Eaton Corporation Investment Management - Essay Example

The share in analysis is Eaton Corp initials ETN traded in the New York stock exchange. Current stock price: $67.08 Target price: $ 75 Total projected return (include divided yield) 52 week price range: $ 57.11 – 79.98 Market capitalization: 31.99 Billion Diluted share outstanding: Dividend Yield: 1.96, 2.90% Company Description Eaton Corporation is a multinational power management company. Eaton provides energy efficient solutions to help its customers effectively manage electrical, hydraulic and mechanical power. The company provides services for lighting, wiring, power transmission, aerospace fuel, hydraulics, power quality and truck and automotive drivetrain. Eaton has subsidiaries like Cooper limited of which are included in its consolidated financial statements. The company headquarters are in Dublin, Ireland. The company operates worldwide in over 60 countries and employees 102,000 employees. The firm sells its products to over 175 countries which gives it a very, wide, firm market share. The firm’s objective is to make use of electrical, mechanical and hydraulic power more efficient, reliable and sustainable. The sectors the company deals in include; Aerospace, hydraulics, filtration and vehicle. Eaton’s 2013 revenue was $ 22 billion. Eaton Business Segments Eaton’s business segments include; Aerospace, hydraulics, vehicle and sale of electrical products. Sale of electrical products accounts for the largest revenues followed by vehicles. The Aerospace segment is a leading supplier of aerospace fuel, hydraulic and pneumatic systems for commercial and military use. Products produced in the aerospace segment include; motors, pumps and hydraulic power units. The hydraulics segment is a leader in hydraulics components, systems and services for industrial and mobile equipment. The hydraulic segment made 15% of its sale in 2013 to 4 large distributors of electrical products and electrical systems and services. The vehicle and automotive segment is a leading supplier of powertrains and drivetrain systems for fuel economy, efficient performance and safety of commercial vehicles. Components supplied in hydraulic systems include; valves, cylinders and electronic controls. The electrical products and electrical systems and services accounts for the highest revenues for the company. Eaton has a competitive position in this segment. Firms Sustained competitive advantage. The firm’s competitive advantage includes its leading in aerospace energy efficient systems. Eaton’s hybrid electric power train combine a diesel engine and electric motor to drive the vehicle which is unique and gives the product a competitive advantage. Also Eaton’s diversification into aerospace, automobile, hydraulics and electrical businesses have also reduced the business risk of the company. Eaton has also made a number of acquisitions which have increased the firm’s competitive edge. Eaton acquired Westinghouse distribution and controls business unit in 1994. In 2012 Eaton acquired Cooper, based in Ireland which manufactures electrical products and systems. Acquisition of Cooper provides synergies including operational efficiencies and increased revenue opportunities. Eaton’s electrical distribution and control business acquired the electrical division of Delta Plc. The company is also able to market its products into Europe and not just the USA which increases its market share and revenues. Also setting up offices outside US like in Ireland enables the firm to offer better services to clients in Europe. The firm also features well on sustainability of its products including being a global leader in the Carbon Disclosure Project (CDP), and Eaton is first amongst industry leaders. Market share, addressable market, growth drivers. Eaton has a number of divisions through which it diversifies its risk that is; hydraulics group, aerospace group, vehicle group. In the hydraulics group, Eaton is the leading manufacturer for systems and components use in; agriculture, construction, mining, forestry Investment thesis Eaton Corporation has a lot of advantages due to its global nature. The huge market for its energy efficient products earn Eaton corporation huge revenues each year. However Eaton also faces diseconomies of scale due to volatility in raw materials costs, currency and interest rates. The 52 week range is from $57.11 - $ 79.98 which represents a $ 20.87 price range. This indicates that the stock is stable, also due to the gigantic nature of Eaton it seems it is operating on its optimum profitability state. Therefore buying the share for short term gain may not be a very prudent decision. The projections for revenue growth however indicate that the stock will increase in value due to increased earnings every year. Risks to your recommendation Eaton faces a wide range of challenge due to its global nature like currency fluctuations, wars like in the Middle East, economic zones regulations like in the European Union, and price of inputs like metals. However Eaton also faces a host of opportunities due to its global nature such as clients in over 175 nations. However Eaton stock as an investment opportunity may not offer a huge return on investments as it seems Eaton has almost optimized on its available opportunities. Eaton’s challenges therefore at present include maintaining of current clients