Eaton Corp. plc (NYSE:ETN) had a solid first quarter, despite a few notable trouble spots. And while that's good news, the most interesting information lies behind the headline numbers -- which is why CEO Sandy Cutler wants you to know a few things about the quarter.
It's a balanced thing
Eaton's operating earnings were $1.01 a share in the first quarter. That figure beat analyst estimates, though revenues were shy of the mark. There are a number of reasons for both results, Cutler explained it this way: "[O]ur balanced strategy is working -- our balance from a geographic point of view; our balance across our individual businesses -- and that's what allowed us to deliver what we think is a solid first quarter."
|Region||% of Sales|
Let's break that down. The United States makes up around half of Eaton's business. The rest is split roughly evenly between developed and emerging foreign markets. The company's electrical-products segment makes up about a third of revenues, electrical products and services 29%, vehicles 18%, hydraulics 13%, and aerospace 8%. Furthermore, about 10% of the business has relatively constant demand through the economic cycle, with about 30% each exposed to early cycle, mid-cycle, and late-cycle demand. So Cutler is telling you not to think that the company has put all its eggs in one basket. It's spread the eggs around pretty well.
That said, being globally diversified isn't always a benefit. Foreign exchange rates are a problem right now, in fact. As Cutler said, "You've seen in our guidance that we now think that the FX full-year impact will be larger than we thought." For example, the company explained that organic sales in the first quarter were up 1%, but the foreign exchange headwind caused sales to tumble 5%.
For the full year, the company is now expecting foreign exchange rates to trim about $0.25 a share off earnings. That's higher than the previous estimate and is part of the reason Eaton lowered its 2015 guidance to a range of $4.65 to $4.95, down from $4.75 to $5.05.
Although this is surely not a good thing, there's not a whole lot Eaton can do about foreign exchange rates. It's a part of doing business. And over time, the minuses and pluses tend to even out. So it's something to watch and understand, but it's probably not something to worry much about.
On a more positive note ...
On the whole, the company's earnings got a boost from continued margin strength. According to Cutler, "Our segment margins came in right where we thought they would be: 14.6%, up from 14.5% a year ago." Aerospace and automotive were the notable strong points here. Continued cost cutting and synergies from the integration of Cooper Industries are driving forces on the plus side.
Two weak spots, however, were electrical products and hydraulics. In electrical products, the reasons weren't all that worrisome. For example, historically speaking, the first quarter tends to be relatively weak. There was an issue of product mix, and intercompany costs -- specifically, parts made in the United States and shipped for use in Canada -- were affected by the foreign exchange issue.
Eaton is working to deal with that last issue and expects margin improvement as the year progresses. It's still calling for the division's margins to be in the 18% range for the full year, well above the 15.7% the company achieved in the first quarter.
Hydraulics is the problem child
More worrying is the continued weakness in the hydraulics segment. There, sales were down 15%, with foreign exchange rates accounting for only about 6 percentage points of that decline. The bigger concern was the 9% drop in organic sales. Margins, meanwhile, fell from 14.3% a year ago to 10.1%.
|Operating profit||Down 40%|
|Margin||Down 420 basis points|
The problems this segment is facing haven't changed, either. Demand from the agricultural sector has fallen drastically, and there's continued weakness in the Asian construction market. In this case, the cure is part of the current problem: restructuring efforts.
"We will have restructuring expense in every quarter as we go through this year," Cutler said, which will take "somewhere between a point and point and half out of margins in every quarter as we go through the year."
So look for hydraulics to remain a tough spot over at least the next nine months. However, know that Eaton is doing something about it. It just won't feel good while in the meantime.
Returning value to shareholders
With all the moving parts, there's one more thing that Eaton wants you know: It's returning value to shareholders. Cutler said the company repurchased around $170 million worth of stock, or about 2.4 million shares. That's a continuation of a trend. As Cutler said, "You'll recall that last year we had repurchased 650 million shares, or about 2% of our outstanding."
And while the first-quarter repurchase was relatively tiny in comparison with last year's full-year activity, it's nice to see the company continuing to return cash to shareholders -- and it did so with a 12% dividend increase. So shareholders are benefiting directly from the overall strength of this well-diversified industrial giant as it focuses on getting better internally while returning value to its owners.
It was a decent quarter. Although everything isn't rosy at Eaton, the company is built to withstand some headwinds. That's exactly the kind of company you should be interested in. Better yet, it's paying shareholders to stick around through any turbulence with a 3% yield and a dividend that's increasing over time.
It was a solid, though not exactly good, quarter. Overall, investors ought to be pleased.