Eaton Corp (ETN 2.27%) has a 100-year-plus history behind it, with a strong track record of shifting its business to keep up with the world around it. It started as an auto parts supplier and now makes the majority of its revenue from electrical products. This puts it in a strong position to benefit, given the increasing importance of efficiently managing power.
Here are some hard numbers to back up that assertion.
A giant shift for Eaton
In late 2012, Eaton completed the purchase of Cooper Industries. It was the company's largest acquisition to that point, at roughly $13 billion. This ushered in a time of major change for Eaton, which was trying to shift more of its business toward electrical parts and components. Since then, the company sold off a number of businesses, including its hydraulics operations, to better position itself for growth.
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One key goal was to reduce the cyclical nature of its revenue. It isn't unusual for an industrial company like Eaton to have a cyclical business, but that fact means that financial results can rise and fall dramatically over time. Although there are nuances here, the company's gross margin has been trending higher since the acquisition of Cooper Industries. (Note that recessions lead to steep drops, but that is to be expected given the decline in economic activity.)
ETN Gross Profit Margin data by YCharts
That said, the shift toward electrical products was also an attempt to get more in line with the way the world was moving in a broader sense. The decision played out extremely well, with electrical businesses now representing nearly 70% of sales. The proof of that is found not in the past, but in the future.
Looking forward
The biggest area of strength is Eaton's Americas segment, which accounts for roughly 42% of sales. The backlog in this division rose 51% year over year in the first quarter, with orders up 18% on a rolling 12-month basis. While the electric global segment wasn't nearly as strong, it still saw backlogs increase 3% year over year, with orders up 4%. Put those two divisions together, and electrical backlog is up 39%, with rolling 12-month orders up 13%.
That, however, is really a shorter-term read on what's going on. According to management, "Megatrends, reindustrialization, [and] infrastructure spending have changed the long-term growth outlook for our company." Management highlighted a number of global initiatives to back this view up, including the Inflation Reduction Act, the CHIPS and Science Act, the U.S. Infrastructure Investment & Jobs Act, and companies looking to create resilient supply chains in the Americas business. Overseas, it notes the EU Recovery Plan and China's "1+N" Policy Framework. All these big-picture initiatives will lead to increased sales of electrical products.
Eaton management believes the number of mega projects (of $1 billion or more) is running at three times the historical average. The total dollar figure is somewhere near $600 billion. The company doesn't expect to win a place in every project, but it does believe it will get a fair share, adding between $2 billion and $4 billion to annual revenue over the next five to seven years. To highlight what is going on, its pipeline of potential deals, at roughly $4.8 billion, is twice what it was in 2019.
The future is bright
Eaton shares aren't cheap today, noting the historically low 1.7% dividend yield. However, when you look at the opportunity ahead of the company, it is easy to understand why. But don't forget that Eaton is a cyclical industrial stock. If there is a recession, a drawdown might make it look attractive to both growth investors and value investors. The key is to have it on your wishlist, knowing the opportunity ahead, so you can be confident enough to act when the time is right.
