Eaton Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 2, 2023

There are 13 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton First Quarter 2023 Earnings Call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. And as a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yin Zhen.

Operator

Please go ahead.

Speaker 1

Hey, good morning. Thank you all for joining us for Yitin's Q4 2023 earnings call. With me today are Craig Arnold, our Chairman and CEO and Tom Oakray, Executive Vice President and Chief Financial Officer. Our agenda today includes the opening remarks by Craig, Then he will turn it over to Tom, who will highlight our company's performance in the Q4. As we have done on our past calls, We'll be taking questions at the end of Craig's closing commentary.

Speaker 1

The press release and the presentation we'll go through today have been posted on our website. This presentation including adjusted earnings per share, adjusted free cash flow and other non GAAP measures, they are reconciled in the appendix. A webcast of this call is accessible on our website and will be available for replay. I would like to remind you that our commentary today All included statements related to the expected future results of the company and are therefore forward looking statements. Our actual results may differ materially from our

Speaker 2

Okay. Thanks, Jen. We'll start with some highlights of the quarter on Page 3. And I'll lead off by noting that we've delivered another strong quarter. We generated adjusted EPS of $1.88 for the quarter, well above our guidance range, a record for the quarter and up 16% from prior year.

Speaker 2

And we continue to post strong margins, Q1 record of 19.7%, Up 90 basis points over prior year. Our sales were $5,500,000,000 up 15% organically, Our 3rd quarter in a row of 15% organic growth. We have particular strength in our Electrical Americas business, which was up more than 20%, including very strong growth in commercial, institutional, utility and data center markets. We also had exceptional growth in our commercial aerospace and e mobility businesses. Our orders also came in ahead of expectations for the quarter.

Speaker 2

On a rolling 12 month basis, electrical orders were up 13% and aerospace orders increased by 21%, which led to another quarter of record backlogs, up 39% for Electrical and 27% for Aerospace. I think it's well understood at this point, but I'd note once again that reindustrialization, infrastructure spending along with 2nd, the growth trends of electrification, energy transition and digitalization have fundamentally changed the growth prospects for our company. Lastly, free cash flow in the quarter was nearly $300,000,000 driven by higher net income and improved working capital. So I'd say a good start to the year to keep us on track to deliver our free cash flow guidance despite higher revenue and receivable balances. So on balance, I'd say we're off to a very good start for the year.

Speaker 2

Moving to Page 4, I'd like to once Again, if I like that Eaton is marking its 1 hundredth anniversary of our listing on the New York Stock Exchange. And as many of you saw, we celebrated by ringing the bell In early March, Eaton is one of 32 companies who have reached this milestone. I'd say, our longevity on the exchange in Our resiliency is really a function of our ability to adapt to a changing world. But what has been constant over that time is spirit of innovation that guides us and our commitment to all of our stakeholders, our employees, our customers, our shareholders, Communities and all of society. Now as Eaton stands at the forefront of perhaps the most significant growth trends that we'll see in our lifetime, We're convinced that our best days are still ahead of us.

Speaker 2

And we've been busy planning for this moment. As we look at Eaton today, we position ourselves as our customers' trusted partner across power management spectrum. And Slide 5 provides a good example of how we're playing across the electrical value chain from power generation to power distribution So how it's consumed in various applications. We're building a business that supports our customers with a full range of end to end solutions, Beginning with deep domain expertise and specific applications and the ability to specify electrical solutions, we're now providing intelligent electrical products, Offering data as a service, providing software solutions, doing installation and commissioning and providing aftermarket services. Our role has changed from simply selling components to helping owners fulfill their changing energy needs.

Speaker 2

We're also proving that we can leverage our technology and create scaled solutions that serve all of our end markets. For those of you who were with us at our March meeting in New York, You saw an example of this in a new product we call Breakdoor. Breakdoor is a combination of a breaker and a contactor. We developed the technology in our Electrical business and have successfully sold it in our eMobility and Aerospace businesses. And as the electrification of everything continues, the need for Eaton's technology and solutions will certainly continue to grow.

Speaker 2

And the primary source of this growth is coming from the megatrends that we've discussed. In addition to electrification, We're benefiting from energy transition from digitalization and the reindustrialization of the U. S. And European markets, And we're seeing record capital spending levels. And as you know, this capital is being supported by an Unprecedented level of infrastructure spending by governments around the world.

Speaker 2

And while early, we're tracking a large number of infrastructure related projects. For example, in our Electrical Americas business, we've already seen over $1,000,000,000 of projects and have won roughly $450,000,000 of orders. And as this chart reflects, we're also at the beginning of a strong aerospace growth cycle and seeing rapid adoption of electric vehicles. Collectively, these trends have positioned the company for strong growth for the foreseeable future. Next on Page 7 of the presentation, we provide an example of how reindustrialization is creating a record number of mega projects.

Speaker 2

And we define a major project as a project with more than $1,000,000,000 of capital. Since 2021, Announced nonresidential mega projects have a cumulative value of almost $600,000,000,000 At least 3x historical run rate for non residential projects. And this is North America only. $600,000,000,000 announced over the last 9 quarters, dollars 400,000,000,000 more than the historical run rate. These projects are certainly in various phases of design, planning or construction.

Speaker 2

But as you can see, These secular trends are translating into specific projects and they haven't slowed down. There's billions more in the planning stages, Which will certainly sustain our growth for years to come. On Slide 8, we take you from the $400,000,000,000 announced mega projects, What it means for the electrical industry. We estimate that the electrical content on these projects is in a range of 3% to 5% of the total project value. This suggests $12,000,000,000 to $20,000,000,000 of incremental electrical revenue.

Speaker 2

Keep in mind, there's certainly a wide range of electrical content on various projects and our exposure is tied more closely to building infrastructure. But assuming these projects get planned, designed and built over the next 5 to 7 years, they will expand the electrical market by some $2,000,000,000 to $4,000,000,000 a year. And that's just from what's been already announced in mega projects. We naturally expect more large and small projects to come. Yes, I'd say these products are a good example of how megatrends are playing out and creating a very different growth outlook for the electrical industry And one we think will run for decades or more.

