Eaton Q4 2022 Earnings Call Transcript

Participants

Corporate Executives

• Yan Jin, Senior Vice President of Investor Relations
• Craig Arnold, Chairman & Chief Executive Officer
• Thomas Okray, Executive Vice President & Chief Financial Officer

Analysts

• Nigel Coe, Wolfe Research
• Josh Pokrzywinski, Morgan Stanley
• Andrew Obins, Bank of America Co.
• Stephen Volkmann, Jefferies Financial Group Inc.
• Jeff Sprague, Vertical Research
• Nicole DeBlase, Deutsche Bank Aktiengesellschaft
• Scott Davis, Melius Research
• Julian Mitchell, Barclays PLC
• David Raso, Evercore ISI
• Chris Snyder, UBS Group AG
• Brett Linzey, Mizuho Americas

Presentation

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Eaton Fourth Quarter Earnings Call. [Operator Instructions] And as a reminder, your conference is being recorded. I would now like to turn the conference over to Mr. Yan Jin, Senior Vice President, Investor Relations. Please go ahead.

[Yan Jin, Senior Vice President of Investor Relations at Eaton]

Good morning, everyone. Thank you all for joining us for Eaton's fourth quarter 2022 earning call. With me today are Craig Arnold, our Chairman and CEO; and Tom Okray, Executive Vice President and Chief Financial Officer. Our agenda today includes opening remarks by Craig, then we will turn it over to Tom, who will highlight the company's performance in the fourth quarter. As we have done on our past calls, we will be taking questions at the end of Craig's closing commentary. The press release and the presentation we'll go through today have been posted on our website.

This presentation includes adjusted earnings per share, adjusted free cash flow and other non-GAAP measures. They're 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 comments today will include statements related to the expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projections due to a wide range of risks and uncertainties that are described in our earning release and the presentation.

With that, I will turn it over to Craig.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Thanks, Yan. We'll begin with the highlights of the quarter on Page 3. And I'll start by noting that we again delivered very strong results in the quarter and record performance for the year. We generated adjusted EPS of $2.06 for the quarter and $7.57 for the year, both all-time records in each period.

Our Q4 adjusted EPS was up 20% from prior year. Our sales were $5.4 billion, up 15% organically and for the second quarter in a row with particular strength in utility, industrial, commercial institution, data center markets for electrical and commercial aerospace, vehicle and eMobility markets on the industrial side. And we continue to post strong margins. Q4 margins of 20.8% were up 150 basis points from prior year, near the high end of our guidance range. And incremental margins were 33% in the quarter. For the full year, we delivered record segment margins of 20.2%, up 130 basis points from prior year. And as noted here, orders continue to remain very strong. On a rolling 12-month basis, Electrical orders were up 25% and Aerospace orders increased 24% which led, quite frankly, to record backlogs as well, up 68% in Electrical and up 21% in Aerospace.

Now lastly, in what was an otherwise challenging year, we generated record free cash flow in the quarter with adjusted free cash flow up 41%. And our free cash flow as a percentage of sales was 18.1% in the quarter. While improved cash flow in the second half of the year, it wasn't enough to really achieve the full year cash flow targets. As we indicated, we continue to prioritize supporting higher organic growth, winning new orders and protecting our customers which all contributed to higher levels of working capital. But we still have work to do and with a focus on those areas that don't impact revenue growth.

On Page 4, I summarize our performance highlights for last year. Overall, I'd say, in a challenging operating environment, our team delivered strong financial results. And as noted here, we exceeded 3 of our 4 key financial metrics. First, for organic revenue, we posted 13% growth which was actually more than 60% above our original guidance at the midpoint. Throughout '22, we raised our organic revenue growth in all segments and the team delivered on the organic growth expectations that we set. It's worth noting that our largest business, Electrical Americas, delivered 16% organic growth, 2x the midpoint of our original guidance. Second, I'd note that we continue to demonstrate our ability to drive profitable growth with record margins of 20.2% in 2022 which was 10 basis points above our original guidance at the midpoint. Third, adjusted EPS of $7.57 was $0.07 higher than the midpoint of our original guidance. And I'd note that we fully offset the impact of some $500 million of unfavorable currency or roughly $0.20 a share.

Lastly, I'd note that we did miss our free cash flow guidance for the year. Most of this miss went into working capital to support higher levels of sales and orders and the record backlogs. But I'd say here, once again, I know we can do better. As you might expect, supply chain disruptions and our decision to prioritize protecting customers with higher inventory played a major role in this inventory growth over the year. But overall, I'd say it was a good year despite a year filled with inflation, labor shortages, supply chain disruptions and FX headwinds and the team delivered record financial results and we go into 2023 with positive momentum.

So turning to Page 5. I hope at this point, you would agree that 2022 wasn't an exceptional year but just another year of delivering what we promised and that it reflects the fundamental changes that we've made to the company over the last decade. We are a very different company today than we were 10 years ago. We've embraced the realities of a changing world and a necessity for us to change as well. We're now in attractive growth-oriented end markets and we have a proven formula for how we run the company better through the Eaton Business System.

With this transformation, we've become a stronger company that has delivered higher growth, higher margins and better earnings consistency. And we continue to be a good steward of your capital. The end result is the new Eaton where some 90% of our profits now come from Electrical and Aerospace businesses. But once again, when I'm done, we'll continue to apply our operational model, our strategic framework and our potential criteria [Phonetic] and we'd expect to continue to maximize value to all of our stakeholders.

And as you can see on Page 6, what this transformation has delivered to our shareholders. As you would expect, our strong results have translated into very strong financial results. And for the sake of comparison, we charted total shareholder returns for 3, 5 and 7 years. And we've compared our results with the S&P 500, the medium of our peer group and the XLI Industrial Index. And in every case, Eaton has significantly outperformed our benchmarks. And as I'll explain in the next few slides, we do believe our best days are still in front of us.

