The future of the auto industry is looking more and more like it will be electric, with major automakers announcing material plans to increase their electric vehicle (EV) output. It's a huge opportunity for companies that supply the auto industry. One name that has been working hard to take advantage of this trend is Eaton Corp. (ETN -1.92%). So far the effort hasn't been very profitable, but that could soon change.
An electrical giant with auto roots
Eaton started life more than 100 years ago making a gear-driven truck axle. Today the company still generates around 13% or so of its sales from the vehicle industry. Trucks remain a core market, with an emphasis on the efficient use of power. That fits well with the rest of the company's business, the vast majority of which is tied to the efficient use of electricity (66.5%), with a small cut out for an aerospace division (15%).
Image source: Getty Images.
Basically, the company has a long history in the vehicle space, giving it a Rolodex of customers to court, and a huge electrical operation, where it can build its expertise in the EV space. In fact, when it went to start its eMobility division (a scant 1.7% of sales) a few years ago, it didn't buy its way into the sector. It just pulled pieces of its existing business together into a new division focused on the EV market, with plans to grow from within.
This is a harder process than buying an existing business with existing customers and revenue. Essentially, Eaton has had to start from scratch on both the technology front and the customer front. Even though it has good leads via its existing auto relationships, getting included in a new platform can involve a lot of time and expense before revenue starts to flow in any material way.
A money loser, for now
That's why it shouldn't be much of a shock to find out that Eaton's eMobility business has lost money from day one. In the third quarter of 2021, it had a paltry $84 million in revenue, lost $8 million, and had an operating margin of negative 9.5%. And while eMobility revenue in the quarter was up 6% year over year, the division's loss rose fourfold. A huge amount of money is going toward research and development because it is still early in the process of building this business. For reference, Eaton's overall revenue in the quarter was $4.92 billion, with segment profits of $978 million, and an operating margin of 19.9%.
However, the company reports that it has won contracts valued at $600 million in "mature year revenues." That's a fancy way of saying that while there are contracts, the deals aren't up and running yet. So in the near term, more spending and more red ink are likely to be the norm. But management has hinted that there's a light at the end of the tunnel.
CEO Craig Arnold explained during Eaton's third-quarter 2021 earnings conference call:
And we expect to see a significant ramp up in revenues in 2023, which positions us well to achieve our long-term revenue target of $2 billion to $4 billion by 2030.
There are a couple of takeaways here. First, 2022 is likely to be another year of building in eMobility, but as revenue starts to flow in 2023, so too should profits. That will be very welcome news, since it means the division will be able to fund its own investments instead of siphoning off of the other divisions. But the $2 billion to $4 billion figure is notable, too.
In the third quarter, the company's vehicle division had revenue of $640 million. Multiply that by four, which is very rough math for an industry that tends to be highly cyclical, and you get $2.5 billion or so. If eMobility can achieve the lower end of the sales figures management is projecting, it will be roughly the same size, if not larger, than the current vehicle division. Basically, this up-and-coming division allows Eaton to offset the financial impact that the broader transition to EVs could have on its business. It's kind of like an insurance policy against the decline of gas-powered vehicles.
Hedging its bets
Although Eaton isn't a pure-play EV stock, the eMobility division is a very interesting story, and it looks like the countdown to a notable upturn in the business has begun. Investors should continue to listen to management's updates as it reports earnings in 2022. That said, don't lose sight of the real goal here, and that's to hedge Eaton's risk of sales declines in the current vehicle division. And 2023 looks like it is going to be the pivotal year to watch.
