Eaton Corporation plc (ETN) Earnings Call Transcript & Summary

All right. Thank you, everybody. Chris Snyder, U.S. multi-industry analyst. Very excited to have Eaton with me, CEO, Paulo Ruiz. Thank you for coming.

Thanks for having me. Excited to be here.

Well, absolutely. Maybe just starting high level with the strategy overview. At the March Investor Day, you unveiled 3 pillars of the strategy. So can you kind of talk us through that? And over the last 6 months, are there any milestones that you would like to highlight there?

Great. So thanks for the question. I would say this, the transition has been fantastic. So I could hit the road running. And the fact that I had 3 quarters of overlap with Craig helped me to gradually take the reins of the company, but more importantly, gave me the opportunity to think about why we needed to raise the bar in terms of our strategy, and we launched the strategy back in March, so before my start date, and we're already in full implementation. So let me walk you guys through. The great concept of the strategy is that we want to recognize the things that the company is doing really well, recognize, identify and keep them. At the same time, we are not complacent at all. So we want to raise the bar on areas we believe we need to do better. So the framework of the strategy addresses exactly that. It has 3 pillars, as you mentioned. The first one is invest for growth. Invest for growth is about us working really hard to be a fast-moving company with higher customer centricity. You might ask, how can you prove this? We decide to think about the fast-moving markets we serve, get the learnings from it and apply across the company. So we are benchmarking with everything that's happening in data center today, that becomes our new standard of how we approach. We have customer centricity we apply across the organization. So if it's good for the fastest growing, it's going to be even better across the portfolio. So that's lead for growth. And the invest for growth, we have generational market opportunity coming from the markets we serve. Think about electrification of society, that touches utilities, touches also behind the meter. We have tremendous opportunities on data centers, digitalization of society. Reshoring the U.S. is another field. Aerospace being commercial and defense, also another growth vector. So if you look at all of this, how can we, as a company, be selective and work and double down on those areas that will give us the biggest return for our buck, give us highest growth and highest margin potential. So that's the framework. And it's all about the organic investments between technology and capacity, but it's also about inorganic investments, M&A. So it's going really well. It's in full implementation. The third one is about execution. I call it execute for growth. You can have the best ideas under your invest part. You can have the best culture, the best leaders. If you are not executing well, you're not delivering to your potential. So we are raising the bar on the way we run our facilities, our factories, our functions. We are applying AI on top of everything we do with the objective to bend the cost curve, the fixed cost curve as we grow the top line. And then ultimately, talking about things that I love in the company, I want to keep under execute for growth. I'm committed to keep a concept that Craig introduced, which is nothing else that we see every general manager is a portfolio manager. So we expect the general manager to look at the head of the portfolio, higher growth, higher margin, how do you fast develop that, how you make it work? What is the tail of the portfolio, how you take care of it and either fix or get out of it. In terms of highlights, I would say every pillar is under full implementation. But for this public, I would say it's important to note that we announced 3 deals in 3 months, right? So 2 in the data center space, Resilient Power and Fibrebond and one in the aerospace. That's the only one that we'll close next year, the other 2 already closed. So high results, lots of discipline, execute on the strategy we shared in March.

I wanted to follow up on the invest for growth pillar. You talked about doubling down on the best, highest growth markets and just kind of making sure that organic stays strong. But as kind of from the outside looking in, one of the beauties of Eaton in electrification is that there are a lot of good end markets out there. So I guess which ones are the most exciting to you? Which ones do you think deserve the capital?