Turning to Page 7. Our transformation into a global intelligent power management company has positioned Eaton at the center of some of -- what we think are some of the most important trends that we'll see in our lifetime. The most significant being climate change and all the downstream implications that it brings. As we all know, climate change is driving the need to transition from fossil fuels to renewables and increased regulations are driving the demand for new solutions. These solutions will require tremendous investments in renewables and grid infrastructure for both new and existing buildings. This trend is also closely coupled to need to electrify the economy. Cars, trucks, planes, buildings are all requiring more electrical content. And as we move away from fossil fuels, this allows us to take advantage of renewables. And digitalization is providing us access to data and insights that are allowing us to be more connected, more productive and more efficient than ever.

It's also, by the way, creating a need for more data centers, an important end market for Eaton. Additive to these trends, we're also on the front end of an aerospace recovery cycle that will drive growth in both our commercial and military markets. I don't know about you but I can tell you, I don't -- I can't think of a company with a better set of market dynamics than Eaton. And while we're not ready to change our long-term growth goals, I'd be surprised if we didn't exceed our previously announced targets of 5% to 8% annual growth.

Next, on Page 8, we highlight how these megatrends are supported by unprecedented government stimulus spending really around the world. In fact, these programs will have a direct impact on the growth rate of more than half of our end markets. And in the U.S. alone, the Infrastructure Act from 2021 and the Inflation Reduction Act from 2022 will fund some $450 billion of grid modernization and other climate-related programs. And of particular importance to Eaton is the $88 billion that are set aside for power grid updates and EV charging networks and incentives.

In Europe, the EU recovery plan recovers -- provides, excuse me, $244 billion of green energy transition which member states are now working on implementing. And in China, the government has set clear goals to lower carbon emissions. They've laid out plans to strengthen their grid by 2025, including investments in more wind and solar. China also continues to lead the world in the adoption of electric vehicles. But even if you exclude China, we still estimate that between the U.S. and EU programs will expand Eaton's addressable market by some $11 billion to $14 billion over the next 5 years. And I'd say this is just another powerful tailwind that supports our confidence in the growth outlook of the company.

Tom will pick it up here and take you through the numbers.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Thanks, Craig. On Page 9, I'll begin with highlighting a few key points regarding our Q4 results.

Revenue was up 12% with organic growth of 15%, partially offset by a 4% foreign exchange headwind and a 1% favorable net impact from acquisitions. This outcome illustrates our focus of prioritizing growth in our customers. With total revenue growth of 12%, we posted solid operating leverage. Operating profit grew 21% and adjusted EPS grew 20%. Further, excluding the $0.05 impact from foreign exchange, growth in adjusted EPS would have been 23%. All in, strong organic growth and margins enabled us to report all-time record adjusted earnings of $825 million and adjusted EPS of $2.06 which was above our guidance midpoint.

Lastly, I'd like to note that we continue to raise the bar with our Q4 records for both segment operating margin and segment operating profit.

Moving on to the next chart, we summarized strong financial performance for our Electrical Americas business. For yet another quarter, we have set all-time records for sales, operating profit and margin. Further, we've also set all-time records for these metrics for the full year. Organic sales growth accelerated from 18% in Q3 to 20% in Q4 with robust growth in every end market and particular strength in utility, data center and commercial and institutional markets. Operating margin of 23.7% was up 450 basis points versus prior year, benefiting from higher volumes. In addition, incremental margins were quite strong at 47%. We continue to manage price effectively to more than offset inflationary pressures. Further, it should be noted that Electrical Americas outperformed their original 2020 guidance by 100 basis points.

Orders in backlog continued to be very strong. On a rolling 12-month basis, orders were up 34% which remains at a high level with strong growth across the board and particular strength in data center, utility and industrial markets. Backlog ended the year up 87% versus prior year and increased sequentially from Q3. In addition to the robust trends and orders in backlog, our major project negotiations pipeline in Q4 was up nearly 100% versus prior year from especially strong growth in manufacturing, data center, industrial and utility end markets. Overall, Electrical Americas had a strong quarter to round out a very good year and continues to be well positioned as we start 2023.

Moving to Page 11, we show results for our Electrical Global segment which produced another strong quarter, including records for Q4 and full year records for sales, operating profit and margins. Organic growth was up 8% which was entirely offset by headwinds from foreign exchange of 7% and divestiture of 1%.

With respect to organic growth, we saw strength in utility, industrial and data center end markets. On a regional basis, we posted high single-digit organic growth in IEMEA and mid-single-digit organic growth in APAC. Operating margin of 18.7% was down 80 basis points versus prior year primarily due to foreign exchange headwinds. We continue to see good order intake. Orders were up 11% on a rolling 12-month basis with strength in data center and commercial and institutional markets. Backlog growth of 17% also remains strong.

Before moving to our industrial businesses, I'd like to briefly recap the combined Electrical segments. For Q4, we posted organic growth of 15%, incremental margins of 44% and operating margin of 21.8% which was 250 basis points of year-over-year margin improvement. For the full year, our Electrical segments grew 15% organically, generated 33% incremental margin, increased margin 140 basis points, posted 25% rolling 12 months order growth and increased backlog 68%. We are confident that we're well positioned for continued growth with strong margins in our overall Electrical business.

The next chart recaps our Aerospace segment. We posted all-time record sales and operating profit for both the quarter and on a full year basis. Organic growth accelerated to 11% with a 4% headwind from foreign exchange. This growth was driven by strength in commercial markets with commercial aftermarket up 35% and commercial OEM up more than 20%.

