Eaton Corporation plc (ETN) — Q1 2025 Earnings Call Transcript

Good day. Thank you for standing by. Welcome to Eaton's First Quarter 2025 Earnings Conference Call. Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Yan Jin, Senior Vice President of Investor Relations. Please go ahead.

Thanks, Jin. Before we begin, I just want to take a minute to acknowledge Craig Arnold as he prepares to retire at the end of this month, for his incredible leadership over the past 25 years at Eaton, but especially during the 9 years as Chairman and CEO. His focus on fostering a values-based culture, strong attention to detail and commitment to high standards have laid a very strong foundation for our growth. The actions he's taken to transform our portfolio have positioned us for faster growth, higher margins, and better earnings consistency. Under Craig's strategic guidance, we have consistently delivered strong shareholder returns with our stock value rising from $61.65 on June 1, 2016, to $294.37 as of April 30, 2025. Thank you, Craig, for your strong leadership and the legacy you leave us with. I'm really excited and energized to be leading Eaton during such an electrifying time. On that note, let's get into the results. We will start with some highlights from the quarter, where we've delivered another strong set of results to start the year. We generated Q1 record adjusted EPS of $2.72, up 13% from the prior year. Organic growth accelerated to 9% from 6% in the prior quarter, with particular strength in Electrical Americas, aerospace, and Electrical Global. We also delivered Q1 record segment margins of 23.9%, which was in line with our guidance and expectations. Meanwhile, market activity remained strong and orders remained at a very high dollar value. Total company orders increased 3% versus the prior quarter. As a result, the total Eaton book-to-bill ratio is at 1.1, with backlog growth year-over-year and sequentially. With the strong start to the year, robust backlog, and strong secular trends, we are set up to deliver another year of differentiating results while we navigate through an increasingly dynamic environment. While I will go into the details on the full year outlook, at a high level, we are raising our expectations for organic growth and reaffirming our adjusted EPS, cash flow, and share repurchases. Turning to Page 4 now. We presented this chart at our annual investor conference in March. It provides an overview of the 8 end markets we play in and the megatrends driving a generational growth opportunity for us. Few companies have such an opportunity in front of them right now, with multiple paths to growth. We remain very confident in the long-term market growth prospects for our end markets. Now turning to Slide 5. Allow me to quickly touch on Fiber Bond, an acquisition we announced at the annual investor conference, which we closed on April 1 this year. Fiber Bond is the right asset at the right time. Data center players are increasingly focused on capital efficiency and deployment speed to improve their competitiveness. Fiber Bond's innovative and customer-focused business positions Eaton as a one-stop shop to rapidly deploy power where it's needed. By deploying outdoor modular powering closures, data center customers can also expand their IT area and generate more revenue per square foot inside the data center. In data center markets, we continue to see construction starts and strong growth. The U.S. data center construction backlog now stands at 9 years based on the 2024 build rates, up from the 7 years of backlog we spoke about last quarter. We are also seeing strong activity in EMEA, in APAC, as well as regional and regulatory policies driving data center build-out globally. Okay. And now I'll turn it over to Olivier for the financial results.

