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Eaton's EV Venture Hits an Inflection Point in 2022

By Reuben Gregg Brewer - Mar 25, 2020 at 10:48AM

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After building an electric vehicle business from the ground up, Eaton expects sales to hit their stride over the next two years.

When most investors think about electric vehicles, the name Tesla probably pops to the fore. That makes sense given CEO Elon Musk's celebrity status, but the industry is so much larger than that. And it includes key industry suppliers that you may never have associated with electric vehicles (EVs) -- like Eaton Corp. (ETN -1.01%).

This global industrial giant, however, believes it can build a multi-billion dollar business serving the companies that make EVs, and it is well on its way to delivering on that promise.

An electric specialist

Eaton isn't a household name like General Electric or Honeywell, but it has a long and storied history behind it that spans more than 100 years. It started out producing parts for automakers in the early days of the car industry in the United States. Over time it has adjusted its operations, buying and selling businesses to create a more diversified portfolio. 

An electric automobile being charged

Image source: Getty Images

Eaton's portfolio, which spans from electrical products to vehicles to aerospace, has created a unique set of skills. Skills that it believes give it a perfect position to capitalize on the future growth of electric vehicles. Roughly two-thirds of its sales in the fourth quarter came from its electrical products and its electrical systems & services segments. It knows what it is doing when it comes to electricity.

Meanwhile, the company remains a key supplier in the vehicle industry, with roughly 12% of Eaton's fourth-quarter sales derived from its vehicle segment. That number can bounce around a lot because vehicle manufacturing is a pretty cyclical industry. In fact, sales in this division were down nearly 20% year over year in the quarter. That drop was largely because of a strike at General Motors and a downturn in heavy duty truck demand. But suffice it to say, Eaton still has worthwhile connections in the vehicle industry.

Note the use of the word vehicle so far. Although Eaton would likely be very happy to provide parts for electric cars, its goal is much broader -- and includes trucks. This is where it has extensive expertise based on its history in the industry. What's most interesting here, however, is that Eaton built its eMobility division from scratch in 2018, piecing together parts from other divisions to create a new one. It did not buy its way into the business. This has some notable implications.

A slow start

As far as Eaton goes, eMobility is a small contributor and, at least for now, a lousy business. To put some numbers on that, eMobility had revenue of $75 million in the fourth quarter -- roughly 1.5% of the company's top line. Margins in the business fell 10 percentage points year over year to just 1.3%. The average operating margin for the entire company was 17.8%, up 0.4 percentage points year over year. Clearly, eMobility isn't a big or strongly performing business today. 

Eaton Financial Results

4Q '19 

Eaton Sales

$5.2 billion down 4%

Eaton Segment Operating Profit

$933 million down 10%

Eaton Operating Margin

17.8% up 0.4 percentage points

eMobility Sales

$75 million down 6% 

eMobility Segment Operating Profit 

$1 million down 89% 

eMobility Operating Margin

1.3% down 10 percentage points 

Data source: Eaton Corporation

But Eaton has big plans. For starters, it believes eMobility could be up to a $4 billion business by 2030. That would put it on par with the company's aerospace and vehicle segments. So, despite the modest beginnings here, Eaton thinks this is a material opportunity. 

The poor recent results, meanwhile, need to be taken with a grain of salt. This is a business being built from scratch. Any revenue it has is related to legacy sales from the units brought into the new division. The goal is to create new products, not sell old ones. Eaton has, as you might expect, been spending heavily to develop those new products. That takes money and time, which is the reason why operating margins are so weak. The long-term goal is to get Eaton products into the plans for vehicle makers' future production -- breaking into existing vehicles isn't a realistic expectation. 

That said, eMobility has actually inked some notable deals, but they won't start to contribute to the top and bottom lines for a bit. That's where things get interesting. Eaton's existing contracts have a revenue run rate of $450 million a year. Management noted during Eaton's fourth-quarter 2019 earning conference call that eMobility is actually progressing more quickly than it had expected. The problem is that those vehicles won't start to come on market until 2021, which is why Eaton is expecting 2022 to be the "real inflection point" for this division. Basically, that's when it will become a more material contributor to the industrial giant's overall results. 

Getting more electric

The entire world is shifting more toward electrification, which is a key specialty for diversified Eaton. So this 4%-yielding stock isn't all about electric vehicles.

That's a good thing when it comes to EVs, for two reasons. First, Eaton has a solid foundation of on-trend businesses to support its efforts in the eMobility division. Second, it has the vehicle and electrification expertise (and connections) to take on the task of building eMobility from the ground up. Investors looking to invest in the EV space should take a closer look at Eaton, particularly if owning a dedicated vehicle maker feels a bit too risky today. It may take another year or two, but this industrial giant is working to become a major player in the EV sector, and positive progress is already showing up -- it just won't hit the revenue and earnings lines until 2022. 

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