Eaton Corporation plc (ETN) Earnings Call Transcript & Summary

I think the big difference is that we worked -- we looked at the architecture of a new 800-volt DC data center more holistically than just one product line. We look at everything that will be required to win in the future, and we decided, once again, think big and act boldly, what do we do to be in a leading position in each one of those 4 blocks. I'm going to run through them in a minute. Before I do that, I must say this is part of our culture in our company, we could settle where we are today because we are a leader in data centers, especially with the Boyd acquisition, the Fibrebond acquisition. why would we bother than looking at transforming that business that we are a clear leader from the utility feeder all the way down to the chip. The answer is that there is economic value to moving to 800-volt DC for our customers, which is a 5% losses that we can avoid by moving that way. Just do the math on 5% on a gigawatt site, it's a lot. So if our customers want that to happen, this is going to happen. So you want to be in a position to drive that, and we want to be in a position to be future ready. Why, The core of your question, why you should feel that Eaton is leading there? I believe we are leading each of the 4 major blocks I'm going to talk about. The first block is medium voltage solid-state transformers. We were developing our own technology, and we decided 2 years ago to go after resilient power. We're accelerating that development. The feedback we get from both hyperscalers, multi-tenant data centers, but also the silicon providers is that we are ahead of competition. As a consequence, we have 10 prototypes that were committed. So we got those 10 orders for prototypes with these people. We are working on that as we speak. And we also decided to start preparing our lines in where we produce our UPSs in a flexible way that we could produce UPS and solid-state transformer. So we are ready. And we start to see activity for larger bids also coming in the second half of the year. We're already working on them. So that's the first block. Leading position. And by the way, we are also working as a chair or co-chair for all the safety and the code discussions among other suppliers to be ready for that new world. The second block is around when you have the solid-state transformer, you need to have DC breaker technology. So we're strong there as well. We've been doing breakers forever. We are leading the pack there as well. The third piece is around power electronics. Think about UPS, think about side cars. We are very strong there, and we don't see any issues migrating to the new world. The fourth one is actually liquid cooling. You can't do 800-volt direct-to chip if you don't have liquid cooling done properly. We talk about boy, they don't need to repeat that. So everywhere you look, we have a leadership position in each one of the 4. And once again, we are working to make that possible. We don't need the market to migrate to that to be successful. But when it does migrate, we're going to be leading the pack.

As you look at those technologies coming together, rack density is rising, how do you think of the content opportunity for Eaton, especially with the move to 800-volt and liquid cooling taking share?

Yes. So I'll talk to you about the transition from cloud to AI, and then we can talk about this new world with 800-volt DC. So the move from cloud data centers to AI make a very, very favorable impact on our content per megawatt, moving from 1.5 million per megawatt in the cloud space to 3 million on AI space before the Boyd acquisition. With the Boyd acquisition, that content goes up to 3.4. So we moved from a 1.5 to 3.4 already as a company. Looking forward, there are many things we need to answer with our customers. We're still working on the designs of the new 4 building blocks I described, the reference designs we agreed with NVIDIA, et cetera, et cetera, but still a moving target. I think the best number for all the investors in terms of modeling is still to use the 3.4 we have today. We're going to mature on that discussion with customers. When we have a better view, we can update you guys. But 3.4 is a good planning number for the future.

And then just looking at demand more broadly, data centers orders were up 85%, revenues up about 65%, how much runway is left? And how do you answer investors who think this pipeline can be a bubble?

