In recent years, Eaton (NYSE:ETN) has prudently moved away from selling brakes, transmissions and similar products to the beleaguered automotive industry. Its new businesses emphasize electrical components for a wider array of industrial applications, including hydraulics and aviation. So while the firm is no longer operating in the eye of the automotive hurricane, it is still being buffeted by severe global economic conditions that may just be beginning to improve.
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Recent Results
Third-quarter sales plummeted 26% to $3 billion, which came in slightly below analyst projections. Management was quick to point out that end-market industry demand fell 24% and sequential revenue from the second quarter actually grew 4%, implying that sales may have bottomed and will be improving going forward.
The top-line decline was dramatic in all five key operating units. Sales fell in excess of 20% in every segment save for aerospace. This is because this segment provides supplies and services for military aviation, although it also serves commercial aerospace clients such as Boeing (NYSE:BA). The drop was most pronounced in the truck and automotive segments, which posted falls of 35.3% and 26.9%, respectively. Hydraulics, which provides components and systems for power products in just about every industrial avenue also fell dramatically with a 34.5% decline.
The profit decline was even more severe, falling in excess of 70% in the hydraulics and truck units and more than 50% in global electrical, which provides electrical control and power systems solutions and has been a primary focus of Eaton in recent years. The end result was a 39% drop in net income to $193 million, or $1.14 per diluted share. Despite the major drop, bottom-line results came in ahead of analyst expectations and sent the shares up more than 7% after they were announced on Monday.
Outlook
Eaton expects end-market demand to fall between 21% and 22% and full-year reported earnings of $2.05 to $2.15 per share. Excluding restructuring and other one-time charges, the bottom line will come in between $2.40 and $2.50. (Learn about the controversies surrounding companies commenting on their forward-looking expectations in Can Earnings Guidance Accurately Predict The Future?)
Bottom Line
Despite anemic near-term trends, things could have been worse. According to a recent interview with CEO Alexander Cutler in the most current edition of SmartMoney, back in 2003, half of the company's profits came from the automotive industry. That number is now down to about 27%, thanks to a slew of acquisitions to refocus the business on the electrical and hydraulic systems and exposure to overseas sales and energy-efficient solutions. In other words, Eaton has avoided the fate of Delphi, which declared bankruptcy in 2005, and the near demise of Visteon (NYSE:VC). Eaton now more closely resembles Danaher (NYSE:DHR) and Teleflex (NYSE:TFX), which serve a diversified client base with a wide array of industrial and manufacturing products. Bolt-on acquisitions also serve to supplement organic growth.
This company's shift in business focus is commendable, as is the steady cash flow it was able to generate during a period of acute end market weakness. But at a forward P/E multiple of 26 times off the high end of company guidance, shares of Eaton are already discounting a full sales and earnings recovery in its operations. Rival Johnson Controls (NYSE:JCI), which is also diversifying out of the automotive industry into industrial building efficiency and related businesses, projects a sales improvement for the coming year but is also trading at about 18 times 2010 forward earnings.
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