Thanks, Paulo. I'll start by providing a brief summary of Q1 results. We posted 9% organic sales growth, well above our guidance range driven by broad strength in many of our end markets. We generated a record quarterly revenue of $6.4 billion and expanded margin of 80 basis points to 23.9%. Adjusted EPS of $2.72 increased 13% from a strong start to the year, above the midpoint of our guidance. Now let's move to the segment details. On Slide 7, we highlight the Electrical Americas segment. Once again, the business executed at a high level and delivered another record quarter. Organic sales growth accelerated to 13%, driven primarily by strength in data center and utility end markets. Our operating margin of 30% was up 80 basis points versus the prior year, benefiting primarily from higher sales. Orders from a dollar perspective remained at a high level. As expected, orders versus the prior year were down 4% on a holding 12-month basis due to a tough comparison from one large multiyear order in Q1 2024. Excluding this lumpiness, orders for the segment were up 4% on a rolling 12-month basis, and data center orders were up 11% on the same basis. Book-to-bill remains above 1 with 6% growth in our large $10.1 billion backlog, providing strong visibility for our organic growth in 2025 and beyond. Our major project negotiations pipeline in Q1 was up 18% versus the prior quarter, remaining at a high level, up 168% since Q1 2023. As Paulo discussed, we closed the acquisition of Fiber Bond on April 1. The next page summarizes the results of our Electrical Global segment. Organic growth accelerated from 5.5% last quarter to 9% this quarter, partially offset by a 2% FX headwind, with strength in data center, machine OEM, and utility end markets. We saw continued strength in APAC and a recovery in EMEA, with both regions posting double-digit organic growth. The operating margin of 18.6% was up 30 basis points over the prior year, driven primarily by sales growth and operating efficiencies. Orders were flat on a rolling 12-month basis with double-digit order growth on a sequential basis, up mid-teens in EMEA and GIS up double digits and APAC up more than 30%. Backlog increased 5% over the prior year and 6% sequentially, while book-to-bill remained strong above 1 on a rolling 12-month basis. Before moving to our industrial businesses, I'd like to briefly recap the combined electrical segments. For Q1, we posted organic growth of 11% and segment margin of 26.1%, which was up 80 basis points over the prior year. On a holding 12-month basis, orders were down 2%, and our book-to-bill ratio for the electrical sector remains above 1. We remain confident in our positioning for continued growth with strong margins in our overall electrical business. Page 9 highlights our aerospace segment. Organic growth accelerated to 13%, resulting in all-time record sales. We had growth in all end markets, especially in military aftermarket, commercial aftermarket, and military OEM. The operating margin was strong at 23.1%. On a rolling 12-month basis, orders increased 14%, up 10% from the prior quarter, with particular strength in military OEM and commercial aftermarket. Our book-to-bill for our Aerospace segment remains strong at 1.1, resulting in a backlog increase of 16% year-over-year and 5% sequentially. We are very encouraged by the strong results from the Aerospace team this quarter. Moving to our vehicle segment on Page 10. In the quarter, revenue was down 15%, including an 11% organic decline primarily driven by weakness in both commercial and ICE light motor vehicle markets in North America and a 4% unfavorable FX impact. Despite top line weakness, the team managed to deliver strong margins of 15.5% with a decremental margin of less than 20%. On Page 11, we show results of our e-mobility business. Revenue increased 2% to reach 3% organic growth, partially offset by a 1% unfavorable FX impact. Operating margins were flat to the prior year, which continues to reflect investments in our growth programs. We are seeing an expanding opportunity pipeline as customers redesign vehicles for lower costs and improved efficiencies. Now I will pass it back to Paulo to go over our market assumptions and guidance.