Speaker 2

Another helpful proof point is represented on Slide 9, where you can see how Our negotiation pipeline has grown. As you can see, our negotiation pipeline has doubled from what we've seen historically. In 2022, we saw nearly $5,000,000,000 of projects in our negotiations pipeline in Electrical Americas alone. And similar to mega projects, we're seeing broad strength in manufacturing and data center, industrial and utility market. This large step up in negotiations has further supported our expectations further supports our expectations for strong markets and faster organic growth as we go forward.

Speaker 2

And just one additional proof point is noted on Page 10. Here we show a few examples of how these projects are Translating into specific orders. As we've reported, our electric orders have been at record levels for 2 years now. So what we're demonstrating here is how these mega projects are translating directly into large wins for our electrical business. For example, we've won $180,000,000 of orders to provide power management solutions for 2 new EV plants in North America.

Speaker 2

Specifically, we're providing power distribution equipment and Brightlayer industrial remote monitoring software. Another example is a $100,000,000 order for a new U. S. Semiconductor plant and we're already working on Phase 2 of this project, which could be even larger. So overall, we're seeing record project announcements, record negotiations, A record set of orders that has led to record backlogs.

Speaker 2

And keep in mind, the revenue impact is mostly in front of us. Moving to Page 11, we're also benefiting from megatrends in Aerospace and Vehicle. We're at the beginning Aerospace growth cycle in both commercial and defense market. Specifically, commercial OEM build rates are expected to grow in the mid teens over the next several years. And our commercial aftermarket should also grow by double digits as global revenue passenger kilometers continue to recover to pre pandemic levels and beyond.

Speaker 2

We've also noted the significant step up in defense orders and expect to see a significant lift in defense revenues beginning in 2024. As a point of reference, our defense orders have more than doubled from 2019 level. And in recent years, we've run increased content on both commercial and defense platforms. In vehicle, Electrification continues to accelerate and we now expect global EV penetration rates to exceed 50% of global auto sales by 2,030, up from our prior estimate of 40%. While we're not providing any new revenue updates today, we once again are relooking our forecast for our eMobility segment.

Speaker 2

And on Page 12, we highlight a few key wins in our Aerospace and eMobility businesses. Beginning with a $500,000,000 win for cryogenic coolers and controllers for the Citi Airbus Urban Air Mobility Program. The CityAirbus win is a good example of how digitalization software And electrification are beginning to benefit our Aerospace business. And as Tom will report shortly, we're seeing more than 30% growth in our defense and commercial aftermarket orders. At Ini Mobility, we continue to realize significant wins.

Speaker 2

The most significant of which are coming from our power distribution product line within our eMobility business. You'll recall, This is where we're able to leverage our broader electrical business and our unique breakthrough technology. Our latest set of wins comes from a leading European Automotive OEM and will generate $100,000,000 a year of mature year revenues. So like electrical, our industrial businesses are delivering significant wins tied to long term megatrends that will support faster growth. When you combine the businesses, we're confident that our market should grow at more than 2x the historical rates.

Speaker 2

And as we've stated, we're in the early innings. These trends are expected to deliver outside growth for years to come. With that, I'll turn it over to Tom to walk us through Q1 financial results and updated guidance.

Speaker 3

Thanks, Craig. On Page 13, I'll start by providing a summary of our strong Q1 results. For the 3rd consecutive quarter, We generated organic growth of 15%. Revenue was up 13% with the organic growth reduced by 2 percentage points of unfavorable foreign exchange. Operating profit, a first quarter record, grew 19% And margins expanded 90 basis points to 19.7 percent, also a Q1 record.

Speaker 3

Adjusted EPS increased by 16% over the prior year to $1.88 All in, The strong organic growth and margins enabled us to report a 1st quarter record adjusted EPS. Our higher growth not only demonstrates the megatrends, but also the importance of prioritizing our customers by carrying higher levels of inventory when supply chains were challenged. Lastly, our free cash flow $209,000,000 was nearly $300,000,000 above prior year and exceeded our expectations. You will recall from our Q4 call, we expected free cash flow to be relatively flat year over year. Moving on to the next chart.

Speaker 3

Our Electrical Americas business had another very strong quarter. We have set Q1 records for sales, operating profit and margin. Organic sales growth was 22%. Electrical Americas has generated double digit organic growth for 5 consecutive quarters, including back to back quarters of at least 20% growth. On a 2 year stack, organic growth is up 32%.

Speaker 3

In the quarter, there was broad based growth in all end markets with especially robust growth in commercial and institutional, Utility and Data Center Market. Specifically, we posted 25% organic growth and our data center revenues in Q1. So we continue to see very strong growth in this important market. Utility and Commercial and Institutional were up more than 30%. It's also worth noting that we posted strong revenue growth 17% in our residential business.

Speaker 3

The 2 year stack is over 40% growth. We're seeing strength in multifamily homes, completion of single family homes in process and increased electrical content per home, which are more than offsetting weakness in new single family start. Operating margin of 22.9% was up 380 basis points versus prior year, benefiting from higher volumes. Incremental margins were very strong at more than 40%. We continue to manage price effectively to more than offset Inflationary Pressure.

Speaker 3

Orders and backlog show continued strength. On a rolling 12 month basis, Orders were up 18%, which remains at a high level with particular strength in data center, distributed IT, Utility and Industrial Market. On a quarter over quarter sequential basis, orders grew 19%. We're also continuing to build backlog. Backlog was up 51% versus prior year and up 9% sequentially.

Speaker 3

In addition to the robust trends in orders and backlog, Our major project negotiations pipeline in Q1 was up more than 20% versus prior year and nearly 20% sequentially from especially strong growth in data center, water, wastewater and Transportation Market. Overall, Electrical Americas had a very strong quarter to start the year. On Page 15, you'll find the results of our Electrical Global segment, which posted all time record sales of $1,500,000,000 Organic growth was up 8%, which was partially offset by headwinds from foreign exchange and a divestiture. Organic growth was driven by strength in utility, data center and distributed IT market. Our data center revenues for Electrical Global increased 32% in the quarter.

