Eaton (ETN)

TOP CONTRIBUTORS

Cecilia Chen

Andrew Lewis

Eaton Corporation (NYSE: ETN) manufactures components and systems for use in automobiles, trucks, aerospace, agriculture, and fluid power systems. Once highly dependent on making drivetrains and other engine parts for the auto and heavy trucks sectors, Eaton has cut auto and truck related sales, shifting its focus to areas like power management, hydraulic systems, and aerospace and defense.^[1] Eaton is based in Cleveland, Ohio, but is geographically spread out, with strong international growth, selling its products in over 150 countries.^[2]

Company Overview

Eaton Corporation is a global diversified industrial manufacturer of electrical systems and components for power distribution and control; fluid power systems for industrial, mobile and aircraft equipment; intelligent truck drivetrain systems; as well as automotive related components.^[3]

While ETN's operations used to be highly cyclical, its improved business model, comprised of a broader range of products and services, has led to less earnings volatility by exposing the company to more higher-growth markets.^[4]

Business and Financial Metrics^[5]

In 2009, Eaton generated a net income of $385 million on $11.87 billion in total revenues. This represents a 63.8% decrease in net income on a 22.8% decline in revenues from 2008, when the company earned $1.06 billion on $15.38 billion in revenues.

Business Segments^[6]

Eaton is a diversified, integrated operating company, with sales and revenue coming from five different business segments:

• Electrical (49.6% Revenue): Eaton is a manufacturer in power distribution and protection equipment, such as circuit breakers, panelboards, switchboards, busway, voltage switchgear, and fuses. ^[7] It provides electrical equipment to a range of customers, from custom industrial and commercial assemblies to simple, innovative residential components.^[8] The electrical business follows seasonal changes, where the business gets much stronger in the second, third, and fourth quarter. ^[9]

• Hydraulics (14.3% Revenue): Eaton designs, manufactures and markets hydraulic systems and components for use in earthmoving, agriculture, construction, mining, forestry, utility and material handling applications. ^[10] This sector includes Eaton's Filtration, Golf Grip and Airflex industrial clutch and brake businesses.^{[11] [12]}

• Aerospace (13.5% Revenue): Eaton makes advanced hydraulic systems, fuel systems, motion control systems, propulsion sub-systems and cockpit interface and circuit protection applications for commercial and military programs. Eaton provides hydraulic power generation and fuel system components on almost every commercial airline Airbus and Boeing aircraft fleet.^{[13] [14]}

• Truck (12.3% Revenue): Eaton works with fleet owners, freight companies and truck manufacturers globally to manufacture drivetrain and safety systems. Among its designs and manufacturers are: transmissions, clutches, collision warning systems, hybrid electric powertrain systems, etc. Its research and development goals are focused on fuel economy, safety, ease of operation, reliability and uptime.^[15]

• Automotive (10.4% Revenue): Eaton develops and designs automotive-related components and equipment to improve fuel efficiency, emissions, safety, and performance. Products include superchargers, engine valves and valve actuation systems, cylinder heads, slip differentials, mirror actuators, transmission controls, engine controls and fuel vapor components.^{[16] [17]}

^[6]

Key Trends and Forces

Raw Materials Shortages or Commodity Price Increases Impact (Increase) Operating Costs

Eaton Corporation uses raw materials and components in its production process; thus, significant shortages or prices increases would raise operating costs and adversely impact the competitive position of Eaton products. It requires the most raw materials in the form of iron, steel, copper, nickel, aluminum, brass, silver, molybdenum, titanium, vanadium, rubber, plastic, and insulating materials. Profitability is partially offset by the increases in prices of certain raw materials, supplies, and basic metals.^[18] Eaton CEO Alexander M. Cutler believes that high commodities and steel input prices are here to stay, as long as worldwide demand stays strong.^[19]

Downturns in Eaton's End Markets Bring Uncertainty to Eaton's Operating Results

Unforeseen volatility in Eaton's end markets can lead to decreased operating margins. In the truck segment for instance, further declines in the North American commercial truck market would adversely impact Eaton.^[20] Luckily, Eaton has taken measures to tamper this volatility through diversification of markets and geographic expansion.^[21] Furthermore, the increased calls for lowering emissions, fuel efficiency and environmental protection have increased demands for hybrid vehicles, fuel economy, and environmental safety, all of which Eaton is well positioned to handle. The question remains whether earnings in Eaton's expanding Electrical and Fluid Power businesses are be able to make up for the decline in the Truck and Automotive production in the coming years. The next emissions standard change is in 2010, a policy that promises to greatly reduce emissions.^[22]

Competition

ETN is considered a diversified industrial company. In the diversified industrials group, Eaton faces many established competitors, such as United Technologies (UTX), Danaher (DHR), American Standard Companies (ASD), Rockwell Automation (ROK), Textron (TXT), and Cooper Industries (CBE)^[23].