and trying to outsmart competition. Eaton also faces diseconomies of scale due to its gigantic nature proper systems should be in place in order to ensure sustainability. Risks Eaton faces include; Eaton may not realize the profits it hoped to gain from the acquisition of Cooper. Also due to the diversification of the segments, the management faces difficulties in integration of the segments. The firm also faces challenges of meeting customers’ orders, keeping existing customers and obtaining new customers. This risks if not carefully handled could lead to increased costs, decreased revenue, inefficiency of management and could eventually affect the net business. Eaton has diversified its investments to take care of volatility in revenues from the markets that Eaton serves. Eaton success also mainly lies on research, marketing and development and there is no assurance that Eaton will continue to successfully introduce new products and services. The company’s business is affected by technological changes corresponding to shift in customers demand. Fundamental drivers of Eaton stock The company records revenue of over $ 20 billion and has strong cash flows. The company has numerous valuable assets including its products and offices all around the world. Eaton also has a formidable market for its products a covers a wide geographical region. This has enabled Eaton to diversify its risks and it is therefore a very stable stock. In 2013 Eaton recorded a diluted share earnings of $3.93 per share valued at around $ 60, which is a quite good return. Economic micro sector Eaton is affected by changes in metals market prices. Eaton also needs to train, develop and retain executives and qualified employees for future growth. Inability to hire skilled personnel when others depart may hinder business, delays in hiring new skilled staff may also affect operations. Eaton also needs to have production spaces throughout the world to minimize disruption of activities by natural disaster, labor strikes or war. The IT technology employed in production of energy efficient products if not safely guarded may be susceptible to cyber-attacks, or network breaches. Economic (or macro) conditions that could hurt your stock Eaton’s results of operation may be affected by change in government regulations and policies including those related to tariffs, trade barriers, investment property rights, taxation and exchange controls. Currency fluctuations also affect Eaton’s operating results. Eaton’s supply of raw materials and components could affects the company’s operations especially due to price fluctuations and shortages. Eaton may also be unable to protect its intellectual property rights which are at the core of its business, this may happen via court suits especially if the methods employed to acquire them are not very legitimate. Eaton is also subject to environmental litigation especially as it uses and disposes components that are hazardous to the environment. Any legislative or regulatory action like Injunctions could adversely affect Eaton. This legislative actions may involve staff welfare, tax compliance, Eaton’s properties Raw materials of metallic nature like; iron, steel, brass, titanium, vanadium, rubber and plastics used in the manufacture of electronic components affect sustainability of Eaton. Fluctuations in the prices of this commodities affect profitability of the company and in turn affect Eaton’s share performance. Also due to the large number of orders Eaton faces from clients worldwide, there is a large number of orders that Eaton is yet to process, this backlog handling of orders, could frustrate clients and lead them to switch their business to competitors. Research and Development costs for new products are also high. Environmental concerns as Eaton uses and disposes substances that are regulated under the Environmental laws are a major concern. Financials The company continues to record high revenues in the year 2014 to 2017. The income statement is inclusive of revenues from subsidiaries like Cooper limited. The company has continued to see improved revenues from $ 13,175 million in 2012 to $ 22,140 million in 2014 and is projected to record revenues of $ 25,696 million in 2015. Discuss Income statement projections The projected Revenues for 2015 at $ 23,865 million and $ 25,696 million in 2016 are feasible. The company has continued to show improved revenues since 2009 and the projection is feasible in the near future. This is as long as there will not be major hindrances like tax lawsuits or injunctions against the activities of the business. The company cash flows are also strong which back this projections. The growth rate for the sales revenue is 35.16% which supports the growth in income projections. Eaton Copr (ETN) Date:09-23-14 Analyst: Tian Xu FY FY FY FY FY FY FY FY Millions 2016E 2015E 2014E 2013 2012 2011 2010 2009 Sales & Revenues: Sales of electrical products 4,530 4,622 4,647 13,456 7,718 7,176 6,423 5,893 Hydraulics, Aerospace and Vehicle 21,166 19,242 17,493 8,590 8,593 8,873 7,292 5,980 Total 25,696 23,865 22,140 22,046 16,311 16,049 13,715 11,873 Operating Expenses Cost of products sold 15,369 11,448 11,261 9,633 8,782 Selling, and administrative expense 3,886 2,894 2,738 2,486 2,252 Research and development expense 644 439 417 425 395 Total Operating Expenses 19,899 14,781 14,416 12,544 11,429 