By:
Sean O’Leary, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is mentioned
in this article.
Summary
• Eaton Corporation plc (NYSE:ETN) is a power management company that
is diversified through providing energy-efficient solutions for electrical,
hydraulic, and mechanical power. Eaton (ETN) operates in five main business
segments: Electrical Products (33% of FY18 Revenues), Electrical Systems &
Services (27.9%), Vehicle (16.1%), Hydraulics (12.8%), and Aerospace (8.8%).
Eaton does business in over 175 countries, with the Unites States making up 55.7%
of total 2018 revenues, Canada making up 4.3%, China making up 4.1%, Germany
making up 3.6%, and many other countries making up the rest of revenues.
• Aerospace sector is
proving to be a strong segment of profit and growth through all time high
margins and 9%-10% growth in Aerospace sales due to high order rates of military
fighters, commercial transportation, and commercial & military
aftermarkets.
• Hydraulics revenues were down 10% with an 8%
decline in organic revenues and operating margins of 11.9%, down 290 basis points
from last year. The organic revenue declines were largely due to weakness in
global mobile equipment markets.
• ETN has announced its
plan to sell the lighting business to Signify for $1.4 billion, which will improve
order growth in other segments and support margin expansion as the lighting
industry will be soft in future quarters.
• Management has long
term potential to implement an 80/20-type excellence initiative and blend A/R,
A/P, finance, sourcing, HR and IT functions from plant and field offices, to integrate
shared service centers. Lean is another long-term opportunity in the fact that
10-15% of plants are rated world-class with an unbalanced level of these in
legacy Aerospace and Vehicle divisions.
Key
points:
ETN
has seen strong revenues and increased margins in the past year even when
facing many challenges. Revenue and EPS have seen increased growth in the past year,
besides in Q3 ($5,314 million) of 2019 when revenues were less than Q3 ($5,412
million) revenues in 2018. This decrease in revenues in Q3 compared to the year
before is largely due to working in global economies and less volatility in ETN’s
end-markets.
With
$4.5 billion plus available cash for 2019-2021, ETN appears to be interested in
added acquisitions. ETN’s management has decided to stay disciplined on how
they will valuate acquisitions and segments that they will sell. Candidates for
acquisition are likely to be focused on product adjacencies and geographic expansion.
With the recent announcement of the lighting segment being sold, this shows us
that ETN going forward will be moving towards exiting areas of business that
have poor margins and negative future outlooks.
In
2018 ETN has segment operating margins of 18.7% which is an all time high and
includes records for Electrical Products, Electrical Systems and Services, and for
Aerospace. Strong operating margins will continue to improve through creating
world-class manufacturing facilities, delivering productivity enhancements, and
enhancing portfolio of products and businesses.
ETN
has changed it’s expected full year expected organic growth rate from 3% to 1%
largely due to reduced global growth, and the cyclical nature of businesses
within ETN. We expect future positive organic growth in Electrical Systems and
Services and Aerospace, along with decreases in organic growth in the
Hydraulics and Vehicles segments.
What
has the stock done lately?
As
of late, the stock has seen growth through all time high earnings on margins
and very strong operating cash flows. In Q3 of 2019 revenue was reported as
$5,314 million, which is down from $5,412 million from the year before. The
stock has seen some growth haltered through the cyclical nature of products
offered and lowering organic growth in the Hydraulics and Vehicles segments. Although
we see a lower revenue, EPS was at $1.44 in Q3 of 2019, which is up from $0.95 in
Q3 of 2018. Although ETN’s had slightly lower revenue in Q3 of 2019, margins have
been higher which increased profits and positively impacted the stock price.
Past
Year Performance:
YTD has
increased 33.79% in value in the last year and has continuously beat the benchmark
in the past year. The 52-week range was $64.46 – $93.38 with the low occurring
in result of challenging global markets. The stock price was at $68.61 on January 2nd,
2019 and has seen steady growth throughout the year where it is now currently
trading at $93.07.
1 Month Stock Chart from FactSet
Source:
FactSet
My
Takeaway
ETN was added to the
portfolio at the end of 2018 and in the last year the stock has increased
33.79%. We have seen strong growth in operating margins that reached an all-time
high in 2018 and is expected to continue to show strong growth through the end
of 2019 through solid performances in the electrical and aerospace segments. ETN
is positioned for growth through strong cash flows, management’s focus on creating
world-class manufacturing plants that provide productivity enhancements and
portfolio of products, and ETN leaving the lighting segment of business that was
bringing down margins. ETN is facing a decline in expected organic growth in
the next year due to the cyclical nature of ETN and may incur reduced global segment
growth because of the global market’s uncertainty. I give ETN a hold rating in
the fact that there are negative factors to consider, but with the strong growth
being seen in 2019 and expected in 2020, ETN has room to grow even more.
1 Month Stock Chart from FactSet
Source:
FactSet