So we are definitely looking at data center, utilities and aerospace as the premier destination of our investment dollars. But I also wanted to give everyone a reminder, a lot of things we do in our technology and our products is fungible across end markets, right? So we look at those end markets as the biggest growth drivers for sure, but a transformer can go into multiple different areas. A breaker can go into multiple different end markets. But that's the frame we're looking at. Why are we excited about those markets in particular? Think about data center. I asked Yan and his team to give me the data from the last Laguna Conference. So the last Laguna Conference 1 year ago, the data center industry had $150 billion in backlog in hand between things they were building and things they announced. This number today folks is $470 billion. So it's over 3x the backlog that the industry had in hand last year. So it's a tremendous tailwind for our business, and we are really excited about it. Are we growing this business? Definitely. You guys saw Q2 year-over-year, we grew 50%, and our orders grew 55%. So that market is really hot. We also like utilities. We grew decent amounts in the past where -- when electricity growth was only 0.5% per year. And now with electrification of everything at data centers, the load growth is forecasted to be 3% per year. It's a lot of a change. And then everything around aerospace that you're aware being commercial and defense, they're actually looking more positive than even the forecast we had for defense back in March.

Yes. I appreciate that. You highlighted the 3 deals that you guys have done in recent months. And that is a bit of a change. And over the last few years, Eaton has been very much an organic growth story. But you guys are adding businesses that are bringing very good growth to the company. So can you kind of update us on the M&A priorities? How is the pipeline? And then what do you consider to be a bolt-on for Eaton?

Yes. We said we want to do bolt-on deals. There are 2 sides of looking at bolt-on. One is the enterprise value and the other one is the degree of complexity for integration. So for us, bolt-on is when it is less than 5% of our market cap. So if you are at $140 billion today, you'll be less than $6 billion to $7 billion down. The deals we closed are much smaller than that, around $1.5 billion, the 2 bigger ones, and the Resilient Power is much smaller as a technology play. But we think about this as we are very disciplined. We're not going to lose the discipline on the way we acquire. We have high return expectations, and we look at the synergies we create. So we remain very, very consistent with that approach that Eaton always had. And we have those opportunities, right, at the end markets provide to us. And I just want to remind you that the commitments I made back in March did not include M&A dollars, right? So whatever we do to put this $21 billion of cash generation over the planning cycle to work is going to be an upside.

Yes. No, I appreciate that. Maybe kind of getting to the more thematic side of the house, anyone who reads my research knows that I'm a big proponent believer in U.S. reshoring. Obviously, everything needs to get powered. Manufacturing 26% of the electricity in the country, which I feel like is underappreciated. So I guess, what do you think about reshoring? What could that mean as you look out to the end of the decade? And what verticals within the Eaton complex benefit?

Yes. We see the reshoring as a very long tail and it's actually a trend that touches a number of end markets. Think about, of course, our definition of mega projects is any project that has more than $1 billion in investment. Most of the data centers will fall into that category today, but they are much more than data centers. Think about LNG terminals, think about petrochemical plants. Think about all this manufacturing reshoring that was already happening, and we expect that with the advent of the tariffs, it's going to happen even more. So it's a long tail. We track this every single month. And since we started tracking those projects for 3 or 4 years now, the current backlog of projects is $2.6 trillion. It's incredible, right? Only 15% of it started. So it's like $390 billion to $400 billion actually started. So there's -- the message here is a very, very, very long tail of projects to come. What we see in our books today, early innings, early moves, we closed around $2 billion in orders already. We are in current negotiation of other $3.5 billion. And I just wanted to make one project as an example for you to make it more tangible for everyone. We recently closed a deal in Pennsylvania. It's a power gen site. It's called Homer City. It's a huge power generation site, $10 billion for 4.5 gigawatts of power. The electrical content of our project is around $200 million. So we are lucky to win the first phase. We already booked $100 million. So we feel good about it. And the reflection always is because we get that question, why your market share is as high or even higher than your bread and butter business. If you're a project manager sitting on a $10 billion budget, would you take a risk on 2% of your cost to maybe save 5% or 10% of 2%. You probably won't. So I'm saying here, we know we can compete and we track this very closely, and they're more than data center only.

Yes. You mentioned that $2 trillion-plus mega projects kind of -- I think if we go back to -- I think that number probably started in '21 cumulatively. I guess, any sense on how those mega project announcements are tracking maybe in '25 versus '24? And is there any change in conversations with customers following the election and all the policy that's come through?