Speaker 3

Utility was up 25% and Distributed IT up 20%. Operating margin of 18.3% was down compared to prior year, primarily from manufacturing inefficiencies and investment in growth, partially offset by higher sales volume and inflationary price recovery. Orders were up 4% on a rolling 12 month basis with strength in data center, commercial and institutional and Utility Markets. Sequentially, orders grew 12%. Backlog increased 3% year over year and 6% sequentially.

Speaker 3

I'm also pleased to highlight that last month we closed the acquisition of a 49% stake and Jiangsu Ryan Electric Company. This is a Chinese based business with approximately $100,000,000 of revenues, which manufactures power distribution and sub transmission transformers and will accelerate Eaton's growth in renewable energy, Data Center, Utility and Industrial Market. This is Eaton's 4th JV in China in the last 2 years, allowing us to expand our market presence serving high growth markets inside and outside of China. Before moving to our Industrial businesses, I'd like to briefly recap the combined Electrical segment. For Q1, We posted organic growth of 16%, incremental margin of 34% and operating margin of 21%, which was 180 basis points of year over year margin improvement.

Speaker 3

Orders grew 13% on a rolling 12 month basis with sequential growth in the quarter of nearly 20% compared to roughly flat sequential order growth in the 6 years prior to the pandemic. Backlog grew 39% in the quarter and 8% sequentially. On a rolling 12 month basis, Our book to bill for our electrical sector remains very strong at above 1.2. It was also above 1.2 for Q1. We remain confident in our positioning for continued growth with strong margins and our overall Electrical business.

Speaker 3

The next page recaps our Aerospace segment. We posted Q1 record for sales and operating profit. Organic growth was 13% with a 1 percentage point headwind from foreign exchange. Growth was primarily driven by strength in commercial aftermarket, up more than 30% and commercial OEM, up more than 25%. Operating margin was 22.5%, which was 40 basis points over last year, driven by volume growth and inflationary price recovery.

Speaker 3

Order growth and backlog trends also remain encouraging. On a rolling 12 month basis, orders were up 21% organically with strength across all end markets, including continued outgrowth in defense OEM orders. Similar to the second half of the year, we continue to see second half of last year, we continue to see strong growth In our defense orders in the quarter with OEM up 55% and aftermarket up more than 40%. On a rolling 12 month basis, our book to bill for our Aerospace segment remains very strong at more than 1.2, including more than 1.25 for Q1. Year over year backlog growth increased 27% in Q1, an acceleration from up 21% in Q4.

Speaker 3

Moving on to our Vehicle segment on Page 17. In Q1, revenue was up 10% With 11% organic growth and 1 percentage point of unfavorable FX, we saw particular strong growth in both the Americas and IEMA markets. Operating margins came in at 14.5% with unfavorability to prior year primarily due to manufacturing inefficiencies, partially offset by higher sales volume and price cost. We continue to make progress towards securing more sustainable technology wins, which most recently includes multiple new programs for our e POWERTRAN solution. On Page 18, we show results for our eMobility business.

Speaker 3

We generated strong growth in the quarter. Revenue was up 17%, including 18% from organic growth. Margin was down 30 basis points versus prior year driven by higher manufacturing start up costs associated with new electric vehicle programs. We remain very encouraged by the growth prospects of the eMobility segment. We continue to leverage Our capabilities across our entire portfolio, including core technology in both Electrical and Industrial Businesses.

Speaker 3

Since 2018, we have won $1,400,000,000 of mature year revenues in this business with many of these programs ramping up in 2023 2024. This strong momentum includes Additional recent wins with Breakdore, including on next generation battery platforms with a large European OEM. Next on Page 19, we show historical backlog charts for the Electrical Sector and Aerospace segments. We think it's important to illustrate how backlog has grown over time. Our record backlog was roughly $12,000,000,000 to end Q1.

Speaker 3

This is up nearly 3 times The ending 2019 level. These metrics provide us with great confidence in the outlook for the full year and going forward. On the next page, we show our fiscal year organic growth and operating margin guidance. We are raising our organic growth guidance for 2023. We continue to have a robust negotiations pipeline and build backlog with particular strength in Electrical Americas and Aerospace.

Speaker 3

We now expect organic growth in Electrical Americas of 11% to 13%, up 300 basis points from our prior 8% to 10% guide. We're also raising Electrical Global 200 basis points to 6% to 8% from 4% to 6%. And we're increasing Aerospace 200 basis points to 10% to 12% from 8% to 10%. In total, we're increasing our 2023 organic outlook by 200 basis points from an 8% midpoint to a 10% midpoint. Our strong end market growth forecast combined with building backlog provides tremendous visibility and confidence in this 2023 outlook.

Speaker 3

For segment margins, we're raising our guidance range for Electrical Americas by 20 basis points to a revised range of 23.3 percent to 23.7 percent, which reflects the continued strong momentum that we have in this business. Overall, we are reaffirming our total Eaton margin guidance range of 20.7% from our 2022 all time record margin. For eMobility, we are adjusting both the organic growth and margin ranges. This is primarily due to delayed OEM launch plans and higher start up costs related to large new program wins. In summary, we continue to be well positioned to deliver another strong year of financial performance.

Speaker 3

On Page 21, we have the balance of our guidance for 2023 and Q2. Following our strong Q1 performance and improved organic growth expectations for the year, We are raising our full year EPS range to $8.30 to $8.50 At the midpoint of $8.40 we have raised guidance by 0 point 1 $6 This represents 11% growth in adjusted EPS in 2023. We're also raising our CapEx guidance from $630,000,000 to approximately $700,000,000 to fund additional investments for growth, including in our Utility business where we continue to experience strong increases. Free cash flow guidance remains unchanged. For Q2, we are guiding organic growth of 10% to 12%, segment margins of between 20 point 5% 20.9 percent, representing 60 basis points growth at the midpoint versus prior year And adjusted EPS in the range of $2.04 to 2 $0.14 a 12% increase versus prior year at the midpoint.