Thanks, Olivier. Before we walk through the details of our end market assumptions and guidance, I just want to address the uncertainties arising from the dynamic global trade environment. We will fully compensate for the tariff impact through the actions described on this chart. We have maintained a localized sourcing and manufacturing strategy globally for a long time. As you know, we've recently announced large investments to increase our manufacturing presence in the U.S. Those decisions are helping us be even more resilient to the trading impacts the world is experiencing. It's also important to highlight that following COVID, we have spent the last couple of years introducing additional flexibility, resiliency, and digital tools into our supply chains. Many of those actions noted on this slide are aligned with our long-term strategy and it will take time to be fully implemented as the global landscape continues to evolve. But that's the way we run the company today. In the meantime, we have also implemented our proven playbook to control costs and limit discretionary spending. We have and will continue to take the necessary commercial actions to offset the impact of tariffs. In dynamic markets like this, we rely on a strong Eaton culture and the value of our strategic relationships with customers and suppliers, so we can minimize disruption. Now we are shifting our attention to 2025 on Page 13. We have our latest view on the end market growth expectations. We continue to see growth across most of our end markets with a few adjustments to our assumptions, which are highlighted on the slide. In aggregate, broad market growth is similar to the view we shared last quarter, and we are confident in our ability to outgrow the market, as outlined in our increased growth guidance. On the plus side, we are raising the defense aerospace guidance to solid growth based on momentum we are seeing with increased government spending. However, we now expect slightly lower growth in electric vehicles, projecting solid growth instead of strong double-digit growth. We have also lowered our forecast for internal combustion engine light vehicles from slight growth to a slight decline. While we acknowledge the current economic uncertainties, we remain confident that the portfolio of businesses and end markets we enable Eaton to continue to deliver differentiated growth. Moving now to Page 14, we have our updated guidance for 2025 and Q2. One of the things we pride ourselves on here at Eaton is our ability to plan for and navigate through headwinds. Our healthy and diverse end markets, combined with our large backlog, continue to provide premium visibility to support our businesses. Our teams always target high internal plans, as you know, providing greater line of sight to additional opportunities to hedge against potential pockets of weaker growth. We are raising the 2025 organic growth outlook by 50 basis points to a range of 7.5% to 9.5%. We are reaffirming our adjusted EPS guidance. For 2025, we reconfirm our adjusted EPS range of $11.80 to $12.20. The $12 midpoint represents 11% growth in adjusted EPS over the prior year. We are also reaffirming our cash flow and share repurchase expectations for the year and we provided guidance for Q2 on this page. This reflects the net impact of the announced tariffs and assumes the current 90-day pause on reciprocal tariffs will persist through the end of the year. On the next page, we have the balance of our guidance for organic growth and operating margin. The high organic growth outlook includes increasing the Electrical Americas guidance by 150 basis points to a range of 12% to 14% growth. Meanwhile, we are decreasing vehicle growth by 350 basis points to a range of minus 5.5% to minus 3.5%, which reflects weaknesses in the light motor vehicles. For segment margins, our guidance range of 24% to 24.4% is 40 basis points lower than the prior guide. Our guidance reflects the impact on margins from our commercial actions offsetting the impact of tariffs on a dollar-for-dollar basis. As such, we are lowering the 2025 outlook for Electrical Americas by 80 basis points and in vehicles by 200 basis points. I will close with a quick summary on Page 16. We are in the right markets, and the identified megatrends are creating some of the biggest opportunities we have seen in our lifetime. The growth opportunities are everywhere. We had a very strong start to the year, but there's a lot for us to do. We've discussed before that high standards are deeply instilled in our culture, and we remain focused on delivering our commitments. We are prepared to weather any uncertainty ahead. So with that, I will open up for your questions.

Thanks, Paulo. For the Q&A today, please limit your opportunity to just one question and then a follow-up. Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys instructions.

I just want to say congrats to Craig. Five times in the market cap of a 100-year-old company is pretty incredible. So best of luck going forward. For my question, I wanted to ask about data centers, given all the market focus there. Could you just provide some color on Q1 performance? The comps are really tough, obviously, in data centers this year. I think you guys had 45% organic growth last year and 75% orders. So what should we expect for data centers for the rest of the year as well?

Thanks, Chris, for the question. Well, we remain very excited about this market. During our Investor Day last month, we highlighted that the fundamentals are really strong in the marketplace. Our business did exceptionally well in Q1, with very strong double-digit growth versus last year, actually stronger than the 45% that we shared with you in our last discussion. We are really proud of the team's performance there. In terms of the outlook, we expect orders to remain at a high level, supported by the high level of negotiation activity we have. As discussed before, we're also really excited about the Fiber Bond acquisition because it's timely when data center operators are considering their designs and how to move quicker in executing on their backlogs and increasing revenue per average square foot inside the data center. So we remain bullish that business is doing well, and this is a key focus for us moving forward.

I appreciate that. And then maybe just following up, has there been any change in the U.S. market competitive positioning here following Trump 2.0 tariffs? Obviously, you guys have a lot of big EU competitors. Also, we've heard a lot in the last couple of years about competitors adding a lot of capacity, whether it be transformers or switch gears, given the undersupply. So any thoughts on what that could mean?

