Eaton Corporation's (ETN -0.53%) second quarter results were less than impressive, leading the company to trim its industry outlook. Shares responded, as you might expect, by trading lower, now down over 15% since early July. This could provide a reasonable entry point for long-term investors, however, and here's why.
Fair, not cheap
Eaton shares are trading with a trailing price to earnings ratio of around 19.5, right in line with its peers but above its five-year average of 18.6. Its dividend yield, meanwhile, is 2.9%. That's slightly above its five-year average of 2.7%, but about 20% above the industry's 2.2% average yield. Eaton's price to book value, meanwhile, is in line with its five year average at 1.8x, but below the industry's 2.7x.
So Eaton's shares look a little overvalued on some metrics and a little cheap on others. When all is said and done, however, this $30 billion market cap industrial giant is most likely close to fairly valued. Value investors should look elsewhere, but long-term investors with a growth bent should like what they see.
Well re-positioned
That's because Eaton today is very different from the Eaton of 15 years ago. When we were preparing to enter the 2000s, the company was largely a vehicle and industrial equipment manufacturer. Some 50 acquisitions later, Eaton has transformed into a "power management" company. What does that mean? Well, it still serves the vehicle and industrial markets, among others, but it has refocused around how energy is made, transmitted, and used.
And its purchases have allowed it to expand into new areas. So today Eaton serves markets as diverse as utilities and aerospace. Most importantly, the acquisitions, though numerous, weren't made just for the sake of growth. The company focused on "higher-margin, higher-growth market segments." The goal was to soften the blow of economic cycles and improve margins.
Although blunting the impact of ebbing economic growth is nice, Eaton is still an industrial focused company. No matter how hard it tries, business results will wax and wane with economic conditions. However, margins are a different story. Getting out of low margin businesses and into high margin ones is a good long-term call. And Eaton's margins have shown notable improvement over the past decade, increasing from around 10% in 2003 to about 15% last year. Clearly, management is doing something right here.
Like the economy, margins wax and wane. So high margins today don't guarantee high margins tomorrow. In fact, during the second quarter, Eaton saw segment operating margins contract 6% year over year. That's clearly not good, and adds further explanation to the price drop, but the falloff shouldn't overshadow the nearly 50% margin improvement made over the last decade. While they may not sit at recent highs forever, Eaton's margins are likely to remain higher, on average, than they were.
Source: Travelpleb, via Wikimedia Commons
Emerging opportunities
Not only has the company rejiggered its portfolio, but Eaton has increasingly been focusing on faster growing economies. Emerging markets accounted for roughly 24% of sales last year, with a goal of hitting 30% by the close of 2015. With between 70% and 75% of its business tied to developed markets, Eaton's performance is still heavily reliant on mature markets. However, getting more exposure to countries that are expected to handily outpace such stalwart regions is a huge long-term opportunity.
Asia provides a case in point. The World Trade Organization expects this region, driven largely by China and India, to grow its gross domestic product (GDP) by around 7% a year through 2016. The United States (around half of Eaton's business), for comparison, is projected to grow GDP at less than half that rate (3%).
Is it time to buy?
Eaton Corporation's stock has fallen sharply, bringing shares to a level that is best described as fair. If you are a long-term investor now could be a good time to take a look at this refocused industrial player. And the near 3% dividend yield will pay you reasonably well to stick around if the price falls a little further over the near term.