Speaker 3

Now I'll hand it

Speaker 2

back to Craig To wrap up the presentation. Thanks, Tom. Now turning to Page 22. As we continue to track our end markets, we want to provide a slightly revised look and our assumptions for the year. Once again, we do expect a mild recession in 2023 and we built that into our base case assumptions.

Speaker 2

But with healthy demand and strong secular growth trends, we continue to expect growth in almost all of our end markets. And we raised our growth assumption for the utility market from solid growth to strong double digit growth. Here, Energy Transition and Electrification continued to gain momentum. And we've increased our residential market from declining to flat. So while we recognize the slowdown in U.

Speaker 2

S. Single family housing market, the combination of resilient renovation market, Pricing momentum and strong backlog now supports an upward revision. And as Tom noted, we posted a 17% organic growth in Residential in Electrical Americas in Q1. The balance of the forecast remains unchanged, but I want to emphasize once again that Market concerns about nonresident construction markets, we have a robust negotiation pipeline, a growing backlog and strong orders. Data centers, utility, industrial, commercial institutions continue to perform extremely well.

Speaker 2

Now I know that most of you have drawn reference to the declining PMI data, but I point out that our market and revenue growth are much more aligned with capital spending, where we continue to see strong momentum. As a result, we do not expect any of our end markets to decline in 2023 and most are expected to see healthy levels of growth. Let me close on Page 23 with just a few summary comments. Once again, we delivered a strong quarter and set a handful of Q1 record. We delivered 15% organic growth and have record backlogs.

Speaker 2

While electric orders are experiencing some expected normalization as supply chains continue to improve, the secular growth trends and strong execution Support another strong year of growth. Having exceeded our Q1 forecast and continued secular tailwinds, We're raising our guidance for the year. Despite macro uncertainties, Our markets are performing well and we're improving our internal execution. And as I highlighted, we're seeing more evidence that megatrends are accelerating. I'll stop here and open it up

Speaker 1

for any questions you may have. Thanks, Craig. For the Q and A today, Please limit your opportunity to just one question and a follow-up. Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys the instruction.

Operator

Thank You will hear an acknowledgment tone that you've been placed in the queue and you may remove yourself from queue at any time by repeating the 10 command. Our first question is from the line of Joe Ritchie from Goldman Sachs. Please go ahead.

Speaker 4

Thanks. Good morning, everyone, and great start to the year.

Speaker 2

Good morning, Joe. Thank you. Thanks, Joe.

Speaker 4

Let me just kind of start on the Electrical Americas margins. Clearly a standout this quarter, I think your highest quarter highest first quarter ever. As you think about kind of like the incremental margins going forward, it looks like you posted About a 40% incremental in the Q1. How should we be thinking about the rest of the year? Are there any Yes, items that potentially reverse as you progress or do you expect incrementals to be as strong throughout the year?

Speaker 2

We appreciate the recognition, Joe. And our team in the Americas is just doing an outstanding job of executing. And as we talked about We had fairly sizable inefficiencies in our manufacturing operations as we were dealing with a number of supply chain related disruptions. And so those got clearly better into the Q1. And we would expect that, as we go forward, while The incrementals for the company, we're still calling the company in and around 30%.

Speaker 2

We do expect our Americas business to perform better than that

Speaker 3

There were no unusual items in the Q1 driving the Americas margin.

Speaker 4

Got it. That's super helpful. And look, Craig, you outlined a lot of reasons to be Excited about the growth dynamics for the companies going forward. I saw you took up the utilities expectation for the year. I'm curious, are you starting to See some of the money loosen from the Jobs Act, particularly on the grid side, Or what's kind of driving your increased expectations on utilities growth for the year?

Speaker 2

Yes. I mean, this is something that had been long Quite frankly, Joe, by us, as you know, as we think about all of these megatrends of whether it's electrification of the economy or energy transition, We knew at some point the utility market would have to start to make the kinds of investments that are going to be needed to support of the economy. As I mentioned, I think on the last earnings call, one of the longest lead time pieces of equipment that you could order today In the electrical industry is a transformer. And in many cases, lead times are 12 months or beyond. And so we continue to See the utilities making investments in their distribution infrastructure to really support this energy transition that's taking place, the electrification of the economy.

Speaker 2

And so, yes, we think the utility market is going to be a really strong growth market for some years to come as they deal with needed investments. And so, No question, as we began the year, we were a little bit conservative in terms of what the expectation is, but it's coming through. As you heard from Tom and some of the orders growth, orders growth are quite significant now and we think that's going to go on once again for some years to come.

Speaker 4

Thank you.

Operator

Thank you. The next question is from Josh Pokrzywinski from Morgan Stanley.

Speaker 5

So good to see that supply chain looks like it's starting to unlock there in Electrical, I guess even though it's not as bad today, maybe labor with the either in your plants or maybe on the installer side or somewhere else in some of these bigger projects might still be a limiting factor. Craig, I guess if you just sort of take a step back, notwithstanding the current backlog, demand is All those sorts of things. Is there sort of a cap on how fast the industry can grow thinking about kind of the totality of the Including that labor pool at the contractor level?

Speaker 2

No, I appreciate the question, Josh. And that's certainly of the things that we're spending a lot of time trying to sort through right now, I mean, clearly, as I mentioned, supply chain on the material side from our suppliers has improved. We're not out of the woods by any means, especially when you think about electronic and semiconductor related components. They still are constrain constraining our growth. But to your point, labor is also a fairly significant constraint today.

