll add over $100 million in growth this year in LNG, chemical and traditional energy, so everything Lal was talking about really reading through nicely in the numbers.

Joshua Pokrzywinski

And Mike, you touched on it a little bit on the discrete destocking. It's probably one of the areas of the business where you could still see inventory ebbs and flows, it doesn't seem like it happens as much as process, but where do you see in on that, I think some of your competitors there have had a more acute experience. How have you guys seen it? When do you think it ends?

Michael Baughman

Yes. So in the discrete space, you're right, we started to see that in our second quarter. And certainly, in our third quarter, we were down in orders. For the business on the year, it will be up. The channel de-stocking, we'll start reading through. Historically, that's been a four to six quarter down before it turned, so we would expect to see a turn in the back half of our fiscal '24.

Joshua Pokrzywinski

Got it. Then shifting over to the project funnel. You guys gave a lot of great disclosure on that. And certainly, the growth in that funnel over the last, what, eight, nine months has been pretty encouraging. And I think maybe even beyond that, just how small that piece that -- of traditional energy has gotten over that period and certainly relative to past durations of it.

I guess two questions that come out of that. First, when should we start to see bookings really accelerate out of that funnel? At some point, you would hope the funnel stops growing and then you'd put it all in backlog. And then I guess related to that, how committed are these projects, given that the macro environment's still dynamic, certainly interest rates, churn, the ROI a little differently? How do customers think about some of those pieces?

Surendralal Karsanbhai

Yes, I'll have a few comments on that. So very interesting. The funnel has grown. Of course, we expanded it inorganically as well. The totality of the funnel is $9.7 billion. What's interesting about it is that if you think about the categories of sustainability and energy security, that makes up $5 billion of the funnel, nearly $5 billion, with pure sustainability about $2.5 billion.

A year and a half ago, that number was practically zero. So those projects, albeit they're smaller but they're numerous, and they comprise hydrogen, carbon capture, emissions monitoring and a few other things. The energy security is the one that is accelerating in terms of bookings, that's particularly the LNG expansion. Those are the ones that you're seeing us execute today.

So they're going into the backlog, Port Arthur being a very relevant one. And then on the metals and mining and life science side, which we added into the funnel because we wanted to give our investors visibility to the opportunity from a capital formation perspective. But we also wanted to have the focus internally around the processes, around account management and pursuit that the funnel provides for us, because it is part of an ecosystem and a process that we run for pursuit.

Those continue to move forward as well so you're starting to see that I'm not going to here where we'll be at the end of the year on the funnel. But we'll see, there's always puts and takes. But at this point, we're continuing to see things move from right to left in terms of execution through the funnel. I feel very optimistic about that capital formation.

Now having said that, the big question is going to be how resilient are those macros going to be to a general macroeconomic slowdown, right? And whatever kind of landing you forecast is energy security, is the need for affordable energy in Europe. Are the nearshoring trends going to be resilient and continue to be invested in? Maybe at a slower pace but continue to be invested in throughout the economic cycle.

So far, we have not seen any of that slow. As a matter of fact, continued on pace in terms of funding of the LNG jobs, funding of the nearshoring as it impacts life sciences. And of course, I don't know if the world will ultimately have 400 battery factories, but surely aligning with the key winners in that space will be important for a Company like ours.

Joshua Pokrzywinski

Understood. I guess one thing that stood out, and this is even pre-COVID, I think, true, your win rate in some of these mega projects, particularly around gas is extremely high. I think 50%, maybe a little bit higher. What's driving that? Is there sort of a core competency that pulls in the rest of the exposure? I think there is some valve exposure you have there that's particularly rich. But I don't want to lead the witness too much. Why do you guys win so much?

Surendralal Karsanbhai

No. Look, it's around focused effort and expertise. And just like it happens in a lot -- in the pharmaceutical industry where we have 24 of the top 25 pharmaceutical companies on DeltaV, 3200 installed. Process, credibility and knowledge builds on itself. And that's what's happened with LNG. We went at 10 years ago, 15 years ago, the first significant wave of investments in LNG, which occurred in Qatar.

We have over $400 million of installed base in the Qatar fields alone. That's instrumentation valves and, of course, DeltaV. And that's grown from there. And those reference points are not insignificant in terms of what the technology can do, how we can differentiate. And then you bring to the table further capabilities with AspenTech which we did in Golden Pass.