• Johnson Controls (JCI) - Johnson Controls provides automotive interiors, products and systems that aim to optimize energy usage in buildings, automobile batteries, and hybrid electric cars. Johnson operates globally in three main businesses: building efficiency, automotive and power systems.^[24] Johnson's building efficiency sector competes directly with Eaton's Electrical sector.^[25]
• Honeywell International (HON) - Honeywell operates as a diversified technology and manufacturing company worldwide through four segments: Aerospace, Automation and Control, Specialty Materials, and Transportation Systems, offering products and services that overlap substantially with those of Eaton.^[26]. In July 2007, Honeywell completed the acquisitions of Enraf Holding B.V., of the oil and gas industry, and Dimensions International, a defense logistics business. In December 2007, it acquired Maxon Corporation, an industrial combustion business.^[27]
• Illinois Tool Works (ITW) - Illinois Tool Works is a worldwide manufacturer of engineered products and equipment, with 852 operations in 52 countries. These are organized into eight segments: Industrial Packaging, Power Systems & Electronics, Transportation, Construction Products, Food Equipment, Decorative Surfaces, polymers & Fluids and All Other. The operations serve end markets such as construction, general industrial, automotive, food institutional/restaurant and service, food and beverage, consumer durables, electronics, primary metals and others on a worldwide basis. In March 2008, the Company acquired VS Acquisition Holding Inc. In June 2008, the Company acquired Quipp, Inc.^[28]
• ITT Corporation (ITT) - ITT makes various engineered products and services in the US and internationally. Its focus is on three distinct segments as well. ITT's Fluid Technology sector designs, develops, produces, and markets fluid systems for residential, municipal, commercial industrial, and agricultural applications; its Defense Electronics and Services segment provides systems integration, communications, engineering and technical support services; Motion and Flow Control designs and manufactures products for communications, industrial, transportation, military/aerospace, and consumer markets.^[29] ITT is the world's largest supplier of pumps and systems to transport, treat and control fluids and is among the top 10 U.S. defense contractors.^[30]
• Parker-Hannifin (PH) - Parker-Hannifin is a full-line diversified manufacturer of motion control products, including fluid power systems, electromechanical controls and related components. The Company also is a producer of fluid purification, fluid and fuel control, process instrumentation, air conditioning, refrigeration, electromagnetic shielding and thermal management products and systems. Its operations are located in 35 states and 42 countries, and are not quite geographically diversified as ETN. Parker-Hannifin products are classified into three segments: Industrial, Aerospace, and Climate & Industrial Controls. In April 2008, the Company acquired Vansco Electronics and Ventrex Inc.^[31]

References

1. ↑ Seeking Alpha, "Eaton: Unappreciated New-Age Stock - Barron's," 6/1/08
2. ↑ Seeking Alpha, "Eaton Scores First for Industrials," 4/16/08
3. ↑ ETN, 2007 Annual Report, Item 1. Business, Page 3
4. ↑ ETN, 2007 10-K, Item 1A: Risk Factors, Page 6
5. ↑ ETN 2009 10-K pg. 17  
6. ↑ ^{6.0 6.1} ETN 2009 10-K pg. 51  
7. ↑ "Electrical" 7/25/2008
8. ↑ Eaton Business Segments 7/2/08
9. ↑ Eaton Q1 FY08 Conference Call, Alexander M. Cutler - Chairman and Chief Executive Officer; President 4/14/08
10. ↑ "Hydraulics" 7/25/2008
11. ↑ Eaton Business Segments 7/2/08
12. ↑ Eaton Hydraulics 7/2/08
13. ↑ Eaton Business Segments 7/2/08
14. ↑ Eaton Aerospace 7/2/08
15. ↑ Eaton Business Segments 7/2/08
16. ↑ "Automotive" 7/25/2008
17. ↑ Eaton Business Segments 7/2/08
18. ↑ ETN, 2007 10-K, Results of Operations, Page 62
19. ↑ Eaton Q1 FY08 Conference Call, Alexander M. Cutler - Chairman and Chief Executive Officer; President 4/14/08
20. ↑ ETN, 2007 10-K, Item 7. HIGHLIGHTS OF RESULTS FOR 2007, Page 56
21. ↑ ETN, 2007 10-K, Item 1A. Risk Factors, Page 6
22. ↑ [A. G. Edwards & Sons, Inc., "Eaton Corp: Equity Research Recent Development Report" 3/7/06, Page 7]
23. ↑ [Credit Suisse "Eaton Corporation" 1/17/06, Page 5]
24. ↑ Reuters, "Johnson Controls Inc. Company Profile: Full Description," 7/3/08
25. ↑ Reuters, "Eaton Corp. Company Profile: Full Description," 7/3/08
26. ↑ Reuters, "Honeywell International Inc.," 7/3/08
27. ↑ Reuters, "Honeywell International Inc. Company Profile: Full Description," 7/3/08
28. ↑ Google Finance: ITW Summary, 7/3/08
29. ↑ Yahoo Finance: ITT Corporation Profile "Business Summary" 7/3/08
30. ↑ ITT Corporation Home, "ITT at a Glance," 7/3/08
31. ↑ Google Finance: PH Summary, 7/3/08