Tuesday, November 17, 2020

An International Equity holding: Eaton Corporation (ETN, $114.01): “Outlook is neat on Eaton" by: Manuel Cukaj, AIM Student at Marquette University

 Eaton Corporation (ETN, $114.01): “Outlook is neat on Eaton"

By: Manuel Cukaj, 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.




• Eaton Corporation (NYSE:ETN) provides solutions that help its customers manage electrical, hydraulic and mechanical power. The power management company operates in over 175 countries in the segments of Electrical Products, Electrical Systems and Services, Hydraulics, Aerospace, Vehicles and eMobility.


• Strong Q3 results were driven by better-than expected operational efficiency and margin control as well as positive end market trends and secular shifts caused by the pandemic.


• The commercial and residential construction and aerospace segments face headwinds that will negatively impact revenues


• Future catalysts will be secular tailwinds for data centers, electrical vehicles, and clean energy in the wake of electrification and digitalization


• Upcoming hydraulic divesture and possible acquisitions could play out beneficial for ETN


Key points:


Eaton achieved better-than expected third quarter results, beating market estimates by declining less-than feared. Reported revenues of $4.5B beat the consensus of $4.2B and were driven by tailwinds in the data center market due to growing demand for digitalization and connectivity. The stay-at-home policies across the world only contributed to this trend and helped offset declining demand in aviation and construction. 


Operating margins beat consensus by over 50bps. Over the past years, ETN has shown a consistent execution in controlling margins and being able to replicate this during the pandemic is an affirmation of the company’s operational efficiency. Considering that the company is in the process of integrating an acquisition, the result is even more a positive sign. 


The future performance of the company is strongly determined by the head and tailwinds that each of its end markets are facing. While the overall demand is expected to be solid the company expects several headwinds. Commercial and residential construction are both expected to be down and negatively impact revenues. Even though the aerospace segment is expected to improve, the recovery will be slow. At the same time, management is concerned about the industrial segment of ETN’s electrical business. Continued weaknesses in oil and gas will negatively impact those industrial markets. However, solid secular tailwinds in Eaton’s dominant segments will help offset and outperform these negative trends. In particular, expansion is expected in markets connected to electrification and digitalization. This will spur growth for Eaton’s electrical products, data centers, and clean energy products and solutions. Other end markets expected to support strong growth are the electrical vehicle market and overall e-commerce. The question will be whether the company can break out of this upcycle and outgrow the economy.


Another determining factor for Eaton’s future will be the company’s portfolio choices. With the upcoming divestment of the hydraulic business in the first quarter of 2021 and global M&A activity picking up, it will be interesting and important to see what deals ETN decides to pursue.


What has the stock done lately?


Over the past three months, ETN returned 10.9% compared to the 6.3% return of the MSCI AC World ex USA. This superior performance is partially due to company’s the better-than expected Q3 results that show good signs of recovery. Adjusted EPS were reported at $1.18 and ahead of market consensus of $1.05.


Past Year Performance: 


YTD Eaton Corporations stock has grown bullish compared to the world market. While ETN’s year to date return is at 19.6%, the MSCI AC World ex USA has basically stayed stagnant at a return of 0.2%. Comparing the returns from the lowest price at the end of March 2020, Eaton outperformed the market by a staggering 46%. 


YTD Returns vs Benchmark

Source: FactSet


My Takeaway


Since ETN was added to the Marquette International Portfolio, the stock has returned above 50% for our fund. During the pandemic and an economic downturn, the company has proven its ability to operate efficiently, that it can benefit from the secular shifts caused by the pandemic, and surprised investors by beating market estimates. Even though some of Eaton’s business segments are expected to face headwinds, the strong growth in areas of electrification and digitization are undeniably going to help the company grow. Considering this and Eaton’s global diversification, the stock can be viewed a thematic play on efficient energy and power solutions. I believe we should hold on to the stock while it will benefit from secular trends and generate more returns.


1 Month Price Chart


Source: FactSet