We always track cancellations and announcements. The announcements are surpassing the starts by a lot. So the way to think about it, if you think about announcements around $40 billion per month. So every month, on average, there's $40 billion of announcements on new projects. Starts are on the $25 billion per quarter. So it's much lower. So there's a huge tail. Now someone might ask, well, maybe they're canceling those projects or delaying those projects. We track that as well. The severe delay or cancellation is around 11%, which is lower than the average project size globally. So it's not high. So still to be seen whether tariffs is going to increase the pool. We believe it will. But we already see a lot of business for us to go attack in the near days.

If we kind of think about what you're saying on the announcements for starts, clearly, announcements always lead starts. Has there been elongation on that? And why do you think it is? Is it just there's a lot of competition for whether it's a transformer, labor? What's causing that?

Yes. There is -- of course, if you think about data center being a big portion of it, they're competing for the same resources, right? The power, they're competing for the labor, they're competing for the specialized crafts. So as we look at it, and it was one of the many reasons why we got so much excited about Fibrebond, we can only observe that or we can work to make it better for our customers, right? So when we decided to acquire Fibrebond was exactly with that direction, right? We are hearing you want to move faster, you don't have engineering to design one by one. You don't have the labor on site. I can do that in my factories in a controlled environment. So there are actions we can take. But definitely, there is a competition for resources. And that's why in our long-term plan, although we are a firm believer of the data center development, I haircut the CAGR -- the forecast CAGR of the market for 35% at the midpoint, I embedded only 17% to my plan. And I'm working towards 35% or more, but it was just like a proactive way to be on the safe side.

Yes. No, that makes sense. It's hard to know when these constraints are going to come. And then maybe just asking on data center. If my memory is right, Q2, you guys had sales up 50%, orders up 55%. I mean I think I'm sure everyone saw Oracle a couple of days ago, pretty eye-popping. I guess kind of maybe leave this one high level, why are you positioned to win in data center? And how do you make sure that you guys capitalize on the opportunity?

Yes, it's an excellent question. So historically, we've been very strong with our portfolio, diversified products, service offerings, software as well. And with advent of AI, we believe we can even expand our presence. So traditionally, we were very, very strong in the gray space, right? Now with power requirements being much increased on the server side from a few kilowatts per rack to a megawatt per rack, that requires much more sophisticated power management solutions. So the white space that, although we always had the technology to attack, we didn't want to because it was highly commoditized, high volume, low margin is resembling much more of the businesses we love, mission-critical, high technical content, and that's what we love. So with the advent of AI, something that was very, very good for us already is going to get much better. So that's why the content per megawatt for Eaton will increase. So we are very excited about the market. Why we win? Because we approach this from a solutions approach. So by the recent acquisitions we made and also the people we hired, today, we can have conversations with NVIDIA that we can take all the way up to the utility feed. We can go from the grid to the chip. That's powerful. We have the scale, manufacturing scale. We have the engineering scale. We have the service scale. And we have good technology. We have unique IP in some products that we are leveraging. So something that was good, I would say, excellent is supposed to be even better for the company.

I appreciate that. When you guys look within your data center business, can you talk about how you see AI versus maybe some more of that traditional enterprise cloud developing, whether it's growth share of the business? anything you could share there?

Yes. So of course, everyone talks about AI all the time, and it's important. It's growing really fast, but still it's not the majority of the data center business we see. It's moving fast, as I said. Last year, for example, 15% of our orders were AI related. This year, it's 30%. It's growing, well, but cloud is also growing and still 70%, right? So there is a lot coming that way. AI gets all the headlines understandably, is exciting, but there is more to it.

Yes. So as we kind of move to AI, you talked about the content per megawatt opportunity increasing. I guess kind of -- so are you having conversations with customers on that side of the business yet or on that specific white place? And then is that what makes AI so compelling to you guys is the ability to play on both sides?

