Eaton has transitioned its business so that it is focused heavily on electricity.
Along the way, the company has worked to favor higher-margin operations.
A key long-term goal for this industrial giant is to be a less cyclical business.
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Eaton (NYSE: ETN) has been a great investment for me. I’ve owned it since 2015, when it was still working on integrating Cooper Industries. That acquisition, and subsequent fine tuning, has been hugely important to Eaton’s development as a business. In five years, I expect Eaton to be an even better business than it is today.
Eaton is an over 100-year-old industrial company that has long focused on power management. It started life selling truck transmissions, which it still does today. But the business took a major directional shift when Cooper was acquired. Cooper’s primary focus was on managing the flow of electricity, and it materially increased Eaton’s exposure to this niche of power management.
After integrating Cooper, which was a multiyear effort given the size of the deal, Eaton shifted its efforts to streamlining. It was still making bolt-on deals, which are basically a constant for the industrial giant (it is one of the largest industrial companies on the planet), but it also started to exit some historically important operations. One big move was to exit the highly cyclical hydraulics sector, which managed fluid-based power systems and sold into heavy construction markets. Construction equipment is highly cyclical, with demand rising and falling along with economic activity.
There were really three big goals during this period. First, set the business up for long-term growth. Second, shift toward higher-margin operations. And third, move toward a business model that would be more consistent through the economic cycle. That last one is the one that will be most evident in five years’ time.
Aside from a fairly impressive stock price advance since I’ve owned Eaton stock, I’ve also watched as the company has altered its business in dramatic fashion. Today, electricity-related businesses make up around 70% of the top line on its income statement. And, as the chart above highlights, the company’s profit margins have been generally heading higher.
Management is, basically, doing what it set out to do. That said, in the next five years, there’s likely to be a stress test. The longer-term goal is to create a business that is more resilient to the economic cycle. That won’t be proven out until there is a longer recession. The recession during the coronavirus pandemic was short and driven by the health scare, so it is hard to count it as a real test.