Relative to profit, operating margin was strong at 24.5%. And it's worth noting that Aerospace outperformed their original 2020 guidance by 100 basis points. Order growth and backlog are very encouraging. On a rolling 12-month basis, order acceleration continued, up 24% compared to 22% in Q3 and 19% in Q2 with strength across all end markets. Similar to Q3, we saw especially strong growth in military OEM orders, up 80% in the quarter which positions us well for growth in 2023 and confirms our expectations for increased defense spending, including breakout performance in 2024. Year-over-year backlog increased from 17% in Q3 to up 21% in Q4.

Moving on to our Vehicle segment on Page 13. Vehicle had strong revenue growth in the second half of the year. In Q4, revenue was up 16% with 18% organic growth and 2% unfavorable foreign exchange. This coming off 19% organic growth in Q3. We saw growth across all markets with particular strength in North America and South America light vehicle. We also saw double-digit growth in APAC. Operations came in at 15.2% with unfavorability to prior year, primarily due to manufacturing inefficiencies. As expected, we were able to completely offset the impact of inflation with pricing in Q4. We also secured wins in new and sustainable technologies, such as EV gearing and transmissions, with a large and growing opportunity pipeline.

On Page 14, we show results for our eMobility business. We generated very strong growth in the quarter. Revenue was up 58%, including 17% from organic growth and 44% from the acquisition of Royal Power, partially offset by 3% negative foreign exchange. Margin improved 780 basis points versus prior year driven by higher volumes and the impact from Royal Power. We remain encouraged by the growth prospects of the eMobility segment. Since 2018, we've won $1.4 billion of mature year revenues in this business, including a recent $400 million win for power protection and distribution units with a European customer. This is a major new program win in both U.S. and European markets with production starting in 2024. This win demonstrates Eaton's ability to leverage our capabilities across our entire portfolio, including core technology in both electrical and industrial businesses.

We partnered with our customer to electrify their mobile platform with solutions, including Breaktor and Bussmann fuses. We also leverage our extensive vehicle expertise and added content from our Royal Power acquisition. Overall, we continue to make progress toward our long-term goal to create a $2 billion to $4 billion business with 15% margins by 2030. We are now on track to exceed our expectation to deliver $1.2 billion of revenue and 11% margin by 2025.

Moving to Page 15. I'm going to unpack a theme that Craig mentioned at the top of the call related to our strategic investments in working capital to support strong orders and backlog which enables accelerated organic growth. Overall, in spite of supporting surging orders and backlog, we are driving working capital improvements.

To illustrate the trend, I'll provide a couple of examples. Net working capital to orders and inventory as a percentage of backlog. Focusing on the left side of the chart, the average value of our Electrical and Aerospace quarterly orders in 2022 was more than 20% higher than 2021 and 33% more than 2019. However, to support these increasing orders, we have only slightly increased the absolute value of our working capital. The result is shown in the graph on the left side of the page. Our ratio of net working capital at year-end to trailing 12-month orders has stepped down significantly from 2019 to 2022.

Moving to the right side of the chart. Another way to look at working capital efficiency is comparing backlog growth to inventory growth. At the end of 2022, our Electrical and Aerospace backlog reached approximately $11 billion which is up almost 160% since the end of 2019. However, to support this much larger backlog, inventory for our Electrical and Aerospace businesses has only increased by 38% since 2019. The graph on the right side of the slide highlights the significant improvement since 2019. Our inventory as a percentage of backlog has been roughly cut in half from the end of 2019 to the end of 2022. We are supporting a much larger backlog with a smaller percentage of inventory.

In summary, we have prudently prioritized taking care of our customers and capturing growth which has required investments in working capital and has impacted free cash flow metrics in the short term. That said, we are managing working capital more efficiently.

The 2023 guidance on Page 16 shows that we are well positioned for another strong year of financial performance. Our organic growth guidance for 2023 is a range of 7% to 9% with particular strength in Electrical Americas and Aerospace with organic growth rates of 8% to 10%. eMobility is also a standout with 35% organic growth guidance at the midpoint tied to the ramp of new programs. These organic growth rates correspond to our end-market growth assumptions that we provided on our Q3 earnings call and that Craig will update in a few slides.

The end-market growth, combined with increased backlog, provides tremendous visibility and confidence in our 2023 outlook. For segment margins, our guidance range of 20.7% and 21.1% is a 70 basis points improvement at the midpoint from our 2022 all-time record margin of 20.2%. In addition to projecting strong organic growth for 2023, we're also growing margins and continue to invest in future organic growth.

Moving to Page 17. We have the balance of our guidance for 2023 and Q1. I'll touch on some highlights. For 2023, we are guiding adjusted EPS in the range of $8.04 to $8.44 which has a midpoint of $8.24 is 9% growth over 2022. We expect continued foreign exchange headwinds which we estimate between $100 million and $200 million adverse. For operating cash flow, our guidance of $3.2 billion to $3.6 billion is a 34% increase at the midpoint over 2022. The key drivers here are a combination of higher earnings and improved working capital, particularly lower inventory levels as supply chains normalize.

While our plan includes significant improvement in free cash flow during 2023, I'll note that we anticipate due to higher interest expense and capex in Q1 as well as timing-related headwinds such as taxes that free cash flow in Q1 will be relatively flat year-over-year. For share repurchases, we anticipate a range of $300 million to $600 million.

Moving to Q1. For Q1, we are guiding organic growth of 8% to 10%, segment margins between 19.5% and 19.9% and adjusted EPS in a range of $1.72 to $1.82.