That's a $1 trillion question. So the market is really strong. Let me give you this. Of course, we grew 65% revenues, 85% orders. But you look at the pipeline, the negotiation pipeline was over 130% in data centers. And this is what we are working today as we speak. We're negotiating with our customers. And then you look at what our customers announced that most of those projects, we are not even yet quoting for. And every time you look at that, the number is higher. So when we released our Q2 numbers, the total announced projects for data centers was 307 gigawatts to be built, just think about that. And now today, we checked this week, is already 342. So less -- a month later is already more. And then you contrast to what this industry has ever built, we have installed 50 gigawatts. So today, operating there 50 gigawatts. So we are talking about between 6 and 7x what exists today is what's going to be built in the next years. Most of this is not going to turn into '27 or '28 revenue. So it's going to be a longer cycle. That's the way to think about it. So everywhere we look, we see strength in this market. I'm also aware of the discussions around models. I think large language models can adapt much quicker than the physical infrastructure. I don't see a slowdown. I don't expect a large slowdown anytime soon.

I guess as you think about that visibility and orders, like your backlog was up about, I think, $700 million sequentially, book-to-bill of 1.3. What kind of visibility do you have? And how does that -- how far out does that look?

So once again, we have a larger business just the data center. So we track our negotiation pipeline. Our negotiations pipeline was up 60%. And a subtract of that, a part of that is data centers being up 130%. So we have a lot of visibility. We also look beyond that and look at the markets. I just talked about 340 gigawatts of data center to be built. We look at mega projects announcement that goes much broader base to chemical plants and pharmaceutical plants and semiconductor plants. So every indication, including reshoring, extends to a much more solid market coming up, which is great for data centers, but goes much beyond data centers. We are proud of the portfolio we have because we have multiple paths to growth, including utilities, including commercial and institutional, industrial facilities, et cetera, et cetera. And let's not forget the smaller part of our portfolio, which is the short-cycle business, we see some green shoots of that market coming back. So it's a good setup.

To that point on the verticals outside of data centers, the growth does not seem only driven by one end market. What other verticals have been most attractive? And what are the underlying drivers there?

So we -- still today, data centers get most of the air coverage, which is understandable. It's a very exciting market. But the biggest segment we have today is still commercial and institutional. We have a massive, massive and very traditional, very well-performing distribution network as a company, especially in North America, but also over the world. So that is a growth -- a perpetual growth market. It is not susceptible to much of the cycle and it is a good business to be in. We also are very strong in utilities. And utilities, you have all the dynamics we talked about being data centers. But even before data centers, there is electrification of society in many different areas, right? And loads were increasing even before data center. They're going to increase much more. And you still have on top of that grid hardening because of natural disasters, et cetera. But you also have old infrastructure, especially in North America that needs to be replaced. So the utility market is a growth story today, and it's going to be even stronger in the future. Just think about all this power generation coming online that all those gas turbines being sold, et cetera, this is going to turn into transmission already now and it's turning to utility distribution business for us in the next couple of years. So this is coming our way. So it's a great place to be. And then again, we have other markets in the electrical franchise, they're also coming back like machine OEMs. We see that coming back. We also see distribution IT, which is more on the edge, not so much on data center. That market is also recovering. So we have many paths to growth. Let's not forget about aerospace as well that adds up.

Then kind of shifting gears, looking at Electrical Global, 18% organic growth. What's been driving that strength? And how durable is it given what some of your peers have been saying about Europe?

So we are really proud of the global electrical franchise as well. So you said 18% growth. We see that every business inside the global segment did their work. So I'm talking about APAC. I'm talking about EMEA, both growing 20% organically. And then our global energy infrastructure business related more to energy markets growing high teens. So everyone delivered on the quarter. The underlying performance is motivated by improvements in our portfolio, improvements in execution and also the fact that especially in Asia and in Europe that we are getting a lot of traction on data centers. Coincidentally, we reported that in Q2 that the data center business for the global segment grew the same 65% as the North American business last year, coincidentally. But if you look at their backlogs for the whole business, Global, the backlogs were up 103% year-over-year. So large, large orders gaining share, gaining momentum. And even if you look at the total backlog, and I got the question earlier today, well, Paulo, how much of that was Boyd? Boyd was half of the backlog. If you deduct Boyd, the traditional legacy Eaton businesses in Electrical Global grew backlog 54%. So very strong performance. The mindset back to think big and act boldly and win together is about not looking at PMIs, not looking at this -- if we have market share gains, we have the platform, and our customers in the U.S. want us to be successful elsewhere, let's win with them. Let's win with the hyperscalers, let's win with the multi-tenant and let's win with the local players as well. So that's the mindset. No one is looking at PMIs.