Speaker 2

And so one of the reasons why I think you've seen this big gap between Orders and revenue is because once again our extended supply chains and labor availability have been constraints on the industry. I don't really have an answer to your direct question in terms of from an industry perspective, what's the limiter, Because as you know, in these very complicated supply chains, it only takes 1 supplier, 1 player in the market To become the constraining factor. So it's a great question and one that we're trying to spend some time thinking through, But not one today that we have a really clear answer to today in terms of what is the real upper boundary of the industry's ability to deliver Given labor, given our standard supply chains and some of these material constraints, I can tell you that Today, things are getting better across the board and we're feeling much better about the growth outlook for our company and for the industry and There's tons of positives that we talked about in our opening commentary, where we're seeing just significant broad based strength And it's showing up in our backlog, it's showing up in our order books, and we would hope that we continue to post very strong revenue growth Tied to these secular trends.

Speaker 5

Got it. That's helpful. And I understand it's not an easy question to answer just yet. Maybe shifting over to the pipeline for my follow-up. Anything you can share in terms of the book out rate and Maybe any churn that you see in that pipeline with things like financing, supply chain, all these stimulus projects, some of which I would imagine are Kind of mutually exclusive.

Speaker 5

Has there been any underlying volatility in that? And how should we think about the lead time between when something Enters the pipeline and then maybe transmits in the backlog.

Speaker 2

Yes. No, I appreciate the question. And it's I mean, there's a lot in the question that you asked Very specific in terms of whether or not we're seeing a lot of churn. I'd say that overall economic activity, whether it's negotiations or orders or revenue, everything is kind of Doing significantly better than it has historically and certainly better than even quite frankly we anticipated when we put our plan together for the year. So in general, Things are positive and we continue to with more negotiations, with more orders than we anticipated, obviously translating to more revenue.

Speaker 2

So I'd say that stimulus specifically, we talked about that a little bit in some of the opening commentary. We are starting to see stimulus have an impact. We are in the very early innings. If you think about that $600,000,000,000 of projects, mega projects that we talked about, We think some 25% of that has already broken ground and started many of that, whether it's Semiconductors or EV factories or battery factories are obviously being buttressed by some of the early Infrastructure Spending Act. The Inflation Reduction Act, we really have not seen any impact from that yet.

Speaker 2

We're certainly seeing some impact From the Semiconductor Act. So yes, a little bit of a mixed bag there, but I'd say most of the impact there continues to be out in front of us. And lead times today on these projects, I would say we have better visibility today as these projects are bigger. They tend to run then over a multiyear period. And so we're feeling great about our visibility into the future because of these Very large projects that will be delivered over multiple years.

Speaker 2

But I'd say

Speaker 5

Hey, that's great color. Buffalo, I think it's

Speaker 3

Yes. The only part that I would amplify on that is going back to Our speaker remarks, our negotiation pipeline in the U. S. Quarter over quarter is up almost 25%, Year over year up almost 25% and some of the big segments are up Well over 30% growth. So we're seeing very robust pipeline here.

Speaker 1

Got it. Appreciate it, guys.

Speaker 6

Thank you.

Operator

Thank you. The next question is from Scott Davis from Melius Research. Please go ahead.

Speaker 6

Yes. Good morning, Craig and Tom.

Speaker 2

Ann, how are

Speaker 5

you?

Speaker 7

Good morning,

Speaker 6

Scott. Look, how I want to just fixate on these big projects because this is so new, At least in since I've been covering this space, maybe a couple of different angles to go at here. One is just the competitive dynamic. Does it change when you get to This size, meaning there's just a lot less people that can really at least be trusted suppliers For the customer when you're talking about orders and $10 plus 1,000,000 up to $100,000,000 kind of total bid stuff?

Speaker 2

Yes. You mean, first of all, we'll acknowledge what you just said, Scott. These we've always had mega projects, But historically speaking, they've been relatively few and far between. But I think it's really if you go back to this broader theme that we talked about around of manufacturing in the U. S.

Speaker 2

For sure to a certain extent also in Europe, this is resulting in a really, It's a big surge of investing in the manufacturing sector in the U. S. And to the point that you raised, The bigger the project, the more complex the project, the fewer companies who are able to essentially provide The services that our customers need. And so we think the competitive dynamic in this environment certainly favors companies like Eaton because of our Large capable organization and quite frankly, in general, when you think about the more complex projects in general, They're also more electric intensive. If you think about a typical office building versus a typical semiconductor plant or In EV factory, the electrical intensity or a data center of electrical intensity of these applications is much greater than typical strip mall or office building, which also helps support the underlying growth of the industry and companies like Eaton.

Speaker 2

So we think it's certainly it's an important trend that's going to drive growth for the industry, but it should also allow our companies to grow at a faster rate.

Speaker 3

And I think it really gives another lens in terms of these big projects focus not so much on the PMIs, which We've all read historically and to Craig's point, this reindustrialization, which is driven by these higher levels of CapEx, Which we just don't see slowing down.

Speaker 6

Yes, helpful. And then just to back up a little bit, when you talk about selling Less traditional products and let's just say like softwareremote monitoring, etcetera. Is that a separate sales process And the facilities like this, is it the same? I mean, I'm kind of picturing the EPC firm putting out a bid, But this is a little bit of a different animal. So how's the sales process really changing and evolve with this type of unique product?

Speaker 2

Yes. As we spent some time with you over the years talking about the way we think about the sale of software to state of data and insights is that for us, We really do think it's linked to the equipment. And so for us, for the most part, we're selling products that are Digitally enabled, they're digitally native. These products all have the ability to stream data. From that data, we create algorithms and that allow us to provide insights from the data coming off our products and we can either monetize that either in the form of data as a service or software.

Speaker 2

So for us, and it's not the same for every company in this space, we do link the sale of Hardware, the places where we have deep domain knowledge and expertise to the sale of Data and software and these services that we bundle together. So for us in the way we go to market, we do go together Through the same channel, through the same decision point, but that's not the same for every company in the space.

Speaker 6

That's very helpful. Thank you. Best of luck, guys.

Speaker 2

Thanks, Scott.

Operator

The next question is from Nicole DeBlase from Deutsche Bank. Please go ahead. Yes, thanks. Good morning,

Speaker 3

guys. Good morning.