Now, I'll hand it back to Craig to walk us through the market outlook and wrap up the presentation.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Thanks, Tom. Turning to Page 18, we provide a look at our current market assumptions for the year. This chart has been updated from what we shared in our Q3 earnings call but we really don't see any material changes here. I'll remind you that we do expect a mild recession in 2023. But given the secular growth trends that we've talked about, our strong orders and healthy backlog, we would expect to see growth in most of our end markets with 6 of our end markets representing some 70% of the company up nicely. And these markets are also, by the way, supported by a very strong negotiation pipeline.

Of note, we now expect even stronger growth within our commercial and institutional segment given the relatively strong orders growth in the quarter and the continued strength in Dodge nonresidential construction contracts. The only down market is expected to be residential which only accounts for 8% of our revenue. In total, we're encouraged to report that 85% of our markets are expected to see positive growth in 2023.

And lastly, let me close on Page 19 just with a few summary comments. First, I'd say our thesis for Eaton as a changed company has continued to pay even better than we expected. Second, the growth trends, the right investments have delivered better top line growth and we continue to run the company better. We delivered 13% organic growth with record orders and backlog. And despite supply chain challenges, an inflationary environment and significant FX headwinds, 2022 was a year of record profits, record margins, record adjusted earnings and adjusted EPS.

And I'm particularly encouraged by our 20% increase in adjusted EPS growth in Q4 which I see as a positive indicator for 2023. So despite the macro concerns, we expect 2023 to be another very strong year. And the company is on track and likely ahead of schedule for delivering our 2025 goals for revenue, margins, free cash flow and adjusted EPS.

So I'll stop here and open things up for any questions that you may have.

[Yan Jin, Senior Vice President of Investor Relations at Eaton]

Thanks, Craig. [Operator Instructions] Thanks in advance for your cooperation. With that, I will turn it over to the operator to give you guys the guidance.

Questions and Answers

[Operator]

[Operator Instructions] And our first question is from the line of Nigel Cole from Wolfe Research.

[Nigel Coe, Analyst at Wolfe Research]

So still very strong trends in -- especially in Electrical Americas. I'm just curious, we are seeing a divergence, especially on backlog between Americas and Global. Is that primarily macro in your opinion? Or do you think there's more secular tailwinds hitting in the Americas with all the similar money coming through? And any details on the front log of projects in the Americas would be very helpful.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. No, we're very pleased, obviously, with the growth that we're seeing in both our global business as well as in the Americas business but the Americas business is clearly performing extremely well. And I think -- if you think about some of the things that we talked about, Nigel, whether it's this stimulus spending where the U.S. is really pumping fairly significant dollars into markets that are really important for us, you think about some of these large projects and let's call it, reshoring that's taking place in the U.S. market, that's certainly strengthening the U.S. business as well. So I do think there's a lot of macros today that are strong for the company across the board that are just, I'd say, intensified when you think about what's going on in the U.S. market right now. So the secular trends are everywhere. We talk about energy transition, electrification. It's taking place across the world. And I just think the U.S., because of this increased focus on infrastructure reindustrialization, is seeing an additional boost above some of the other regions of the world.

[Nigel Coe, Analyst at Wolfe Research]

Okay. I'm not sure if there's any particular projects you'd call out or when you call out on the front log. But my follow-up question is probably for Tom. The $70 million [Phonetic] of corporate expenses in 2023. Maybe you could just break that out between true corporate, interest and pension.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. Thanks, Nigel. Most of that is going to be in interest expense and pension with interest expense even being greater than pension. And I would caution that there's a lot of moving parts on both of those, what's going to happen to interest rate, what's going to happen to the shape of the yield curve, discount rates, those types of things. But as we're projecting it now, the headwinds are really related to interest expense and pension with interest expense being the dominant one.

[Operator]

And the next question is from the line of Josh Pokrzywinski from Morgan Stanley.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

So Craig, you mentioned kind of planning for a mild recession and guidance. Can you maybe put that in the context of backlog conversion? And maybe specifically, I think data center and commercial construction, you're starting to hear a little bit more in the way of cyclical concerns. Obviously, the orders are so strong. But how would you think of how much backlog ideally you'd be converting, if any, this year in the context of that recession outlook?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. I appreciate the question, Josh. And we've obviously spent a lot of time internally trying to sort that one through ourselves. And I would tell you that orders have just stayed so strong in general. It's really tough to really put a finger on how much of this very large backlog that we'll be able to convert. It certainly will depend upon what happens during the course of 2023. And I can just tell you what's actually baked into our forecast for the year is relatively modest reductions in backlog, if at all. Because at this point, it looks like these markets, driven by the secular growth trends that we talked about, are going to stay stronger for even longer than what we anticipated. And so at this point, we'll have to wait and see. But if we end up with perhaps a little bit of a respite here in terms of some of the order intake or some of the supply chain challenges, we'll be able to convert more and that could be upside on the revenue side. But at this point, we're not anticipating that we're going to be burning a lot of backlog.

[Josh Pokrzywinski, Analyst at Morgan Stanley]

Got it. That's helpful. Then just a follow-up. Really appreciate kind of the TAM expansion color that you gave from some of the stimulus. I know not a lot of folks have taken a stab at that. I remember from the Analyst Day correctly, I think you sized the TAM for Eaton before that -- in kind of the high $50 billion [Phonetic]. Does this mean that we kind of take this extra $11 billion to $14 billion divided by 5 because it's over 5 years and you have sort of 4% uplift to growth like -- or is this an apples and oranges kind of discussion? Just any context how the TAM increase relates to kind of the growth uptick would be helpful.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

I think your simple logic there is the right logic that based upon this stimulus spending, these are essentially incremental dollars that we would expect to be going into these end markets which will increase the size of the TAM in our served market. And so I think your kind of high-level assumption is the right working assumption to have. And obviously, there'll be lots of discussions around how it plays out and over what period of time do these investments play out. Is it 3 years, 5 years? I mean, what's the time frame? I think it will be the more difficult call to make but it absolutely increases the size of the market.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. And just to add a little bit more color on that, I mean going back to the prepared remarks, if you look at our major project U.S. pipeline, many of the end markets quarter-over-quarter are up over 100%. And that's also translating to order volume even higher than that. So we're just seeing some good tailwinds on these major projects.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. Just to build on Tom's point, as I think everybody's aware, we obviously have sales and orders but we also look at negotiations and our negotiation pipeline. And as Tom mentioned, the negotiation pipeline being up more than 100%. And I'd say that is supported by the other data point that I talked about which is essentially nonresidential construction contracts which are also up quite dramatically through, once again, the fourth quarter. So we continue to see very good strength in these underlying markets, especially in the Americas.

