Eaton Shows Broad Recovery Continues

By Stephen D. Simpson, CFA | April 25, 2011 AAA

Conglomerates like Eaton (NYSE:ETN), Dover (NYSE:DOV) and Illinois Tool Works (NYSE:ITW) can be a pain for investors to follow with all of their moving parts. On the flip side, they can also give you a quick look at a wide range of industries and how they're performing at any point in time. To that end, while a weak aerospace industry is still a drag on Eaton, overall there continues to be a strong recovery across many industry segments. (To read more on conglomerates, check out Conglomerates: Risky Proposition?)

TUTORIAL: Fundamental Analysis

Good On Top, Not So Good in the Middle
Eaton seemed to have no problem booking sales in the first quarter. Overall revenue rose nearly 23% and surpassed the high end of the analyst range by about $100 million. Within the overall revenue number, the electrical business was a standpoint performer with 21% growth, and that's clearly a good thing as the electrical business is nearly 45% of the total. The hydraulic, automotive and truck segments all showed very strong growth as well, while the aerospace business was a laggard at just over 3% growth.

Top-line performance was clearly strong for Eaton, but profitability was a bit more problematic. Gross margin did increase slightly and the company did deliver over 61% growth in operating income but expectations were broadly higher than this - particularly problematic since the company surpassed revenue estimates so handily. Aerospace and automotive were relative laggards (segment operating profit margins declined), while the other units simply failed to improve as much as hoped. Still, overall segment profit growth of 46% is hardly a bad outcome. (To learn more about this type of analysis, See Fundamental Analysis For Traders.)

When Do the Hard Comps Arrive?
Eaton's guidance for the year suggests that the company will surmount its prior high-water mark for revenue. That also suggests that the comps could get more difficult moving forward.

That said, the aerospace market has yet to really recover (due in no small part to delays at Boeing (NYSE:BA) and Airbus) and larger rivals in the power space like ABB (NYSE:ABB) and Siemens (NYSE:SI) still seem to think the best is yet to come in that market. What's more, new business opportunities like the company's joint venture with China's national aerospace company COMAC should pay off in years to come.

In the meantime, the company clearly has opportunities to make hay in hydraulics, automotive, and trucks. Although the Japan earthquake has complicated matters and led to some production changes for the likes of Toyota (NYSE:TM) and Honda (NYSE:HMC), the heavy-duty truck market is still experiencing a sharp turnaround (as seen, in part, with PACCAR's (Nasdaq:PCAR) 53% growth in truck-related revenue). Likewise, demand for heavy machinery from Caterpillar (NYSE:CAT), Deere (NYSE:DE) and so on is feeding strong demand for hydraulic products. (For more information on revenue, check out Revenue Projections Show Profit Potential.)

The Bottom Line
Whether it is simply the strong rebound in growth and prospects for ongoing expansion in the industrial sector or the possibility of an acquisition by a larger player like Siemens (which has stated its intentions to get active in M&A), Eaton shares have done quite well relative to the market. As such, they are no longer much of a bargain.

There really are not many bargains left in the industrial sector, though, apart from harder-to-own names like Sumitomo Heavy Industry and maybe a few unusual ideas like Columbus McKinnon (Nasdaq:CMCO). If investors want to chase industrial names and don't mind the valuations, Eaton is a fine name to hold, but the market has moved this one solidly out of the bargain bin. (For more on merger and acquisitions, see Mergers & Acquisitions: An Avenue For Profitable Trades.)

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