Saturday, December 21, 2019

A Current AIM International Equity Holding: Eaton Corporation Plc (ETN, $91.86): “Power of Eaton”

 Eaton Corporation Plc (ETN, $91.86): “Power of Eaton”
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.


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