[Operator]

And the next question is from Andrew Obin from Bank of America.

[Andrew Obins, Analyst at Bank of America]

So the first question, I guess, we've been getting incoming calls on data centers. And just if you can talk as to how much visibility do you have where you are in terms of capacity for '23? Do you have any left? And the new one we're getting was all the focus on ChatGPT, right? Are you getting any inquiries sort of related to AI and more computing sort of required to do that? And if you have any conversations related today at the interest of that topic.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. We -- as you can imagine, we anticipated this question because we too are reading some of the conflicting headlines in terms of what's going on in the data center market. And then as we talked about, our data center business continues to be very strong. And what you talked about, Josh, in the context of AI and these other various technology platforms that continue to be rolled out. That's just, once again, generating the need for more data, more processing and ultimately more data centers. And I know there's a little bit of a cause for some concern given what some of the hyperscale guys did with respect to their own outlook. But I can tell you that for us, the data center market continues to be very strong. And even the hyperscale guys are still talking about mid-teens kind of growth over the next 3 to 4 years. And so those are very strong numbers. And we haven't talked about autonomous driving and expansion of 5G. And every device that we make today and that is made by every company continues to get more intelligent, driving a greater need for data and processing. And so we think the data center market is going to be a great market for quite a number of years to come and it's supported by our order intake and our negotiations. To your question specifically on capacity, at this point, we really don't have a lot of spare capacity. We're making investments to expand our capacity. But at this point, we have lots of visibility into the data center market and it feels good.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. I would also point out --

[Andrew Obins, Analyst at Bank of America]

And just -- yes, sorry.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Oops, sorry, Andrew. I would also point out that this isn't only an Americas phenomenon. We're seeing strong order growth across the entire globe.

[Andrew Obins, Analyst at Bank of America]

And just a follow-up question. And at both stimulus, I think, related to IRA but also what's happening with LNG in Europe, what's the latest out of Crouse-Hinds? Because I think it is exposed to all these trends. And also have -- does Crouse-Hinds benefit from any decarbonization efforts, hydrogen, carbon sequestration? Just as I said, just maybe talk a little bit about what you're seeing in Crouse-Hinds.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. Appreciate the question. The first thing I'll just maybe give the team a little bit of a news announcement that we've changed the name. What was formerly known as Crouse-Hinds and B-Line is now we're calling it our global energy infrastructure business, so GEIS. And so just if you hear us talk about GEIS, that's the formerly known Crouse-Hinds and B-Line business. And I'd say absolutely, I mean, as the name implies, anything that has to do with energy infrastructure is a real positive for our GEIS business. And we would expect that, that business continues to perform well as we continue to see investments in energy. And certainly, as we look at hydrogen and other new greener forms of energy, all of the infrastructure that's required to support those investments will be very positive for our GEIS business as well.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. I mean, for example, if you look at trailing 12-month orders in GEIS and utilities, they were close to 30%, very strong.

[Operator]

The next question is from the line of Stephen Volkmann from Jefferies.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Craig, maybe just start off, could you provide a little bit more color on what you're seeing in commercial and institutional that made you sort of bump that market outlook up?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. And I'd say, once again, the very minimum, we saw very strong order intake in Q4. But also, we talked a little bit what's going on generally in nonres construction. And we look at the commercial negotiate nonres commercial contracts, construction contracts, just really posting pretty significant numbers in the fourth quarter. And so we thought that, that market would be positive. But given the activity level, our negotiations in that segment as well as what's going on more broadly in the industry and some of the macro data, it caused us to be even more positive on that market. And so it's, I'd say, a good news story. We'll wait and see how it plays out in total. But certainly, the data that we saw in the fourth quarter was definitely more positive than what we anticipated.

[Stephen Volkmann, Analyst at Jefferies Financial Group]

Okay, great. And then, I know it's early for this question. But Tom, since you brought it up, I think you mentioned something about breakout performance in 2024. Not sure if that was sort of military aero-specific. But just can you expand on that a little bit?

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. No, it is a little early but I walked into it and I mentioned it in the prepared remarks. We're just seeing significant order growth in military OEM. And we've been waiting to see that just given what's happening in the world. And now it's starting to come through in all of our order metrics, whether it's trailing 12 months or Q4 year-over-year or even sequentially, up very, very high numbers.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

In fact, our military OE orders for the last 12 months was up 45%-ish.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Exactly, and 80% in the quarter.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

So, really strong.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Really strong, yes.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

And given the lead times in that business, it will certainly support the growth assumption that we have baked in for 2023. But we do expect that 2024 will be a really strong year.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

And it comes back to the way Craig started out the presentation of what these megatrends. And maybe we'll have pockets of weakness here and there but the portfolio is so sound that -- we've also got the aero megatrend with pent-up demand. We've got military that's growing. We have pent-up demand with vehicles. So we're really not susceptible to any one small thing that's going to knock us down. It's a very robust portfolio.

