There have been a lot of changes at Eaton Corporation (ETN 1.90%) since the turn of the century, as the company positions itself for the long term. However, Wall Street's focus is often on the short term. So the 15% share price drop since the end of the second quarter isn't an impressive vote of confidence. That said, CEO Sandy Cutler wants you to understand that the headline numbers were hiding some good news.
It's complicated
Running a company is never easy and Cutler was quick to point out that the second quarter was a "busy quarter." That included the sale of a portion of the company's aerospace business and "several special or unusual items." In fact, "busy" might be something of an understatement.
(Source: Gillian, via Wikimedia Commons)
The company's GAAP earnings were $0.41 a share. That number already excludes one wrinkle, $0.05 a share worth of acquisition integration costs. However, the really big numbers came from "the gain on the recent Aerospace divestitures, and the settlements and associated costs of the Meritor, Triumph Group, and related litigation." Take those numbers out and operating earnings per share were $1.11.
At $0.70 a share, messy might have been a better description than busy.
Underneath, we're OK
But, the point that Cutler was really trying to make was that Eaton Corp. is doing OK once you look past those numbers. In fact, year over year, $1.11 a share in earnings was a 2% improvement. That's much better than the over 60% year-over-year decline the GAAP numbers indicated.
Moreover, sales were "right on the button" and margins were "very much in line with our expectations." While performance across the company's main divisions were really a mixed bag, with some doing better than others, the overall result was, well, OK. Indeed, a 5% sales increase and 2% earnings advance really aren't something you'd write home about, nor are they a disaster for a $30 billion market cap industrial company.
What wasn't said
Another notable comment was actually something that didn't get said: "No changes on page 16, which [is] our Cooper synergy projections. We really just provided this for your reference." That's noteworthy because the 2012 Cooper purchase, worth more than $11 billion, was that largest acquisition in Eaton's over 100 year history. And it was just one of the 50 odd buys that the company has made since the turn of the millennium.
It's always good news when an acquisition is going so well that the CEO has little to say about it. However, Cutler did toss in that, "We've got additional synergies." So all is well and there's still room for improvement. That's a great update, even though details were scant.
Our end markets are slower than we expected
So that's the good news. The bad news is that guidance for the year was based on a range of market growth numbers of 2% to 4%. But, as management noted, "At this point having a half of the year behind us and markets growing at a lower number in these first couple of quarters more on the order of 2%, we don't think 4% is realistic anymore." They trimmed the top side of their end market growth expectations to 3%.
That, however, is front-end loaded because Eaton's markets grew around 2% in the first half. The expectation is for 4% growth in the second half. If that comes to pass, Eaton could see its top and bottom line results solidify from here. However, the weak first half shows that Eaton can't control demand. So even though there's a strong backlog of work to support their 4% second half expectation, that doesn't necessarily mean they'll see it. This is one question mark that you'll need to watch.
We aren't planning a spinoff, for now
And the last salvo from Cutler was to squash rumors of a potential spinoff. The CEO first stated that, "each of our businesses remain ... key contributors to our results and we continue to see real benefits from being able to apply our multiple power management technologies to meet our customers' needs." That's something he pretty much had to say.
The more likely reason why a spinoff isn't going to happen is the company is "not able to do a tax free spin of any business for five years post the acquisition date of the Cooper transaction." So, Cutler is saying there's no spinoff in the cards until late 2017 at the earliest.
Not good, not bad
At the end of the day, the quarter wasn't as bad is it might have looked from a cursory glance, but it wasn't good either. And while management thinks the rest of the year will be better, there are issues to worry about at Eaton, notably the growth of the company's end markets. For long-term investors looking at Eaton as a company positioning for the future, the next six months to a year may not matter so much. And, thus, the recent share price pullback, and near 3% dividend yield, could be a decent buying opportunity. However, for those with a shorter time line, there doesn't appear to be a near-term catalyst brewing that will push Eaton's shares higher.