Yes. No, thanks for the question. This is very important. It's no surprise that we are, by far, the biggest player in the U.S. in terms of our footprint historically, and we made record announcements to expand that footprint and capacity starting last year. We have a head start. All those projects are ongoing gradually, and I think we feel really good about the position we are in. In terms of the competitive advantages, we do a lot in the U.S., so we depend very little on the external world to serve this big market. Our other businesses in Europe and Asia don't depend on the U.S. Some other competitors serve the U.S. from Europe. We don't have that. We operate with a local-for-local strategy. While we're not advocating for tariffs, there is a positive effect on Eaton's competitiveness.

Congratulations to Craig. What a run. Appreciate that. And now I'll turn it over to Paulo. So first question on Electrical Americas order outlook. You had a tough comp in the first quarter. But how should we think about your Electrical Americas orders going forward for the balance of the year?

Thanks, Andrew, for the question. I would say we should expect orders to remain strong at the dollar value. Based on the record backlogs we have and the visibility into 2025, we feel good about Electrical Americas performance and execution, which is why we raised our guidance for the full year in terms of growth. As you pointed out, those orders can be lumpy, especially when you have a very large multiyear order in a single quarter. It is also important for us to track the pipeline in terms of negotiations. Our negotiation pipeline remains very strong, similar to past quarters. We see sequential momentum about 18% higher than last quarter, especially in larger businesses like data centers and industrial. For instance, data centers are up 18%, while industrial is over 40% up. We also have increases in smaller businesses like healthcare and education, among others. The only market showing a decline in negotiation pipeline is commercial buildings and transportation, but they represent a smaller portion of the overall markets. Overall, we feel confident in our future order pipeline.

To complement Andrew, you saw the guide, yes, at the midpoint, it will grow at 13% in revenue, and we expect the company, including Electrical Americas, to have a book-to-bill over one.

Okay. And just a follow-up on the Electrical Americas. Can you give us some color about your performance in the first quarter, particularly for utilities? We attended Distributech several weeks ago that seemed to be pretty optimistic, and your utility business has continued to post strong revenue growth over the last several years.

Yes. As we shared during our Investor Day, utilities are another market with very strong growth potential. We feel very positive about our performance in utilities, highlighted in March. The teams are doing a fantastic job, not only in North America but globally. If we were already very well positioned with our vast and comprehensive portfolio, we are preparing as we continue to invest in leading technologies. We are fully committed to this end market. Our electrical business globally for the electrical sector grew in the mid-teens compared to last year, which is a strong performance; high single digits globally and high teens in America.

So Electrical Global has been lagging, but showed a nice acceleration this quarter at 9% organic growth and pretty strong orders. You called out APAC orders and OEM also up, I think, double digits. So just curious if you could provide a bit more color on those two verticals.

Yes. Thanks for the question, Nigel. We had an excellent performance in Global this quarter, seeing growth around 9%. The individual businesses showed fantastic performance, particularly in APAC with mid-teens growth and low double digits for EMEA. The utility markets are thriving globally, as previously mentioned, and the data center market is also significantly strong worldwide. In these short-cycle businesses like OEM, we see a stabilization and recovery globally, with positive performance across several markets. I am encouraged by the results and appreciate the opportunities we have in improving our aerospace and Electrical Global businesses.

That's great. By the way, I noticed that you have a slide pack, and there are a few slides that seem to be missing from what we usually see. The mega project slide has always gotten a lot of attention. Can you provide an update on mega projects in the U.S.?

Thanks for the question. In retrospect, I think I should have added that slide back on. We track that very rigorously. Q1 was another strong quarter for announcements—42 projects totaling $169 billion, which is significantly above last year. If you look back, the monthly announcement rate increased to $57 billion. We emphasize that there is a long tail of businesses coming into the U.S. from those mega projects. According to Dodge data, the forecast sees around $300 billion in starts for this year compared to $135 billion last year. Even if we don't believe all those projects will start as planned, there's plenty of room for strong growth year-over-year.