[Operator]

The next question is from the line of Jeff Sprague from Vertical Research.

[Jeff Sprague, Analyst at Vertical Research]

I was wondering if we could just drill into Global Electrical a little bit more, just the quarter itself and then the outlook. Could you possibly elaborate a little bit more on what happened in the margins in the quarter? And I guess the perspective of my question is, it was a pretty sizable sequential step-down in margins on similar revenues and it looked like similar FX to me sequentially. Maybe I'm wrong there. But is there something else going on with mix or some other factor in the margins in the quarter? And then I was wondering if you could also just address the top line outlook in Global. The 4% to 6% is somewhat moderating. Just maybe a little color on the underlying demand trends you're seeing there or if anything is going on in the channels.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. Thanks, Jeff. Let me start out with talking about the Americas margins. I mean the story is really when you look at it compared to Electrical --

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Global margins.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. No -- oh, yes. We have 20% in the Americas volume growth. We had 8% in Electrical Global. So there's the real disparity going on there. And if you look closer into Global as well, we had some transactional FX issue, not necessarily translational but transactional, where we still have dollar-denominated costs. And with the dollar weakening, that hurt us there. So that was part of also the compare and the hurting of the margins on Electrical Global.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

And on the growth side of the equation, I'd say that we're looking at kind of mid-single-digit growth in our Global business. And I'd say in the face of what we're saying today is likely typical recession, we think mid-single-digit growth is the right kind of place to kind of be thinking about that business. Now once again, if the world turns out to be a little happier than what we're anticipating and on the margin, I would say that I think we're all feeling a little better today about 2023 than we were maybe a month ago. And we have seen even in the European market, on a relative basis, some strengthening. Those numbers could be better. But at this point, given our current assumptions, we think mid-single-digit growth for our Global business is the right place to kind of be thinking about it.

And the other one I would say just on the margin that could be slightly better than what we're currently thinking is what's happening today in China. Nobody anticipated COVID running through China as quickly as it did. It had an impact in Q4 for sure. Part of maybe the inefficiency challenges we had in Global was the fact that we had some unanticipated disruptions coming out of Asia, coming out of China, specifically around COVID. But at this juncture, they're through it and they got through it much quicker than anyone imagined. And we think on the margin, China and Asia could be stronger than what we anticipated.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Right. Yes. Thanks for the assist, Craig. Yes, coming back to the margin question, in addition to transactional FX, Jeff, we also saw weakness in in China opening up. So APAC was weaker than we had expected.

[Jeff Sprague, Analyst at Vertical Research]

Great. And then just as a follow-up. Can you just -- sorry if you said it, I missed it. But I know you're not going to give us price. But when I look at the margin bridge for next year, what does that kind of assume for the price/cost gap there? I assume there is some lift. Maybe you could give us a little perspective on what you're expecting.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. We're not going to break it out specifically as per our policy. What I will say is that we expect to continue to effectively manage price/cost. It's something we really focus on and we expect to manage it effectively.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

And the only thing I would add to what Tom is that I would not anticipate it would be accretive to margins, right? So clearly, there's still inflation that we have in the business. We are more than offsetting inflation. But in terms of how it's impacting the margins in the business, I would not expect that it would be accretive to margins. That's really a function of what we're doing to drive improvements in efficiencies as well as the volume lift that we're getting from the company overall.

[Operator]

The next question is from the line of Nicole DeBlase from Deutsche Bank.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Maybe just starting with channel inventory levels, Craig. Have definitely heard some concern about distributors maybe having a little bit of excess inventory or inventory building. What are you guys seeing in your channels within Electrical?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. I'd say -- in aggregate, Nicole, I would say that we've not that nor have we heard that from our big channel partners in aggregate. Today, if you look at -- once again, if you think about our order intake, our growth in backlog and you throw that up against -- Tom did a great job of laying out what it's meant in the context of our own inventory. And while we're building inventory, we're actually increasing our efficiency as it relates to a forward view of revenue. And I think that would be true for many of our distributors as well given the strength in the underlying market, certainly in the Americas. I would say that if you take a look at Europe specifically, while we're still seeing growth in our own orders in Europe, there has been a little bit of a slowdown in Europe. And while still growth, we have seen a little bit of a slowdown and a bit of an inventory adjustment that's taking place with some of our European distributors. And I think -- China, I think, will be going in the other direction as that market comes through COVID and begin to grow again. So very slightly regionally in aggregate. I'd say no inventory destocking to speak of at all. Regionally, a little bit of destocking in Europe with the U.S. and perhaps Asia market still a little bit tight.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. Just to punch a specific number Nicole, I gave some numbers on the one chart but our average quarterly orders in 2022 versus 2020 are up 55%, very big number.

[Nicole DeBlase, Analyst at Deutsche Bank Aktiengesellschaft]

Got it. And I guess, looking at the guidance for the first quarter, you got organic decelerating to the 8% to 10% range versus 15% in 4Q. I guess, can you just talk through some of the segment-level drivers there? And is that mostly a function of just tougher comps?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. The revenue guide for Q1 versus Q4, I'd just say, one, we're anniversarying bigger numbers in Q1 last year. So certainly, it's the anniversary effect of it. We certainly have gotten quite a bit of price during the course of 2022 to offset inflation. So on a relative basis, you don't maybe have as much lift on a quarter-over-quarter basis in price. And I'd say those are really the two. And then, there's this whole question around recession and how that's going to impact confidence in the outlook. And so lots of uncertainty. If you think about our growth for the year, Q1 is very much aligned at 9% at the midpoint with our growth for the year. And we'll see how the year unfolds but those are primarily the reasons.

[Operator]

The next question is from the line of Scott Davis from Melius Research.

