Eaton Corp. plc (NYSE: ETN) is BUY. This blue-chip industrial company appears poised to deliver high single-digit EPS growth over the long term, driven by margin improvement, share buybacks, and modest top-line growth. In this pandemic, we think that companies with strong balance sheets and experienced management teams are in the best position to survive and thrive. Financial strength will carry a company through the crisis, and talented management will lead it to the other side. Demand has declined for Eaton during the coronavirus crisis, but trends are slowly turning around. Meanwhile, management is taking steps to reduce costs and bolster a balance sheet that was already strong. We are raising our target price by $10 to $130, implying a modest premium valuation, which we think is deserved given the company’s solid long-term track record.
The beta on ETN is 1.14.
Eaton is expected to report 4Q results in late January or early February. However, the results would mark another sequential improvement: 3Q adjusted EPS declined 22% and 2Q EPS fell 54%. Sales in 4Q are expected to decline 12%. Estimates have been rising over the past several weeks.
The company is on target to complete the sale of its Hydraulics business to Danfoss A/S, a Danish industrial company, for $3.3 billion in cash by the end of 1Q21.
EARNINGS & GROWTH ANALYSIS
Eaton’s operations are organized into six segments: Electrical Americas (38% of 3Q sales), which includes components, circuit breakers, automation and control systems and transformers; Electrical Global (27%), which provides power and energy engineering services globally; Hydraulics (9%), which provides pumps, motors, transmissions, valves and cylinders for heavy equipment; Aerospace (11%), which provides hydraulic power generation systems, controls and sensing products, fluid conveyance products, and fuel systems for commercial and military use; Vehicle (13%), which manufactures transmissions, clutches, powertrains and differentials for OEMs; and the new eMobility segment (1%).
Our estimate implies an EPS decline of 27% this year. We look for a return to EPS growth in 2021, but are lowering our EPS forecast to $4.65 from $5.20 to reflect the impact of the divestiture of the Hydraulics business. Our five-year earnings growth rate forecast is 8%.
FINANCIAL STRENGTH & DIVIDEND
Eaton pays a dividend, and has every year since 1923. In February 2020, it raised the payout by 3% to $0.73 per share. We expect continued dividend growth going forward.
The company also has a share buyback plan.
MANAGEMENT & RISKS
Craig Arnold has served as chairman and CEO of Eaton since June 2016. He became Eaton’s president and chief operating officer and a member of the board of directors in September 2015. He joined Eaton in 2000 as senior vice president and group executive of the Hydraulics Group. Richard H. Fearon has been the company’s CFO since 2009.
Its growing international presence provides exposure to infrastructure development and population growth in developing countries. With world energy consumption expected to grow more than 50% by 2035, we believe that Eaton has the opportunity to generate steady growth over time.
Investors in ETN shares face risks.
Eaton generates substantial revenue overseas and its results are typically linked to global economic trends, which are not always positive, especially during a pandemic.
Eaton is also sensitive to trends in the dollar. A strong dollar reduces Eaton’s revenue. Looking ahead, we think the greenback is fairly valued and likely to remain in a trading range. A stable or falling dollar would be a positive development for the Industrial sector and Eaton.
Eaton Corp., founded in 1919 to manufacture geared truck axles, is now a diversified power management company. It has six operating segments: Electrical Products, Electrical Systems & Services, Hydraulics, Aerospace, Vehicle, and eMobility. Its customers similarly span a wide range of industries, and sales are evenly split between the U.S. and abroad.
Since the March 2020 lows, the bullish pattern has resumed. Our dividend discount model renders a fair value near $130 per share.
On December 9, BUY-rated ETN closed at $117.89, up $0.03.