Yes. So the answer is yes to both. We are having the right conversations, not only the hyperscalers that we always had, we improved a lot with the multi-tenant through acquisitions and relationships. PDI, which was a small business we acquired 4 years ago, we tripled that business. But that business also helped us pull a lot of other Eaton solutions and products through the multi-tenant data center channel. So we improved our relationships there. And then as we start to be more of a solution provider, we were recognized by the likes of NVIDIA as a company they want to partner with and put in their road maps of the next chip. So we work ahead of the game to make whatever they're trying to put on the market possible inside the white and the gray space.

I appreciate that. Maybe kind of talking about the ability to serve all of this demand. You guys have talked about $1.25 billion of incremental growth CapEx to kind of serve all the demand that's out there. Is there any updates you can share on that -- on the CapEx?

Yes. So those -- we have a dozen projects in U.S. today that are under implementation. They are going well. Of course, for a business to stomach 12 expansions in a year is not a small feat. I think the business is doing well, and I'm proud of my team there. In terms of completion, if that's the background of your question, out of the $1.25 billion, we plan to finish $700 million of that investment this year, and the remainder will be mostly next year, a little bit going to '27. But between this year and the next, the bulk of it will be done.

And we're seeing -- if we kind of look at you guys, you guys incurred some margin pressure in Q2. I think there are some tariffs, but also some related to this ramp. But then we're also seeing a call for acceleration as the year goes on as that capacity brings new volumes to the business. So can you talk about both the margin and top line implications from these capacity adds, both in '25, and if you could share anything on '26 there?

Yes. So I'm not going to give you '26 guidance, if that's what you're looking for. No, we're excited about the exit rate. I -- jokes aside, I will be disappointed if the Electrical Americas business cannot meet the long-term average growth we committed in March, which was 10%. I think we should be there, if not north of it. But again, guidance will be shared later. If you think about -- you talked about the margin pressure in Q2, we calculate those investments we are making and the inefficiencies that come with it to be around 100 basis points, right, of margin pressure. And on top of that, in Q2, we had the cost of the tariffs and none of the pricing because we implemented prices in May. So this has come in the second half. So we saw all that pressure in Q2. And if all of that -- the margin eroded 40 bps. So you load the business of 100 basis points, you load with all the tariff pressure and still the business absorbed the vast majority of it. And so we remain confident. We believe we're going to continue to operate well. And as soon as those expansions are done and those inefficiencies start to go away, we can push the team to continue to operate better under the execute for growth umbrella.

Yes, I appreciate that. And maybe I could follow up on the tariff impact on Americas margins. So clearly, you guys are getting hit with tariff costs and that pressured the margin. And you guys have a lot of backlog. So maybe it takes longer to realize the price. But I think the question is, do you guys feel confident that when you go out to the market and get new orders that they're coming through at kind of a post-tariff price level?

Yes. We do.

Happy to hear that. I guess on the topic of orders, the Q2 accelerated, I mean, faster than I thought. When I tried to isolate Q2, it seemed like it was in that 20% kind of plus range. Can you talk about what drove that improvement, whether it was data center and others? And then you also talked about Q3 being better again. So any update there that you could share?

Yes. So the way to think about it -- first of all, we are proud of the team and the results in Q2. A good way to think about it, we shared with the investor community, we had a large, large order in Q1 last year that we are anniversarying now, over $1 billion in one single order. So with that huge bulky order gone, the team managed to compensate for that with -- I wouldn't say bread-and-butter business, but not so large orders and stay at the same level over time. Having said that, I'm confident the book-to-bill will be larger than 1. Making order forecast is very difficult because we have several large deals we are discussing and negotiating, especially on the data center space. And I cannot forecast when they're going to land. They can land in Q3, they can land in Q4, they can land in Q1. What doesn't change is when it's going to be invoiced and delivered to the customer. So what matters to me is that our backlog is at record levels. We expect to have book-to-bill higher than 1, and our negotiation pipeline is actually 31% higher than last year. So that gives me the lead indicator. When the orders will fall, they will fall.

Yes. One thing that I think is kind of interesting is over the last year, the view was that when Eaton or other companies with a lot of backlog, as capacity comes online, always orders go down because lead times compress. We obviously saw orders accelerate. Do you think bringing capacity to market and maybe being able to serve customers quicker could be a catalyst or a driver of share gain in the market?