And honestly, it seems like all the electrical players have been able to beat and raise on AI demand. What differentiates Eaton?

I think what differentiates Eaton is that we started early in this moment of recognizing we need to ramp. So we have most of the headache behind us. I told you guys that Q4 and Q1 will be the bulk of the disruption. We have that behind us. The other thing that differentiates us in this environment is that we can categorically say today, we have the most complete portfolio from the grid all the way down to the chip. Everything you see inside the data center that matters. We have a strong presence as a company. And we are not taking a victory lap here. So the difference is that not only we have that, we are saying, what's next and let's be ready for that environment where this is going to change to 800-volt DC, and we want to be the leader in that new world. And we have all those 4 tech blocks I talked about. So the difference is we are already today in a very strong position all the way from the utility down to the chip, one. Two, we are working in being future-ready in that particular market. Three, we don't depend on data center only. We have many other growth avenues you asked me about. So that differentiates us. The fact that we have that connection to utility market, data center is something we want to explore more as well because we can help our operators -- our data center operators to be more successful in the way they handle the loads with the utility. So it's a unique setup, and I think this differentiates us. The other thing that differentiates us is the culture because we have this culture of humility, courage and collaboration that not everyone is displaying the same way.

And between the capacity coming online, the portfolio coming together, as we look out to the 2030 targets, that $31 billion revenue for electrical, at this point, is that maybe a floor? Can that push higher?

It is a floor. You got me young. I'm looking at him here. We need to see investors next year ready. Why is it a floor? When we announced the 2030 growth setup, and let's just summarize to all investors here, we said we would grow between 6% and 9% organically, so 7.5% at the midpoint. We said we will reach 28% margin -- segment margin, and we would reach 32% margin in Electrical Americas. As you look at our setup today, including our guidance for this year, we're going to reach already 33%. And what we didn't have in our model, and I told everyone, so we conservatively baked only 17% growth in data centers in that model. And in Q2, we completed 8 consecutive quarters of growth beyond 35%, including last one was 65%. So we're clearly ahead because of the data center growth, we also didn't include in that growth any of the M&A dollars. I said we have a strong balance sheet. And since then, we deployed $13 billion in acquisitions. So that was not part of the calculus. What also was not part of the calculus was the fact that back then, we still have and still have today the mobility business. But moving forward, as they become part of this combined business with Dana, that will have an impact -- a positive impact on our growth rates organically and also in terms of our margins. So we need to get all of this together, probably going to be seeing you guys next year to make a mid-cycle review to the upside.

And I guess at this point, demand seems like it's pretty hard to argue, but what most people have started to poke at is execution risk. I think some of your peers have pointed to supply chain congestion and pushouts in project timing. How has Eaton been able to deliver through that environment?

So we've been there. It's the reality, right? We started earlier than other folks, which is a good position to be in today. So most of that hard work and it's hard work was a headwind for us in Q4 last year and Q1 this year. So think about building new facilities physically, but also staffing, training people, but also bring your supply chains along. So the numbers I described before of 25% revenue per day increase, that's the way we track. We track revenue per day increase. We could only get there because we did the homework in the last 18 months. Now in a much better place, having 18 of our 24 expansions behind us and ramping really fast. So we see that most of that headache is behind us. Moving forward, what we're going to do a little bit differently is to have not so many projects done at once. We did a lot of catch-up as a company. So we announced one project here. We might have another project launched next year, but we should not expect the company to be running 20 projects in parallel.

I think we're about at time, but thank you again. Really appreciate it.

Thank you so much.