And that was a very big differentiator with ExxonMobil that we could integrate DeltaV and AspenTech, and this was pre-investment in AspenTech, and deliver a very differentiated solution to the marketplace. So that combination of the technology being well aligned, the application knowledge and the incredible installed base is important.

Yes, just to build on that, we see that in EVs and the metals and mining space where, as Lal said, we've developed a good metals and mining position but then bringing the expertise around processing when you think about the refining of the lithium being largely in China and companies looking to make their supply chains a little more efficient with our process knowledge around that refining process reads through and is key to some of those wins.

Joshua Pokrzywinski

Makes sense. Now if I think about older versions of Emerson, certainly around mega projects, there was always a sort of phantom sitting just outside that said like, well, if commodity prices change too much, some of these things go out the window. Certainly, oil prices do not have the pull that they used to on the portfolio

But are there either commodities or certain economic inputs that you're focused on that say these projects that you're tracking become more or less viable? Obviously, interest rates kind of affect anything. But anything else out there that we should just be cognizant of?

Surendralal Karsanbhai

No. Look, I think it's important to be keenly aware of the nearshoring efforts that just about every nation in the world is driving. It's important to be keenly aware of energy costs in Europe and what the investments that are being funded in Europe and in the United States and across the world to bring cheaper gas onto its shores. I think that can transcend the cycle but we're watching that very carefully, obviously.

But beyond that, the macro has impacted our discrete business, as you referred, and we saw that there. But in terms of these secular trends, we're yet to see an impact. And we feel very confident in the exit rate on orders for the year in the mid-single digit. I think that's -- we have some confidence going into '24 as well.

Joshua Pokrzywinski

Understood. In terms of the profitability of these projects, I think most of us would assume, okay, you start adding zeros to some of these orders and the competition goes up, the margin goes down. That doesn't seem to have been the case or at least not something that you're flagging. But I guess, why hasn't that been more of sort of a margin sensitivity than maybe it would have been in the past?

Surendralal Karsanbhai

Well, it's important to recognize that in end of quarter, I'll use the end of quarter numbers and it'll fluctuate a little bit, but 65% of our business is installed base business. We have $130 billion of installed base around the world, and that 65% is purely replacement, repair of existing technology that's out in the field. That is relatively pricing elastic. It serves almost 100,000 customers and we have a very strong pricing power within that.

So that funds a lot of opportunity, be it in the modernization segment, which let's just play around with numbers, 15%, 15%, let's say, for both, and in the capital formation side. Now, having said that, I haven't seen anything so far in this cycle that is differentiated in terms of pricing environment from prior cycles. We have great competitors.

You've seen or we'll see most of them obviously here. And I think -- but I haven't seen any behavior that I would call out as being differentiated in the cycle. So I still feel very confident at the end of the day, Josh, that we can, through this cycle, continuing to deliver 35% and I'll add a plus to it, levered incrementals as we go through it.

Joshua Pokrzywinski

And how sustainable is this aftermarket strength? I mean, at the end of the day, you would think that these assets kind of have a known churn rate of low single digits or something like that. Is this just catch-up from process industries broadly that kind of starve themselves post the hard landing in '15? Like what -- where are we at in that?

Surendralal Karsanbhai

No, look, I think we're well beyond that. The fact of the matter is pressure and temperature hurts a lot of things. And if you think about the application of our technology, it's in very strenuous environments and stuff wears out. And technology moves quicker, whether that's processing rates on a sensor or whether that's communication protocols, 5G and other elements that are coming in or the next generation of optimization and control topologies that we're taking to the field.

So customers want to continue to drive top quartile performance. And to do so, they have to have the latest technology and the accessibility to what the market brings. But having said all that, I think it's a great engine. The investment that we make in KOB1 or capital formation fuels that installed base and gives us then the ability, I think, through time to have a nice stable business there.

Joshua Pokrzywinski

Understood. I'd like to pivot over to portfolio, if we could, maybe starting with Aspen. I guess maybe just starting out, how do you think about the long-term plan for Aspen ownership? Obviously, you're in a standstill right now but eventually that will end. Is there sort of a refresh criteria that you need to have or is that a consideration? We're just waiting until the standstill to add the rest?