[Scott Davis, Analyst at Melius Research]

Guys, you've been a little quiet on the M&A side since the Royal Power deal which is fine but there wasn't really anything in your slides on kind of target buybacks or anything where you're prioritizing capital allocation for '23. Can you comment on that, please?

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. Sure, Scott. Yes, nothing really in the prepared remarks because we're staying the course with our same capital allocation tenets. Obviously, first, we're prioritizing organic growth which we think is so important, especially with all the megatrends and secular tailwinds that we're right in the middle of. We're going to pay a competitive dividend as well. It's important to our investors. Having said that, we continue to be in the market and look for good acquisitions. We're also -- if you noted, we're also shrinking the tail in terms of divestitures. We had a small one that we did in the quarter; so we're actively doing that. And then in terms of buying back shares, this year, we did about $290 million. We guided $300 million to $600 million and we'll be, I mean, opportunistic there as appropriate. But it really hasn't changed. We're in the market. We're always looking. And yes, staying the course on our capital allocation tenets.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

And if I can just emphasize the point that Tom made is that we have just a lot of organic growth opportunities out there more than ever in terms of the history of the company. And so as we think about growing the enterprise, we don't need to go out and do acquisitions to grow the enterprise. There's plenty of organic growth opportunities in front of us that we're investing to support. And -- but we'll continue to be opportunistic. If we see something that helps us strategically, maybe geographically -- one of the things that you've seen us do over the course of the last 12 months is we've really, I'd say, shored up our strategic position in China. We've entered into a number of joint ventures and that's really the way we're trying to play the China card right now given some of the risks and uncertainties. But we entered into a number of really interesting joint ventures with local companies who have a strong position in the local market.

We've taken a minority position. We will basically sell those products in markets outside of China but they really do fill some really key product gaps in emerging markets in low-cost countries. And so yes, we've done some things on the JV side that I think shore up our position where we've had gaps but there are just so many organic growth opportunities out there that we're pursuing; that really is the priority.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. And just to punctuate that, Scott, with a number. If you look at our backlog for Electrical and Aerospace back at the end of Q4 and '19, it was roughly a little over $4 billion. And as we said in the prepared remarks, we're at $11 billion now. So there's a lot of food on the table.

[Operator]

The next question is from Julian Mitchell from Barclays.

[Julian Mitchell, Analyst at Barclays]

Just wanted to understand on that cash flow guide. I think it's at the midpoint guided up about $900 million year-on-year. Net income is about $300 million, I think, of increase. So that sort of the delta of $600 million there. Is that sort of just the $500 million miss from '22? I'm assuming you capture it in '23. Is that how we should think about it? And maybe on the working capital point, is it all inventory kind of shouldering that delta? Or is receivables or payables doing anything interesting?

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. Thanks, Julian. Just a slight nuance in terms of how you characterized it, I mean, while we did miss -- if we go back to that one chart, if we were able to foretell the future perfectly in terms of the order growth in the backlog, we might have guided a different number there. But coming back to the bridge from '22 to '23, in addition to the impact of higher income, it's going to be working capital performance. As we noted in our prepared remarks, we can do a lot better there. It's primarily inventory but I would tell you it's not just inventory. We think we can do better on DSO and collections. We think we can do better on DPO as well. I think we've got a great continuous improvement focus in this area. We know we're not where we want to be. As we said, we invested prudently but we can do a lot better and we will do better this year in terms of net working capital.

[Julian Mitchell, Analyst at Barclays]

That's clear. And just my quick follow-up, you talked about the first quarter sort of organic sales segment a little bit. Maybe on the margins. So I think you're calling for the segment margin to drop sequentially about 1 point from fourth quarter into first quarter. Are we assuming kind of every segment has that similar drop and then sort of builds from there through the year? Anything to call out on that front, the sort of margins as we start the year and then move on by segment?

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. I don't think there's anything particular to call out. I mean I would take you to our full year guide where we're taking margins and we're growing them 70 bps overall. And we've got margin growth in every single segment. Our EPS cadence is going to match our historical cadence of 45-55 to first half and second half. So I don't think there's anything specific to read into Q1.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Other than the volume piece, Julian. As you know, there's certain cyclicality that we have in our various businesses. And that's generally the reason why the margins generally drop between Q4 and Q1. And to the extent that we have more cyclicality in one business or the other, you could see a slightly different play-through by segment but that's really the primary issue.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. And that's a good point, Craig. I think we see that in terms of our aero segment where we go down in Electrical and Electrical Americas as well, too.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes.

[Operator]

The next question is from David Raso from Evercore.

[David Raso, Analyst at Evercore ISI]

The quarterly cadence of the organic sales growth, the 9% we discussed in the first quarter, the way you're thinking about the rest of the year, is it all just sort of at the same kind of 7.5% level? I'm just trying to get a sense in particular about some markets where there's a little more concern about a slowdown in the back half then maybe other areas that could be accelerating. So can you first confirm, is that sort of how you think of the cadence?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. I think that's a fair way to think about the cadence. I mean, I think the great news for us is we're sitting on very large backlogs. And so to the extent that we had a little bit of an air pocket at some place, we can live off of our backlog for a very long time before it would actually impact our revenues. And so I think as we think about the year, we still think it's a year where we're constrained, where -- but for labor constraints, capacity constraints, supply constraints, those numbers would be bigger than what we're currently forecasting. And so I do think a similar pattern of growth is a good placeholder for now in terms of the way you should think about the year.