Operating Income 4,817 4,054 3,260 2,147 1,530 1,633 1,171 444 Other income and (expense), net 21 -105 -55 8 ( 71) 38 1 9 Interest expense -552 -520 -498 ( 271) ( 208) ( 118) ( 136) ( 150) Income Before (Provision) Benefit For Income Taxes 4,285 3,429 2,707 1,884 1,251 1,553 1,036 303 (Provision) Benefit for income taxes (514) (274) (460) ( 11) ( 31) ( 201) ( 99) 82 Net Income 3,771 3,155 2,247 1,873 1,220 1,352 937 385 Profit/share $5.99 $5.35 $4.08 $3.93 $3.54 $3.98 $2.76 $1.16 Profit/share-diluted $5.94 $5.30 $4.01 $3.90 $3.46 $3.93 $2.73 $1.14 Consensus 5.69 5.21 2.92 Guidance 3-6.00 Wtd avg shs (mill) Basic 630 590 550 473.5 347.8 338.3 335.5 332.7 Diluted 635 595 560 476.7 350.9 342.8 339.5 335.8 Sales Growth Sales of electrical products 74.35% 7.55% 11.72% 8.99% Hydraulics, Aerospace and Vehicle -0.03% -3.16% 21.68% 21.94% Total 35.16% 1.63% 17.02% 15.51% Operating Income 140.33% 93.69% 139.45% 263.74% Other income and (expense), net 0.08% -0.44% -0.25% 0.04% -0.44% 0.24% 0.01% Interest expense -2.15% -2.18% -2.25% -1.23% -1.28% -0.74% -0.99% Tax Rate -12.00% -8.00% -17.00% -0.58% -2.48% -12.94% -9.56% Compare financial ratios/margins/ growth Gross profit margin = G profit/ Sales 2016 2015 2014 2013 2012 Gross profit 3,771 3,155 2,247 1,873 1,220 Sales 25,696 23,865 22,110 22,046 16,311 Gross profit margin 14% 13% 10% 8% 7% The profit margins have increased throughout the years from 7% in 2012 to current 10% in 2014 and is projected to increase to 14% in 2006. Valuation and price target Analysis and discussions using valuation multiples Analysis and discussion using DCF DCF uses future cash flows discounted to present value for valuation 2014 2015 2016 2017 2018 2019 Eaton Corp (ETN) Terminal Discounted Rate = 11.00% Date:09-29-14 Terminal FCF = 3.00% Year 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E Revenue 22140 23865 25696 27238 28055 28896 29763 30656 31576 32523 33499 % Growth 8% 8% 6% 6% 3% 3% 3% 3% 3% 3% 3% Operating Income 3260 4054 4817 4630 4208 4334 4464 4292 4105 4228 4355 Operating Margin 15% 17% 19% 17% 15% 15% 15% 14% 13% 13% 13% Interest and Other 443 415 573 545 561 578 595 613 632 650 670 Interest % of Sales 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% 2% Taxes (460) (274) (514) 1811 1669 1719 1771 1717 1658 1707 1759 Tax Rate 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% 35% Net Income 2247 3155 3771 3364 3100 3193 3289 3188 3079 3171 3266 % Growth 40% 20% -11% -8% 3% 3% -3% -3% 3% 3% Add Depreciation/Amort 1328 1432 1542 1634 1683 1734 2083 2146 2210 2277 2345 % of Sales 6% 6% 6% 6% 6% 6% 7% 7% 7% 7% 7% Plus/(minus) Changes WC (442.79) (477.29) (513.92) (544.75) (561.09) (577.93) (595.27) (919.69) (947.28) (975.69) (1004.96) % of Sales -2% -2% -2% -2% -2% -2% -2% -3% -3% -3% -3% Subtract Cap Ex 664 716 771 817 1122 1156 1191 1226 947 976 1005 Capex % of sales 3% 3% 3% 3% 4% 4% 4% 4% 3% 3% 3% Free Cash Flow 2468 3393 4028 3636 3100 3193 3586 3188 3394 3496 3601 % Growth 37% 19% -10% -15% 3% 12% -11% 6% 3% 3% NPV of Cash Flows 20483 57% Terminal Value 43703 NPV of terminal value 15392 43% Projected Equity Value 35874 100% Free Cash Yield 8% Free Cash Flow Yield 7.96% Terminal P/E 13.38 Shares Outstanding 476.7 Terminal EV/EBITDA 7.81 Current Price $65.07 Implied equity value/share $75.26 Upside/(Downside) to DCF 16% Current P/E 13.81 9.83 8.23 Projected P/E 15.97 11.37 9.51 Current EV/EBITDA 8.64 7.23 6.24 Projected EV/EBITDA 9.70 8.11 7.00 Debt 9550 Cash 915 Cash/share 1.92 DCF sensitivity analysis using different growth and discount rates Sum of parts analysis The different divisions of Eaton play a key role. The supplementary division of sale of electrical components however records revenues of higher than 17 billion in 2014, and is projected to have a revenue of over 19 billion in 2015 and over 21 billion in 2016. The sum of parts measures how much the company would be worth if it was spun off or acquired by a different company. It is obvious that Eaton has a number of competitive advantage including over $ 20 billion revenues Technical analysis The projected earnings per share are expected to improve in 2015 and 2016 at prices of, from 2014 $ 550 to 2015 $ 590 and 2016 $635, while the tax rate will be stable at 35% per year. The revenue is also this is a strength for the stock and therefore the stock is a HOLD option. The 52 week price range of Eaton stock is also stable at $ 57.11 - $ 79.98. Currently at price $ 67.08, the share is still below its 52 week peak of $ 79.98, and it is therefore slightly undervalued. However as Eaton exhibits a quite stable price range, the best option is to HOLD the stock due to expected improved performance as the years go. Work cited Gravana, Grant., Eaton Corporation Relocated World Headquarters to Beachwood Put City on Map for economic development. Eaton corporation.2013 Dale, Funk., January Eaton buys Delta plcs electrical division based in United Kingdom". Electrical Wholesaling. Retrieved 2012-01-15.2003. Jack, Bomber., Eaton Expands Power Quality Offerings With Acquisition Of Pulizzi Engineering" (Press release). Eaton Corporation. 19 June 2007. Retrieved 2012-01-15. Karl, Maxwell., Eaton Ranks Among the World’s Most Ethical Companies" (Press release). Eaton Corporation. 20 March 2014. Luke O’Neal., Eaton joins EPAs Green Suppliers Network" (Press release). Eaton Corporation. 10 July 2006. Retrieved 2012-01-15. Read More