Speaker 8

Just maybe starting with the 2nd quarter outlook for organic growth, embedding a bit of a deceleration from the 15% in the Q1. Just can you talk a little bit about what's driving that deceleration from a segment perspective?

Speaker 2

Yes. I'd say that there's always a bit of uncertainty, Nicole, as you can imagine, when you look forward In terms of where you think the market is going to land. But one of the things that I'd say is clearly, if you look at the balance between Price and volume, as you move forward for the balance of the year, you get relatively smaller contributions from year over year price increase, And you get obviously a pretty significant contribution from volume. And so you clearly have that dynamic that's taken place In the business throughout the year and inclusive of the Q2. So we'll see.

Speaker 2

I mean, at this point, we're early days into Q2. We're off to a good start Here, and so if we're able to convert and we continue to have some of the supply chain issues resolved, Certainly, we have a range of possibilities for the quarter. It could be better. But at this point, I'd say we're taking a prudent view Based upon the fact that we're not out of the woods completely from a supply chain standpoint and once again I mentioned less price On a relative year over year basis than we certainly had in Q1.

Speaker 8

Got it. That makes sense. Thanks, Craig. And then Second question, just update on what you're seeing with respect to channel inventory in electrical, still Pretty low relative to history or any movement there in the past quarter? Thank you.

Speaker 2

Yes. We think today channel inventories are We're in relatively good shape, obviously with some spots where they would like more. And I think when you look at channel inventory, I think Probably the most important message that I can leave with the group is that you really got to look at those inventories in the context of the size of the backlog, in the context of the orders. If you're looking backwards, you're going to draw one conclusion with respect to inventories. If you're looking forward, you're going to draw a very different conclusion.

Speaker 2

It's one of the things that we try Express for our own company in our Q1 earnings call where Tom laid out some of the ratios between inventory and orders to say that they're actually below where they've been historically based upon a forward view of our industry and our markets. And so Today, I'd just say inventories in general are generally speaking in good shape. Our distributors today, Where I'm having phone calls and discussions of sugars, it's 90% of the time, it's about I need more. Can you help me solve a particular issue I have today with a customer because I don't have enough inventory? But in general, I'd say they're in fairly good shape.

Speaker 2

We did see a little bit of an issue in the Q4 in Europe, where there was a little bit of destocking in Europe On the Q4, that since that time turned around and as Europe performed better than even we anticipated. So On balance, inventories are in good shape.

Speaker 8

Thanks. I'll pass it on.

Operator

Thank you. And the next question is from the line of Steve Volkmann from Jefferies. Please go ahead.

Speaker 7

Great. Good morning, guys. Thanks for fitting me in here. Craig, sort of a big picture question based on sort of what you were just saying. Do you think these backlog levels are the new Eaton and we should

Speaker 5

think about

Speaker 2

It's a great question And it's not one, once again, that I could tell you that I have a clarified, Well, thought through answer to specifically, well, certainly as we think about for 2023, we don't anticipate Reducing backlogs. We think we'll carry the same level of backlog throughout much of 2023. A lot of that will have to do with obviously lead times and whether or not we can actually get out in front Of some of these ramps that are taking place in the industries and the markets that we serve, and can we get capacity Online quick enough to reduce lead times so that we can go back to perhaps where we've been historically in terms of stated lead times our customers. And so we're not there today. And I do think a lot of it will be a function of how the markets unfold, It's not just in terms of demand level, because demand level, I think, we know is going to be strong, but how quickly can we and others put Capacity in to support this higher level of growth.

Speaker 2

And Steve, where I would chime in on

Speaker 3

that, I think it's Connected, your question was backlog, but I think the new Eaton is definitely a higher growth Eaton. And as Craig said in his prepared remarks, We see the markets doubling over where they have been historically. And that's a big thing when you say doubling And that doesn't include our outgrowth that we think we can put on top of that. And just some perspective, if you look also at order If you look also at order growth that we've got going back to the Q1 of 2019, there's such strong numbers. Electrical America is growing About 50% in terms of their quarterly orders, Electrical Global up over 25% and Aero up over 40%.

Speaker 3

So just a volume of quarterly orders that we're seeing coming in and the continued building of the backlog, I think the new Eaton is a much higher growth Eaton.

Speaker 7

Great. Thank you for that. And then switching gears to Aerospace, we haven't talked about that one too much, but Just kind of reading from the commentary on this call and others that I've heard you guys talk about, it feels like 2024 maybe like A real stair step for your Aerospace business. I think you mentioned, Craig, that you have a bunch of military business that sort of ramps up. I'm just curious if We should be thinking that there's kind of a bigger increase in revenue and margin in 2024 than might normally kind of be the year to year case.

Speaker 2

I think it's certainly early for us to be putting out guidance for 2024. We'll have an opportunity to do that obviously later in the year, but your thesis It's not off the mark. We do believe that certainly on the commercial side, that industry continues to ramp. Both Airbus and Boeing have already put out numbers in terms of increases in line rates for single line is improving. Consumers are getting on planes.

Speaker 2

Revenue passenger miles in kilometers continue to grow, Up, I think, some 60%, I think, in Q1, still not back to 2019 levels. So there's a long way to go just to get back 2019 on revenue passenger miles, which as you know drives the aftermarket for us. And then on the military side, Huge growth in orders this year that will begin to be delivered, most of them into 2024. So I think The setup for our Aerospace business is certainly quite favorable right now and we'll certainly be in a position later in the year to give you an indication of good we think it's going to be.

Speaker 7

I appreciate the color. Thanks.

Speaker 1

Thank you.

Operator

Thank you. And the next question is from Nigel Coe from Wolfe. Please go ahead.

Speaker 9

Thanks. Good morning, guys. Thanks for the question. I do want to come back to these mega projects. But before we get into that quickly, just global margins, you went through the investments.

Speaker 9

Maybe just peel back the onion on global what we're seeing in some of the major end markets and what gets better from a margin perspective to get to that 19.7% full year?