Surendralal Karsanbhai

No, no, I don't think you should think about it that way. I think we should think about it and our ability to execute on the synergies that we communicated to our investors and shareholders at the time of the transaction. They're really around two dimensions that the commercial synergies, which we've brought some and highlighted some at earnings.

Their fund was very strong, both on the capital formation where we won those two large chemical jobs, DeltaV and AspenTech, one in the Middle East, one in Houston, Greenfield facilities, but also in the white space, which if you think about the 3200 DeltaVs in life science and the fact that Ovation controls 60% of the power generated in the United States, 30% of the power generated in Europe, 30% of the power generated in China, none of that, what I just highlighted, has any optimization software alongside it. So the white space opportunity for us in AspenTech is tremendous.

That's the commercial model and that's working quite well. But the more exciting element is the technology synergies. Our vision to drive, whether it's software-defined control but ultimately, autonomous control where you've evolved now already today from control rooms of 10, 20 people to control rooms of two, but imagine the control rooms of two that have accessibility to a fleet of plants and have ability to manage output and efficiency across six or seven different chemical plants versus the one that they manage today.

To do that and that's our vision, and it's not going to be DeltaV 15, which we're working on today, but that is the journey we're on in taking the code that sits at DeltaV, integrating it with AspenTech and our engineering teams collaborating as we start on that journey. I think that's going to be highly differentiated for us.

Joshua Pokrzywinski

Understood. And if I just wind back the clock a little bit, I think there were some growing pains with that relationship in 2Q and maybe a bit of an accounting lesson for me on revenue recognition on how that went through. How have you sort of learned from some of those things? How maybe collaborating or communicating a little bit better today?

Michael Baughman

Yes. The collaboration is great. And as you look at Aspen's forward look, growing ACV at 11.5% for this upcoming year and the profitability getting up around 40% on an adjusted basis. We feel good about it. The operating mechanisms, I think, are working well. And great business.

Surendralal Karsanbhai

We've had a bit of a reset as you saw, if you watched the last quarter earnings. It was very different from the past. see our hands on it, obviously. We feel good about the performance of the Company, to Mike's point, but we need to refine a little bit of the communication and how that's done for our investors and integrating them a little closer to our management processes as well. And we've done that and we put that in place for in Q2.

Joshua Pokrzywinski

Understood. That makes sense. I guess putting all that together, what is sort of the criteria you think about in terms of what would drive Emerson to add exposure to AspenTech? It sounds like there's a lot of opportunity with what you have today. So maybe no hurry, but what are the things that would climb up the list for you?

Surendralal Karsanbhai

Yes. Look, no hurry. We feel, as we close National Instruments, I'm sure you'll ask about that in a moment, that we need to run the Company that we put together here. We need to have a stable period of time, and I don't know if that's 12, 18-plus months.

We'll do some portfolio stuff as bolt-ons and we have capacity to do that, not dissimilar from Flex that we did a few weeks ago. But we need to run this portfolio. And I think we can put some significant numbers on the board here with it. And I don't see any significant M&A activity to change the structure of AspenTech.

Joshua Pokrzywinski

Understood. Very clear, I appreciate that. So you're right. So pivoting over to NATI. I think the question has come up a lot more recently but really came up in the start of this that folks are trying to understand, how do you view the cyclicality of that business? How do you -- how did you view that in the underwriting for the deal economics initially and sort of what are you seeing today? Obviously, you can only be so close to them, but what are you seeing based on their numbers that gives you confidence or concern?

Surendralal Karsanbhai

No, I feel really good. There's been a lot of collaboration between the teams to date, of course, done in a environment with a lot of clean rooms and so that we're ready day 1. We have identified the management team to run the Company at close. We have the general manager identified, CFO, HR leader.

It's a great blend of people who are inside of NI today and Emerson folks that will take that Company forward. We have identified and done the work on the $165 million synergy commitment. The headcount costs and non-headcount costs, about 60-40. Every single headcount cost has been identified by name, so all that work has been ongoing so we're going to hit that day one.

In terms of the cyclicality of the business, look, they reported, they filed June 30. Orders down 17%. Of course, they're having a phenomenal P&L year with GPs back up above 72%, which is great. The trends in orders are not dissimilar from what our assumption was.

Obviously, we forecast an additional two to three quarters in the negative as it flattens out perhaps in the second half of 2024. That's very much to the plan that we put together and calculated in how we need to deliver those cost synergies to deliver the value on this transaction.