[David Raso, Analyst at Evercore ISI]

And within Vehicle, the thought of auto sort of later in the year and truck later in the year, the interplay there? And a similar question on Electrical Global. Europe so far is proving a bit resilient, how to think about China and Europe in the back half of the year? Just those 2 interplays in those 2 divisions. I'll leave it at that.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

As I mentioned in my commentary, I think we're incrementally more optimistic on China. They came through COVID much quicker than what we anticipated. And the Zero COVID policy went away overnight, it felt like. And we're starting to see the Chinese government kind of reignite the economy over there. And so I think as the year builds, we think that we -- that China and therefore, Asia continue to strengthen. It has a relatively better second half than the first half. I think Europe is a little bit more difficult of a call to make. Europe, as you noted, has continued to hang in there and be better than what we anticipated for most of 2022. And we're incrementally, I'd say, sitting here today more positive on 2023. So difficult to really call whether or not we're going to see a different first half versus the second half in Europe. We're kind of planning for steady as she goes and more of a balanced view with respect to the year-over-year growth.

[Operator]

The next question is from Chris Snyder from UBS.

[Chris Snyder, Analyst at UBS Group]

Craig, I wanted to follow up on your comment in the prepared remarks that you would be surprised if the company does not beat the 5% to 8% annual growth targets laid out at the Investor Day. Does this just reflect the fact that the company is running so far ahead of these targets? Or do you think forward growth to continue to top this range through 2025?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. I think, one, to your point, we are certainly running ahead. I mean, if you take a look at, assuming the 2023 guidance is a good number, we've been running around 10% top line growth against the 5% to 8% target. So well ahead on growth. And quite frankly, we've become incrementally more positive on some of these secular growth trends. I think if you take a look at stimulus spending, that number has been topped up since we laid those goals out more than a year ago. I think today, if you think about climate change and some of the investments that are going into grid resiliency -- and so as we sit here today, I would tell you that the secular growth trends that we spent a lot of time talking about, we've become even incrementally more positive on what the longer-term implications are of these secular growth trends.

Now that may not play out completely between now and 2025. I think there's going to be some capacity constraints in the industry and we're already experiencing some of those. That could be a gating factor. But that just gives us a much longer runway on the back end of this thing in terms of what's going to happen with these markets over the long term.

[Chris Snyder, Analyst at UBS Group]

Yes. I appreciate that. It certainly feels like it's showing through with the orders and the pipeline. But then kind of on that, obviously, global orders have decelerated. It sounds like the company is decently optimistic on the rate of change and certainly in China. It sounds like maybe even Europe as well. With that, could we actually see global orders reaccelerate in 2023 just given those 2 economies maybe starting to move in the right direction?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. I mean, I think it's -- when you say reaccelerate. I think it's a question of relative numbers. We had a very strong year for the most part, a very, very strong first half of the year in our Global business. And we're still anticipating growth but we are anticipating the rate of growth will have slowed from what we saw in 2022. A lot of that tied to this assumption around a global recession that could hit Europe perhaps more impactfully than it maybe would in other regions of the world. And so it could -- there's a possibility that we could see a reacceleration. That's not our base assumption. We assume that we're going to still see growth but growth at a slower rate.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

Yes. Let me just punch some numbers on Global because we talked a lot about Americas but just to punch a few numbers. For trailing 12-month orders in our Global segment, we have high double digit in commercial and institution. We're over 20% in residential and data centers is doing significantly well. I mean utility is up high single digits. So very strong growth also in Global, not to the extent of Americas but still very sporty.

[Operator]

And our next question which is the final one in queue, is from Brett Linzey from Mizuho Americas.

[Brett Linzey, Analyst at Mizuho Americas]

I wanted to come back to Electrical. So the incremental margins reported 44% in the fourth quarter. You're only guiding about 30% for the year. I'm just curious why Q4 would not be more reflective of an undisturbed result with supply chains resolving and price catching up. So curious if there's something else through the course of '23 or just conservatism.

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. I mean that's the same discussion I'm having with my operating leaders. Why isn't Q4 44% the new normal? And I'd say that, as you can imagine, in every quarter, there's always a number of things that can go positively in your direction and things that could go against you. And we just had a very strong quarter of execution and good mix in our Americas business in Q4 that drove those incrementals to be well above where they would normally run. We do think from a planning standpoint, especially given some of the investments that we need to continue to make to support this growth in R&D and an customer capture initiatives, that we think 30% is the right planning number to have. And as you think about the business on a go-forward basis and very much consistent with where we've been historically.

[Thomas Okray, Executive Vice President & Chief Financial Officer at Eaton]

I'll just end on 30% is good for planning. But we take the coaching and we don't want to disappoint the Chairman. So we'll work hard to beat that.

[Brett Linzey, Analyst at Mizuho Americas]

And just one last follow-up. Where are we in this pricing cycle? I mean, is there more to do here? Have you made announcements for this year? And then maybe any context for what you're embedding for the price component of the 7% to 9% growth this year?

[Craig Arnold, Chairman & Chief Executive Officer at Eaton]

Yes. Certainly, price will be a contributor to the growth for 2023. It obviously contribute at a much lower rate than it's contributed in 2022. And yes, there is some more to do. We are, in fact, expecting to see positive price over the course of the year. We -- today, commodities have certainly slowed their rate of ascent. In some cases, we treat it a little bit but they're back up again. You see copper is back up again. And the big challenge right now we're finding is really on the labor front. Labor inflation is certainly coming through the system. And so clearly, we still have work to do on the price front and it's baked into the guidance that we laid out but it will certainly be at a much lower rate than what we experienced over the course of 2022. And most of what you're seeing in those growth numbers are volume.

[Yan Jin, Senior Vice President of Investor Relations at Eaton]

We have reached to the end of our call and do appreciate everybody's questions. As always, Chip and I will be available to address your follow-up questions. Thank you for joining us today. Have a great day, guys.

[Operator]

[Operator Closing Remarks]