We are tracking this, and cancellations remain at the 11% range.

To provide additional context, we've tracked orders from those projects, and we currently have a $3.6 billion negotiation pipeline. There is definitely acceleration, but it takes time, as there is a long tail for this business.

Could you share what the gross tariff impact is that you're facing here and give us a sense of how much of it is price versus cost and other actions?

First of all, we take tariffs very seriously. The teams meet frequently, and I personally meet with them weekly. The environment is very dynamic, making it challenging to disclose exact numbers. Expect us to run this with the strictest rigor possible, trying to mitigate cost pressures, and we'll recover costs dollar-for-dollar through pricing actions. Olivier, do you have anything to add?

We have a strategy involving managing costs, implementing supply chain actions, and executing pricing strategies. These three levers will work together to mitigate the impact of tariffs. We expect to recover from a margin standpoint over time, but not this year.

Understood. And in a separate question, Paulo, you mentioned focusing on global initiatives as one of your priorities as you step into a leadership role. While it's nice to see the market tailwind starting to kick in, how quickly can you act on organic initiatives or consider bolt-on acquisitions to enhance your position in growth verticals internationally?

Thanks for the question. There are many elements to Global's improvement, with operational improvements based on the business in hand. We have strong leadership and are committed to integrating new technologies. We're investing in Dubai, which will help us be a player in a market experiencing rapid growth. This includes having engineers focusing on project business across the region. We're not closing off to deals as they arise, but we’re not relying on them for our long-term strategy.

Craig, congrats on your retirement. I know this is a bit nitpicky, but the guidance now implies around 47% EPS in the first half, down from about 48% as of last quarter. Can we discuss the reasons for this shift between the first half and second half?

Yes. Thank you for your question, Nicole. You're correct. Initially, we indicated 48% for the first half, now down to about 47%. Six of the ten relates to corporate items, including higher interest associated with the financing of Fiber Bond and increases in corporate costs. About $0.06 or $0.04 is a delayed timing of tariff recovery. We expect to recover this on a dollar-for-dollar basis throughout the year, but headwinds will continue in Q2. Historically, the first half accounts for about 46% of earnings, so at 47%, we are slightly better than usual.

That was really helpful. I appreciate all the details. As a follow-up, I'm trying to understand the pricing dynamics. Did you take a haircut to volume expectations in the second half to account for macro uncertainties in the more short-cycle businesses?

Overall market expectations remain around 7%. There is a slight increase in pricing due to tariffs and a bit more volume that’s embedded in that 7%. We're confident in our backlog position that we can outgrow that market, which is why we raised our growth guidance for the year. Our approach to managing costs related to tariffs is ongoing, and our teams are dedicated to taking the necessary actions. We've done this before, and if we need to, we will go for pricing.

Special congrats to Craig, and I noticed that Olivier was polite not to name any names around retirement packages, so congrats.

I want to audit that number, Olivier. I'm not sure my retirement package is as big as what you suggested. We'll move on.

Can we dive deeper into the implications of going from a 7-year to a 9-year backlog for the data center industry? What are the implications and opportunities?

The implications are that it will not take 9 years for these projects to build. The industry will continue to find ways to build faster and more productively. Expect modular solutions, similar to our Fiber Bond acquisition, to become increasingly relevant as data center operators look for ways to execute quicker, maximize their revenue per square foot, and enhance the efficiency of capital. This will position Eaton as a preferred partner for these designs, given our capability to help customers become more competitive. Improved designs will yield better returns on investment as well.

What about five-year supply agreements? If the backlog is extending to 9 years, how are you being asked to adjust?

We have those long-term agreements, but I don't see a change there. Nine years seems too long and speculative at this point, so I haven't seen that yet.

Can you address barriers to entry? With increased growth, many competitors are entering the market. Chris Snyder mentioned it in his first question. How is Eaton positioned against this?