Joshua Pokrzywinski

Got it. So I guess just shifting over to the margin side of that equation. I mean, I remember the initial slide deck and conference call when you first started looking at NATI. How does that initial margin benchmarking that drove that interest look today? And where do you think those metrics can go in the combined organization?

Surendralal Karsanbhai

Yes. Phenomenally profitable Company at the GP line with software content growing at a very high rate. Undergoing a conversion from perpetual to subscription, which they have started about 1.5 years ago. As that grows, obviously, probability has upside to it. But the technology itself is highly differentiated. And at 70-plus percent GPs, we feel very, very confident that we can run the Company at that level of margin.

Having said that, the SG&A is where the opportunity resides. And it's really around the commercial element, some of the innovation elements that we can augment with best cost. And we don't -- we have a vision in which we expressed to you that we can -- this Company should run at 30 points of EBITDA and we have a pathway to get us there.

Joshua Pokrzywinski

And does the lack of overlap or, I guess, experience maybe with those markets, some of those channels make that a little bit more difficult or slow going at first? Certainly, it sounds like there's a lot of confidence, but I'm assuming you don't want to move fast for some sake.

Surendralal Karsanbhai

No, certainly. So on the innovation side, look, at the end of the day, this is -- there is a cost exercise here because it's not been managed to the degree that we believe it should have been. But we bought this Company because it's a great technology Company, serving highly differentiated markets in semiconductor, aerospace, defense, EVs and a multitude of 35,000 other customers.

So we feel great about the tech there. So we want to be cautious. Innovation for us is, we will maintain a very significant base in Austin, Texas. We already have 700 engineers five miles down the road. That's the heart in Solar DeltaV. That combination will be very powerful for us with almost 3,000 employees in Austin.

But we're going to augment that with best cost engineering in India, in Manila, in Romania, where we are -- where Emerson Engineering really and the productivity around engineering really gets accentuated.The second is the commercial model.

Look, there are 20-odd, 30-odd customers within NI that make up very significant pieces of their business across those first three segments. Those require card-carrying salespeople, CEO-CEO relationships, but segmenting the customer base, much like we did within our 100,000 customers and identifying opportunities to use differentiated channels, be it distribution, be it digital to reach but reduce the cost of selling is an exercise that, in all honestly, NI had started, kind of stalled a little bit, but we have now a vision on how to accelerate that. And I think that's going to bring the cost of selling down while maintaining that intimacy with customer that is a very important part of what's made that Company successful over many years.

Joshua Pokrzywinski

Understood. And maybe just zooming out on broader M&A at the -- at last year's Analyst Day, you talked about the focus in test and measurement, software, discrete, grid. You sort of have elements of all those present now today. I guess does that mean future M&A looks a little bit more, I guess, synergistic and bolt-on, where the attachment points are a little clear?

Surendralal Karsanbhai

Yes, exactly. And bolt-ons, I think, have been over time at Emerson and will continue to be a relevant capital allocation strategy for us. It brings technology, differentiated technology to the table. Some of those, though, they're not -- they're tough to predict when they'll happen.

Many -- Flexom was a 15-year relationship with four German owners who started that Company. And ultimately, they were ready to sell and we have the opportunity. So relationships have been fostered but really around the technology, sub-billion dollar type of deals.

Joshua Pokrzywinski

Understood. And then maybe just on the other end of the portfolio discussion, there's still some parts of the portfolio that are sort of, I'll call it, less automation. Obviously, Copeland and Climate in general were the bulk of kind of the sales there. But anything else or a timing that you have in your head on when you want to be a gold state for stuff that maybe isn't a long-term fit?

Surendralal Karsanbhai

Yes, it's a great question. Again, no hurry there. There's not -- we don't foresee it to be a value unlock for us to action the safety productivity business. It's a good business. Obviously, at some point in the future, we'll evaluate that. But at this point, much like we won't be doing a big step-up M&A on AspenTech, probably isn't the time to be thinking about the safety productivity divestiture.

Joshua Pokrzywinski

Understood. And I see we're out of time, folks. I really appreciate the time. I enjoyed the discussion. Best of luck to you, guys.

Surendralal Karsanbhai

Thanks, Josh.

Michael Baughman

Thanks, Josh.