With a 3.4% dividend yield, global industrial giant Eaton Corp. (NYSE:ETN) offers an attractive yield relative to the broader market's 2% or so. It's an interesting stock if you are looking for an industrial dividend payer, especially considering that the power management company was recently upgraded by Goldman Sachs. Here's why a key piece of Goldman's call is likely on the mark, along with a key issue to worry about just the same as you read Tuesday's earnings release.

The upgrade

The main factor behind Goldman's upgrade from "neutral" to "buy" was that analyst Joe Ritchie believes Eaton's organic growth is at a key inflection point. He expects to see solid organic growth across most of the company's five divisions. This is welcome news, for sure, since the last few years have been something of a struggle for Eaton.   

Two men looking at a blueprint with an industrial facility behind them

Image source: Getty Images.

Organic growth fell 2% in 2015. Heading into 2016, the company was calling for organic growth to decline between 2% and 4%, not particularly inspiring. The actual number, meanwhile, came in at a 4% drop -- the bottom end of the range. In 2017, however, Eaton was looking for its business to begin stabilizing, projecting that organic revenue growth would net out to zero across its many business.     

The actual result was organic revenue growth of 3% in 2017. There was strength throughout the company, with each division reporting notable organic sales strength in the fourth quarter. One key positive for the year, however, was a material upturn in the company's hydraulics division. That operation, which accounts for roughly 10% of sales, had been a major drag on results following the commodity downturn that started in 2011. (Heavy equipment manufacturers are key end customers for the company's hydraulics products.)

Eaton's 2018 organic growth projections, showing 3% growth in electrical products, 4% growth in electrical systems and services, 10% growth in hydraulics, 3% growth in aerospace, and 1% growth in vehicle. Overall the company is projecting 4% organic sales growth.

Image source: Eaton Corp.

As you can see above, heading into 2018, Eaton is calling for overall organic revenue growth to be up as much as 4%. Each of the industrial giant's five divisions is expected to see growth. Its two largest -- electrical products, and electrical systems and services (about two-thirds of revenue combined) -- are expected to underpin the progress with organic sales gains of 3% and 4%, respectively. Hydraulics will remain the standout, continuing its strong rebound as it pitches in 10% organic growth. With the global economy appearing to be doing well overall, there's no reason to doubt that Eaton's first-quarter results will support its full-year organic growth outlook.   

A key turn

This is great news for earnings, as the company expects solid organic sales to support a 2018 earnings advance of as much as 10%. That would match 2017's earnings gain, and support another sizable dividend hike in 2019. (Note that the company's 10% February dividend hike matched last year's earnings gain.) For the first quarter, Eaton expects earnings to be up 9%, with organic sales growth averaging 4%, roughly in line with its full-year target.   

But there's a potential fly in the ointment here. Goldman's positive outlook for Eaton, and its $88 price target, a 15% gain from its current price as of this writing, rest on a couple of key factors. The biggest is the upturn in organic sales. However, the research firm is also expecting cost-cutting and productivity enhancements to help offset rising commodity costs. This is no small issue. 

Entering 2018, Eaton CEO Craig Arnold noted that, "We are not really seeing commodity prices let up at all." He quickly followed that up by saying, "I can tell you that the businesses today are very well positioned to react and respond and to manage in this increasing environment of commodity cost increases." But the trend of rising raw materials prices doesn't appear to have changed. 

When industrial peer ABB Group (NYSE:ABB) released first-quarter results on April 19, it reported comparable order growth of 6% across the entire company. Comparable earnings were up 6%. Good numbers, and they back the notion that Eaton will report good results, too. However, ABB's news release contained a passing note about rising commodity costs. 

When pushed on the topic during ABB's conference call, CEO Ulrich Spiesshofer joked that he couldn't predict the future. But he added, "It's very clear that we have seen significant increases in a lot of the commodities." In other words, commodity price inflation remains a key concern.

With prices for key inputs rising, the positive of Eaton's organic growth is going to face off against a commodity headwind. And while cost-cutting and productivity efforts can offset rising commodity prices, Eaton just completed a large multiyear cost-cutting effort. It spent $116 million in 2017 alone to make the structural changes needed to reduce its ongoing expenses and improve corporate efficiency. Restructuring is pegged to cost around $90 million in 2018, but the company is no longer looking at this effort as a separate item.

It now considers such restructuring expenses just another ongoing cost of doing business. The concern investors should have is this: If the low-hanging fruit has already been harvested by the big multi-year push on the cost-cutting and productivity front, higher commodity prices could have a bigger impact than the company hoped as it entered the year. That, in turn, could push earnings growth lower than projected and dampen the positive of higher organic sales.   

Keep an eye on more than just organic growth

So, as you read Eaton's quarterly results, pay close attention to its organic sales growth. Results there should be strong and support the company's full-year outlook... and Goldman's positive call on the stock.

However, also keep commodity costs in mind. This factor could limit the bottom-line impact of the company's top-line progress if it isn't able to use restructuring efforts to offset the cost hit.

Higher commodity prices won't derail Eaton's earnings numbers, but it is an issue worth watching because higher input costs could easily turn into a lingering earnings headwind this year -- which could impact dividend growth in 2019.