The designs of the future will determine the success of given companies. Eaton is present from the utility feeder down to the server rack, which gives us a tremendous advantage. While the market does attract many players, collaboration with chip manufacturers is necessary in today's environment. Not many companies, especially new entrants, can engage in these discussions effectively. This is another entry barrier that naturally appears as the market develops.

Congratulations, Craig. I know you don't want to provide the exact tariff impact, but if I look at the change in segment margins for Electrical Americas and Vehicle, what do you think explains it? I'm trying to understand the margin implications.

If you were to look, we haven't changed our guidance. The midpoint of EPS remains stable. You have to conclude that tariffs remain neutral from a dollar standpoint as well. We have noted that the guidance excluding tariffs and Fiber Bond remains unchanged compared to the start of the year.

Understood. And on the top line, it seems like there are better growth expectations, with some impact from pricing. Does it also look like there's a lag in pricing realization?

Yes, we intend to take care of backlogs as needed. There is some lag in realizing pricing, especially in Q2, so we expect it in our bottom line. Therefore, not only the below-the-line impact discussed, but operational margins will also reflect this lag. However, we fully expect to recover these margins as we progress throughout the year.

Can you talk about the opportunity for data center orders to reaccelerate in light of changes, specifically related to rack density? Is this transition reflected in your backlog? Or can we expect a spike in absolute dollar terms?

Everything you mentioned regarding increased rack power will benefit our business, leading to higher dollar per megawatt content. While it’s challenging to forecast orders on a quarterly basis, I invite you to consider our negotiation pipeline. Our data center business has seen significant growth, outperforming the previous 45%. Our negotiation pipeline is up 18% since last quarter. Thus, it's logical to expect continued strength in this market.

During our Investor Day, we projected that the data center market would grow at 15%. This estimate considered constraints on power, which was our business. Absent these constraints, this number could double. All hyperscalers have confirmed their capital expenditure levels during calls this week, so we maintain that 15% CAGR for data centers is still intact.

Is there a difference in content for greenfield versus retrofit opportunities, especially regarding the $1.5 million per megawatt content you referenced?

For retrofits versus new builds, we modularize solutions that provide similar designs to accommodate both types of approaches. Engaging with customers on their designs becomes a significant opportunity for us. On the Electrical Americas backlog, we target to maintain our book-to-bill ratio above 1, which remains our aim.

Discussing the recent Electrical Global performance, we've seen some acceleration in organic growth. What can you tell us about the restructuring charges incurred in that segment? How should we expect timing regarding the realization of savings from these programs?

Margin improvement in our global business has been a focus for our management team, which is why restructuring has been targeted there. The impact of the program will be more significant in the second half.

Got it. And as for cash conversion, there seems to be typical seasonality affecting cash collections, but I've noticed that day sales outstanding appears to have increased. Should we consider this in the context of increased business with hyperscalers?

The cash flow performance in the quarter was primarily impacted by inventory buildup, which was intentional. Similar to other companies, we built inventory to manage future tariffs. This increase was about 4 days of inventory, resulting in approximately $150 million. That inventory was built around parts that will be more heavily targeted by tariffs. We haven't changed our free cash flow guidance for the year, which should remain relatively flat year-on-year. Any variation would be due to how sales are phased in a particular quarter.

I wanted to discuss lead times in regard to your offerings. Are we back to normal lead times or still experiencing some delays?

We are not back to normal lead times yet. We see improvements, think in the range of 20% to 25% reductions depending on the product line. Most of our capacity remains loaded. We are continuing to invest, and we have projects in early stages that support the Electrical Americas team’s strong results which could yield good growth moving forward.

I believe you mentioned additional capacity in North America. Are these plans to build local-to-local going beyond what you've already planned?

We made this $1.2 billion additional investment in growth public much earlier than the tariffs were announced. We're simply executing on that plan. We feel good about our capacity additions for numerous reasons, particularly as market demands remain strong. Customer commitments give us confidence, and our capacity is fungible, so we remain well-positioned.

I think we have reached the end of the call, and I appreciate everybody's questions. The IR team will be available to address any follow-up issues. Have a good rest of your day.

Thanks, everyone.