Definitely. Because you said, of course, the laws of economy would say, if you reduce your lead time, you're probably going to see less orders and less backlog. That hasn't happened. That shows that demand is strong. As we bring capacity in and we keep trying to drive lead times down, I think it will be a competitive advantage for sure.

Yes. And then just kind of on that point, you guys are calling for, I guess, depending on where you're in the guide, but Americas organic growth to get to improve in the back half versus the first half. Is that just -- you're bringing the capacity online, so that's all just like incremental volumes flowing through. Is that also just prices coming through on a bit of a lag because we have to work through the backlog?

Yes, we definitely have both. We have the pricing that's going to hit the second half. But if you look at the bulk of the growth, the vast majority is volume.

Yes. Yes. Maybe moving over to Electrical Global. I guess, what signs of improvement are you seeing there? And I guess, anything particularly you want to share on Europe? And then beyond just the top line, what's your plan for margin improvement there? I don't think anyone ever expects Global to do an Americas margin, but can there be a narrowing of the gap?

Yes. So we're definitely working towards that. If I am to use the strategic framework to give you my answer. So we look at the European business, and we thought about the lead for growth, and we decided we didn't have the right team to win. So we decided to bring a leader from the Electrical Americas group, who knows exactly how you run Electrical Americas. He is leading our European business. He started now this year. He is bringing the best of the industry to support him. So that's under the lead for growth. He has also the mission with his team to not jeopardize the MOEM and the resi business we have there that is the flow business, which is good. But to build on top of that, the systems business that we have in Electrical Americas that make us win in data centers, it makes us win also in utilities. Under invest for growth, what we are doing there is organically, we are getting our products ready to the European codes and standards, and we are working on partnerships, how we can build our systems, our assemblies. And we decided to invest in the UAE. So we have an investment that we kicked off beginning of this year to create an engineering center and also to have highly automated manufacturing to serve the growing data center market in the Middle East. So that's the invest part. Under -- none of this is showing in our numbers yet. It's coming up. But if you look at execute, we're also running our factories better in EMEA. So if you compare this year to last year already, the number for Global is 100 basis points of margin improvement already year-over-year. Now there is a long run to get to the Americas level. And we committed in the long run, this business could go up to 23%. That's our commitment.

Yes. Is it -- when we kind of think about getting growth out of Global, is the biggest driver there just data center spreading beyond America? Or are there other end markets or verticals where you think you could show improvements?

In Europe or Global?

Global.

I think if you see what the Asian team is doing, it's fantastic, right? They are growing double digits in this market today.

Really?

Yes. So it's fantastic, leveraging the JVs they made over time, growing organically, great work. Now can we emulate that in Europe? We can. It takes some time, but we'll do it.

Yes. Absolutely. Maybe moving over to Aerospace. The 2030 margin target of 27%, how do you think -- what do you see in the pathway there to get to that margin level?

So first of all, I shared with you in the past that we are not happy with our operational performance in Electrical Global, especially in EMEA, right, and also in Aerospace. So we started taking actions there. I talked about the margin improvement in Global year-over-year, 100 basis points. Aerospace improvement already 70 bps. So we see some green shoots. The business starts to run better. That also gave us the confidence to raise our growth guidance for the year by 200 basis points. So we see our positions in the platforms are there, right? So it's about execution in the short term. Over the longer term, we also have opportunities to win more in retrofits, especially in the defense side, especially with the acquisitions we made, and we can also change the margin profile there. So economies of scale with the incrementals over time, running the place better and then a push for aftermarket retrofits.

Ultra PCS specifically, can you kind of talk about how that plays into there? And then specifically also how it relates to the margin?

Yes. This is a very neat business, a fantastic small business, around $250 million in revenue, growing mid -- strong double digits, I would say, on the teens and with EBITDA margins north of 30%. So it's accretive not only to Aerospace, it is accretive to Eaton overall on growth and margins. And where they play is 75% defense, 25% commercial. And they open up a number of opportunities for us in the U.S., but also in Europe, where they're quite strong.

