Eaton Earnings: Margin Progression Prompts Us to Increase Our Valuation

Narrow-moat-rated Eaton ETN put forth a solid third-quarter effort. Revenue of $5.88 billion was right in line with our expectations, but segment operating margin of 23.6% materially exceeded what we penciled in. These results, coupled with the company’s higher guidance, prompted us to lift our midcycle operating margin estimate by 50 basis points. Eaton’s margin progression is so far ahead of its 2025 target that the goal now looks laughably low. We think high-single-digit long-term revenue growth driven by infrastructure-related spending and the aerospace recovery should translate to strong operating leverage. Even modest operating leverage means Eaton should hit close to a 23% operating margin by 2025. These changes caused us to raise our fair value estimate to $206 per share from $195.

Eaton’s electrical Americas segment once again soared higher. Organic sales grew 19% year on year and grew sequentially too. Operating margin in the segment expanded 430 basis points year on year and 130 basis points sequentially. In turn, incremental margin rose to a resounding 50%. These results validate that Eaton is in an electrical supercycle in a formerly GDP-growth industry. Data centers and utilities were strong sources of strength, meaning the company is benefiting from electrification trends and the need to harden the grid. Furthermore, Eaton’s electrical backlog continues to grow and is now at $9.4 billion. That means that both the data center and utility-related trends we’ve highlighted should continue until next year. Artificial intelligence data centers in particular require higher power and power density, meaning that Eaton should participate in demand for greater electrical content.

Eaton’s aerospace segment continued to perform well, growing 10% year on year organically, with double-digit order and backlog growth. Original equipment manufacturer markets are exhibiting strength, and book/bill is at 1.2, meaning that demand remains strong.