Speaker 2

Yes. I'd say the big thing that gets better to get to the higher margins is, 1, you're getting to higher volumes and you're obviously Delivering an incremental, but I'd say the single biggest one is, as we talked about last year, we had fairly significant manufacturing inefficiencies in the business last year. Given the supply chain challenges, lots of people standing around in factories waiting for components That didn't show up on time and lots of expedited freight and logistics costs. And so we despite the fact that we had a record year of profitability in 2022, We had a year of record inefficiencies as well. And so if I had to put it on one thing that's going to get better It is getting better.

Speaker 2

It's really of elimination of many of these manufacturing inefficiencies that we experienced Over the last 12 to 18 months or so.

Speaker 9

Okay. Volumes and more productivity, yes, that makes sense. Then at the risk of beating a dead horse, going back to the $600,000,000,000 of MEC projects, in a very general sense, Roughly what percentage of those have been bid on and awarded at this point? You said the majority haven't. So just wondering How that looks?

Speaker 9

And then what's your win rates? Your market share in the U. S, North America is about 3%. How does your win rate compare to that bogey?

Speaker 2

Yes. As I said, on these mega projects, these are all announced projects. And as I said, when we said 25% of them are actually broken ground and are under construction. And I'd say that our underlying win rate These mega projects is essentially pretty much at or above the underlying market share for the company overall. So we've been very pleased with our success rate as we talked about earlier.

Speaker 2

The bigger the project, the more complex the project, the higher the likelihood that We would be selected. And so the underlying win rate on these projects, keep in mind, these products will be delivered over the next, let's say, 3 to 7 years. And so Scott, they have a fairly long tail on them. So I wouldn't necessarily expect to see big movements in the near term based upon these projects. But The underlying win rate is good and the underlying profitability is also good.

Speaker 3

The only thing I would amplify that for the given quarter, Materially above our share win rate. So, yes, we're doing well in terms of closing the deal.

Speaker 9

That's helpful. Thanks guys.

Operator

The next question is from Guillaume Mitchel from Barclays. Please go ahead.

Speaker 10

Thanks. Good morning. Maybe just my first question would be around a lot of electrical equipment manufacturers and sort of broader multi industry ones have had And sort of broader multi industry ones have had very disproportionate price tailwinds to Revenue in Q1 and a very, very substantive price cost margin tailwind as well in Q1. So I just wondered sort of On those two points, how do you see the pace of normalization of those two tailwinds over the next 12 months?

Speaker 2

Yes. I'd say, if we look at our own business, Julien, I'd say that Price versus cost, I mean, while commodity costs are certainly down Versus where they were a year ago, commodity costs in many cases are actually up versus where they were in the Q4. Take a look at steel, for example, a major Commodity for us is steel, it's actually down about 25% from a year ago, but it's actually up 25% from Was in the Q4. So you have a mixed bag there. And then also on the labor side, as you can imagine, we're seeing More labor inflation in the business today.

Speaker 2

And so in our own company, the price versus volume piece maybe is not as significant as it is for others. I would say that as we look forward, and embedded in our guidance is, mostly it's around volume at normal incrementals And the elimination of a lot of the inefficiencies that are in the business that's going to ultimately drive the growth in earnings And the growth in our margins more than it is this relationship between price and cost. As we've said, from a strategic standpoint, We don't think price is either additive or subtractive from the underlying margin rates of the business and that's the way we manage the company.

Speaker 3

Yes. What I would add, Julian, is we don't see ourselves losing business because of our price cost either. We're not getting feedback from our sales organization that we've got too much price. We just think we're managing effectively.

Speaker 10

That's helpful. And then just my quick follow-up. Craig, you mentioned those inefficiencies just now and those were most apparent The Q1 margins at Electrical Global and I think vehicle, as we go through the year, we should see those margins Kind of start to expand year on year. Just wondered when does that happen for the 2 segments? Is it as soon as the 2nd quarter or it's more kind of the second half is when the margins expand in EG and vehicle?

Speaker 2

We would expect to see progress, Julien, in each quarter. I mean, without a doubt, those are the two places where we had some challenges specifically In inefficiencies and we would expect in each of the subsequent quarters to see our businesses Get sequentially better.

Speaker 3

Yes, for sure. And not to get too much into the accounting, but what we're seeing from last year Rolled through the P and L in the Q1 and muted the margins somewhat because it was coming The balance sheet, so it should be a tailwind going forward.

Speaker 10

That's great. Thank you.

Operator

The next question is from Chris Snyder from UBS. Please go ahead.

Speaker 5

Thank you. Craig, you mentioned a few times that the secular drivers coming through are pushing market growth 2x above historical levels. Is this a 2023, 2024 comment? Or do you believe that the 2x market growth rate is now the long term view? And with that, could you just kind of quantify what the 2x uplift means for market growth from here?

Speaker 5

Thank you.

Speaker 2

Yes. There's no It is the long term view. As you think about most of these secular trends that we're talking about, whether it's Energy transition, the move to renewables, the electrification of the economy, whether it's cars or cooking appliances or Equipment in your factories, the growth in digital and data and connectivity, reindustrialization, you think about all That needs to go into the U. S. Market as an example to basically reinvest in manufacturing that had moved offshore And the stimulus dollars that are all supporting that.

Speaker 2

So this is clearly our long term view That we think our markets would grow at least 2x, not 2x, but at least 2x the historical growth rates. And so we think those growth rates for the markets are in the mid single digit range.

Speaker 5

Thank you. I appreciate that. And then if I want to just my follow-up on the U. S. Mega projects and just broader domestic investment.

Speaker 5

There's been a focus of the administration to drive higher domestic content on projects or infrastructure where the government's providing incentives. Does this have a material benefit for Eaton as a U. S. Manufacturer? And could it allow the company to take higher share or even maybe just protect margins or support margins On these mega projects relative to prior cycles?

Speaker 11

Thank you.

Speaker 2

Yes. What I would tell you is that where we get the most direct benefit It is the fact that we tend to have higher market shares in the U. S. Most of the global electrical companies that we compete with around the world, they also have Fairly much localized much of what they do, but our U. S.

