Eaton shares get dragged down in the market selloff despite a nice beat and raise

Eaton on Thursday morning delivered quarterly beats on its top and bottom lines. Segment profit margin and organic sales growth topped estimates. Management also raised its outlook for the year. Despite that show of strength, shares of the industrial Club name were trading lower. Revenue in the second quarter increased over 8% year over year — up 9% organically —, to a new record of $6.35 billion, outpacing analyst expectations of $5.34 billion, according to estimates compiled by LSEG. Adjusted earnings per share advanced 23.5% to $2.73 — also a record and better than the $2.61 consensus. Segment margin , similar to an adjusted operating income margin, expanded 210 basis points, just over 2 percentage points, to a quarterly record of 23.7%. That was well ahead of the 22.7% estimate. ETN YTD mountain Eaton YTD Shares of Eaton, which specializes in electrical components and power management systems, opened lower after a 6% gain in Wednesday’s broader market rally. It mounted a short-lived move toward the flatline Thursday before getting caught up in the broader market’s sharp decline. While down 2.5% in afternoon trading, the stock was still up 23% year to date, performing slightly better than the S & P 500 over the same stretch. Bottom line The momentum on display in Eaton’s quarterly results and in management’s outlook is showing no signs of slowing down. That’s why we don’t see Thursday’s pullback in the stock as anything more than some profit taking in a bad tape. Data center energy demand drove record sales in Eaton’s Electrical Americas and Electrical Global. Record sales were also recorded in Aerospace. Those are the company’s three biggest business segments. Backlog growth in the Electrical Americas and Electrical Global as well as Aerospace continued, with all of them reporting book-to-bill ratios in excess of 1. That’s a sign of strong demand since it shows orders are coming in faster than they can be filled. Eaton Why we own it: Eaton has exposure to several important mega-trends like electrification, energy transition, and infrastructure spending. It is also a player in generative AI, where data centers use its power management solutions to keep up with the heightened demand for more computing power. In North America alone, the company has picked up more than 415 projects valued at more than $1 billion each, $1.2 trillion in total, since January 2021. We see a long runway for growth. Competitors : Parker-Hannifin , DuPont and Honeywell \ Most recent buy : Dec. 8, 2023 Initiated : Nov. 15, 2023 On the post-earnings call, management said 36 new mega-projects worth $1 billion or more were announced during the second quarter. The total value of those orders is $118 billion. CEO Craig Arnold said, “It’s important to point out that we have not seen any slowdown in the number of announced projects. In fact, Q2 was one of the strongest quarters ever.” Since January 2021, 444 mega-projects in North America worth roughly $1.4 trillion have been announced. The company is currently negotiating another $1.3 billion worth of projects with electrical customers. Arnold also said that roughly 40% of announced projects over the past year are related to data centers and power generation/renewables. “In many ways, this is a once-in-a-lifetime opportunity in that the megatrends we shared are having a broad and significant impact on the growth outlook for most of our end markets,” he explained. “We’re seeing the benefit in our sales results and more significantly in our orders, backlog, and negotiation pipeline, all of which are at record levels and growing.” With all kinds of companies needing to spend tons of money to build out data centers to accommodate artificial intelligence computing workloads, Eaton has a promising road ahead. We’re reiterating our buy-equivalent 1 rating and keeping our $350-per-share price target, which is $5 higher than the stock’s all-time high on May 24. Shares are currently trading just under $300. Quarterly commentary While cash flow results were short of expectations, both operating cash flow (up 11% to $946 million) and free cash flow (up 10% to $759 million) represented second-quarter records. Four out of Eaton’s five business segments grew revenue. Sales from the Vehicle unit dropped 3.7% to $723 million. Segment profit grew in all five units, with tiny eMobility up 300%. Aerospace’s segment margin of 21.6% was the only one to drop from a year ago and miss estimates. Guidance Eaton management raised full-year guidance on several line items. Organic sales are expected to increase 8% to 9%, up from 7% to 9% previously forecast, and versus Street estimates of about 8.7%. Segment operating margins are expected to come in between 23.4% and 23.7%, up from 22.8% and 23.2%, and better than the 23.2% consensus, even on the low end. Adjusted EPS are expected between $10.65 and $10.75, up from $10.20 and $10.60, and well ahead of the Street’s $10.54 at the midpoint. Operating cash flow is expected at $4.2 billion to $4.4 billion, and free cash flow is expected at $3.6 billion versus estimates of $4.4 billion operating cash flow and $3.56 billion free cash flow. For the current quarter, which is the third quarter, Eaton expects the following. Organic revenue is expected to grow 8% to 9%, a bit short of the midpoint expectation of 8.75%. Segment margin of 23.5% to 23.9% is expected, in line with the 23.7% midpoint estimate. Adjusted EPS of $2.73 to $2.83 is expected, ahead of the $2.75 midpoint estimate. (Jim Cramer’s Charitable Trust is long ETN, HON, DD. See here for a full list of the stocks.) 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