Yes. Maybe kind of shifting back to the home market, the U.S. When I think about the Trump policy, it feels like the first angle is that it could drive more investment into the U.S. But then I think maybe the second derivative angle is that it could change the competitive landscape in places, whether it's big international companies or even kind of smaller players in the market. I guess, do you think there's been any impact in the competitive landscape or any kind of outlook there?

So I'm not mentioning here that I like tariffs, but if there's someone benefiting from tariffs today, it's Eaton in this environment, right? Because we have the strongest footprint in North America and the U.S. for a very long period of time. And even before tariffs, we decided to come with the $1.25 billion of additional investments. So we are ahead of the curve. We didn't need the tariffs to make a business case for those investments, but we already started. So the tariffs are only making our business case stronger. If your question is that some other players might pause their investments and decide not to come to the U.S., could well be. I just cannot affirm that. It's logically possible. But today is benefiting Eaton quite a bit. And we didn't need the tariffs to protect us. We could compete without them, but they just create additional protection for the company today.

I'd be interested to hear what your philosophy on pricing is because when I hear the stat earlier that the backlog went from a data center with $100 billion to $450 billion, just like wild numbers. And there also could be some competitive tailwinds. It feels like the company would have the ability to push, I won't say as much price as you want, but a lot of price. Clearly, that's not always the best way to run a business and maintain relationships. So kind of how do you think about kind of throttling that back and forth?

Yes. We always try to think about generating value and claiming part of the value as pricing. So if you just want to push pricing on the same solution or product as anybody else, you probably don't deserve it. You don't get it. So we're always looking for opportunities. And in data centers, what we did in the past, we created products dedicated to it. Think about IP we have where we put 3 pieces of equipment in one box. It's the transformer, the switchgear, it is the control tower in one box. So the hyperscalers love that. We give them a lot of value back because less footprint is a cheaper solution than 3 pieces of equipment, but our margins are also higher. So that's the way we think about prices. Of course, we can push because the demand is high. We always will claim, but we also try to create value for our customers so we can claim more than our fair share of it.

Yes. No, perfectly reasonable. Maybe going back to the portfolio and M&A conversation. What do you -- I guess, how -- you guys have announced some -- what I would consider very attractive deals when you talk about the growth rate and the multiples paid. Is there anything you can provide about how big is the pipeline or the opportunity set for you to go out there and find growth accretive businesses at maybe a multiple below your own or whatever that threshold may be?

So we -- again, I think we need to be very intentional. So we look at the areas where we decided to play, and there are not so many. So when then you decide where to play, then you can start browsing the market and look for it. So we do that very intentionally. I don't want to share the number of targets because that would not tell you anything. The one thing I want to tell you is that we don't want to strike any transformational deals. It's not what I want to do. It's not the right time, especially with the new CEO in place. But we can stomach good bolt-on acquisitions where the value creation is evident, and we are the best home for the business because then we can create a good arbitrage between the multiple paid, that will be always equal lower than our own multiple. But on top of that, the after synergy is a much lower number. So that's the way we are thinking.

What about on Americas versus global? Because on one hand, I would think your ability to add value to a new business is the strongest in Americas because you could bring them into the home turf and leverage all the great stuff you do here. But on the other hand, I would think maybe global could benefit from more scale and more touch points coming in. How do you think about that?

So it's part of our equation as well. As I've said before, we believe with a new team in place, we start to run the house better, we can potentially look for deals. That's the reality. But we are not in a rush. We don't need to do a deal for the sake of doing a deal. That's not the way we're wired. So if we find a good business that will accelerate our organic ambitions and we can prove, once again, to my original point that we can create synergies and is a better home for a business versus stand-alone or any one of our competitors, then we'll not be shy to move. But once again, bolt-ons, easy integration and then also higher returns. That discipline is going to continue there.

Yes. Well, it looks like we're up on time, but thank you so much. Really enjoyed the conversation.

I enjoyed it. Thank you so much.

Thank you. Thank you so much. That was great. I learned a lot.