Speaker 2

Market shares just tend to be higher. And so we'll get an unfair share of Projects as this reindustrialization and manufacturing takes place in the U. S. Market.

Speaker 9

Thank you.

Operator

Thank you. The next question is from David Raso from Evercore ISI. Please go ahead.

Speaker 12

So the growth rate exiting 23, just for the framework of how you're laying out your organic sales growth, Is it right to assume 15 1st quarter, you're saying 11 for the 2nd quarter and then the back half of the year is about 7. So let's call 8% in the 3rd and 6% in the 4th. Is that just a decent general framework of how we're exiting 2023, that kind of 6% growth rate is the framework?

Speaker 2

Yes. And I'd say that at this point, and if we missed the front end of your question, I think I get the gist of what you're asking That based upon the implied numbers in our guidance, order of magnitude 7% growth rate would be the Great for the year and there's a lot of assumptions that we need to work through, Dave, to really understand what's the guidance going to be for next year, What happens with supply chain, how the year unfolds. But I don't given where we sit today, if you had to pick a number, That would not be a bad starting point if you're looking to make an assumption for what 2024 looks like. It wouldn't be a bad starting point. Now keep in mind, as we talked about, there are certain of our markets that we think are going to really inflect very positively next year.

Speaker 2

Aerospace is 1. And so early days, but if you had to put an anchor down today as a starting point, it wouldn't be a bad place to start.

Speaker 12

I'm just trying to think through how much negativity you already have baked into vehicle to end the year, particularly the truck part Would probably be viewed positively. So I guess within vehicle, do we have truck down by the 4th quarter? Aerospace is 150 percent the size of trucks. So if Aero is up big in 2024, no problem if truck is down We do. So just trying to

Speaker 9

get levels of vehicle

Speaker 2

down No, we do. We do have by the time we get to the Q4 Of this year, we think North America Class 8 truck will be negative and that is baked into our assumptions.

Speaker 12

All right. That's helpful. Thank you so

Speaker 2

much. Thank you, David.

Operator

The next question is from Phil Buller from Berenberg. Please go ahead.

Speaker 11

Hi, good morning. Thanks for fitting me in. A question for Craig in relation to the portfolio. Obviously, this has Come along quite a lot on your watch and you frame things with this, I guess, grow the head and shrink or fix the tail analogy, which has now Align the group very nicely to these mega trends, but I'm wondering if there's much of a tail at this point. I don't get that sense from the prepared remarks.

Speaker 11

I get that there's always room for some incremental self help here and there, and you touched on some of the efficiencies. But what, if anything, would you be Deprioritizing from here in terms of organic or inorganic investment. And I guess I'm asking in relation to the vehicle segment or trucks or potentially there's something else that you'd call out?

Speaker 2

Yes. No, I'd say that appreciate the acknowledgement. We have done a lot of work To position the portfolio to be where we are at this moment in time to really participate in these secular tailwinds and that's certainly paying off. And to your point as well, we think we're never done with the portfolio. I mean clearly, every year we go through a fairly comprehensive process with our Directors looking at every business in the portfolio and understanding whether we like it today, we're going to like it 5 years from now.

Speaker 2

And so that is a Very well ingrained process inside of our company as we look at the portfolio. And so we will continue to do that. We'll continue to evaluate Every piece of the portfolio, not only the vehicle businesses, we're going to evaluate everything. Today, We like where we are. We think there's a real synergistic element of what we do today across aerospace, Cross vehicle as the whole world and the mobility space specifically continues to electrify.

Speaker 2

We're getting real benefits today by As we launched this new eMobility segment by being a legacy provider to all of the automotive OEMs around the world. And so today, it works. We can't say that it's going to always work into the future. Every business has got to earn the right To stay a part of the portfolio. And that message is one that we deliver to everything, to every part of the company, not just to the vehicle team.

Speaker 3

Yes. A tangible example of that is if you go back to the prepared remarks in Electrical Global, we actually Had a divestiture, which impacted the results in the quarter. It was It would be non strategic by our Geist business, our Old Krause Beeline and it's a great example of how we're fixing the tail. Craig Craig's constantly challenging the organization for that.

Speaker 11

That's great. Thank you. And just one very quick follow-up, if I may, in terms of the defense business. Obviously, it's a good spot To be in, in terms of the growth outlook, but there's a lot of investors, where defense exposure is a bit of a hurdle, particularly so So for some European investors, so I'm wondering how you're thinking about defense M and A from here and whether or not that's a high or a low priority Going forward. Thanks.

Speaker 2

Yes. I'd say, strategically, the way we think about the aerospace business is you're either in or out. And if you're going to be in aerospace, you need to be in defense. It's an important part of national security for sure. So there's a We understand the ESG related concerns, and we understand that many investors have this 5% threshold.

Speaker 2

Today, defense is close to that number for Eaton. It's maybe 5% to 6% of our business overall. But I'd say that for us, we're really focusing on Good businesses that make strategic sense for the company. And aerospace is a platform within the company that We'd like to continue to grow. It's a good business.

Speaker 2

It's got all the right characteristics and businesses that we like. It's High margin, it's highly differentiated based upon technology. You've got great position on platforms with a huge aftermarket that runs for Decades and so it has all the right set of characteristics for businesses that we like. So we will continue to prioritize 1st and foremost electrical. As we've said in the past, for a lot of reasons, including these secular tailwinds, but Aerospace a priority standpoint, it's 2nd only behind electrical.

Speaker 11

That's great. Thanks very much.

Speaker 2

Thank you.

Operator

Thank you. And at this time, there are no further questions in queue. Please continue.

Speaker 1

Okay, guys. Thanks. As always Chip and I will be available for answer or any follow-up questions. Have a good day, guys.

Speaker 2

Thank you. Thank you.

Operator

Thank you. And ladies and gentlemen, that does conclude our conference for today.

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Earnings Conference Call
Eaton Q1 2023
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