Eaton Corporation (ETN) has captured the attention of investors due to its strategic position in the burgeoning data center market and the ongoing "electrification of everything" trend. As the stock hovers below $400, potential investors may wonder whether now is the right time to buy.
Growing Valuation and Investor Sentiment
Historically, Eaton was classified among mature companies with low growth trajectories, often valued modestly based on stable earnings. Typically, such companies fluctuate around an enterprise value-to-EBITDA ratio of about 11 and a price-to-free-cash-flow ratio near 20. However, Eaton’s current market valuation indicates a notable shift in investor sentiment, pushing its ratios to approximately 19 for the EV/EBITDA and 28.6 for the price-to-free-cash-flow based on future estimates.
This growing optimism can largely be attributed to Eaton’s improved growth rates. In 2019, the company’s three-year average revenue growth rate was a mere 2.7%, but projections for 2024 show an uptick to an impressive 8.2%. Analysts expect Eaton’s overall revenue to grow at a compound annual growth rate (CAGR) of 9% through 2027, with earnings anticipated to rise at an even faster rate of nearly 14% annually.
Business Segmentation and Growth Drivers
The growth of Eaton can be attributed to its diverse business segments, particularly the Electrical Americas segment. In terms of operating profit, this segment has grown remarkably:
- 2022: $1.913 billion
- 2023: $2.675 billion
- 2024: $3.455 billion
Representing an impressive 87.5% increase from 2022 to 2024, Electrical Americas is predicted to account for about 17% of Eaton’s total revenue by 2025, largely driven by data center spending.
Additionally, the demand for utilities, which is expected to contribute 11% of revenue, is likely bolstered by power consumption from the data centers, two robust growth areas tied closely together.
Beyond just data centers, Eaton stands to benefit from trends in defense and aerospace, sectors projected to contribute approximately 6% and 9% to total revenue by 2025, respectively.
Risks to Consider
While the growth narrative surrounding Eaton is compelling, several key risks must be evaluated before making an investment decision.
Reliability of Growth Rates: Data centers and utility segments, while currently lucrative, are expected to account for a combined 28% of revenue by 2025. However, the sustainability of fast-paced growth driven by AI-led demand remains uncertain.
eMobility Business Struggles: Eaton’s eMobility segment, focused on components for electric vehicles, is currently unprofitable. While management predicts growth at double-digit rates through 2030, the traditional vehicle segment is only expected to grow at low single-digit rates. This dual performance creates the potential for margin pressures down the line.
- Valuation Concerns: Relative to non-pure play alternatives in the data center market, Eaton’s current valuation may seem high. Stocks like Vertiv, which focus exclusively on data center infrastructure, could present better opportunities for investors specifically interested in that space.
Conclusion: To Buy or Not to Buy?
Eaton Corporation undoubtedly presents an interesting investment opportunity, particularly with its exposure to two high-growth sectors: data centers and electrification. Analysts expect promising revenue and earnings growth that could appeal to long-term investors.
However, potential buyers should approach with caution. The high valuation metrics indicate that Eaton’s stock might be fully priced, relying heavily on continued high levels of data center spending for future support.
Investors concerned about margin pressures from the shifting environments of their eMobility and traditional vehicle segments should proceed with due diligence. A conservative approach might be to watch for clearer trends in data center growth, financial performance of the eMobility segment, and overall market conditions before making a buying decision.
In summary, Eaton’s strategic positioning and growth potential make it a stock worth considering, but the current price below $400 should be weighed against potential risks and market realities.
