Eaton Corporation (NYSE:ETN), a diversified company that deals in power management for its clients, has just announced it would dispose of a few of its aerospace group assets to Paris-based Safran. The businesses set aside for sale include Aerospace Power Distribution Management Solutions and Integrated Cockpit Solutions against a consideration of $270 million. The deal is awaiting board and regulatory approvals, but is probable to be completed in the first half of 2014.
In light of this recent news, I will consider some of the reasons behind the company's plans, upcoming benefits that the company may experience as a result of this strategic move and other favorable activities.
Reasons Behind the Strategy
The divestiture will facilitate Eaton's focus on its fundamental competencies of hydraulics, fuel, conveyance, and motion control and engine solutions. The company claims itself to be an industry leader in these areas.
My analysis of each segment's performance is located under the heading below. This will justify the company's decision to squeeze its investment from the aerospace segment and concentrate more upon other segments.
The company previously operated through segments that included: electrical Americas and electrical Rest of the World; Cooper; hydraulics; aerospace; truck; and automotive. For my article, the aerospace segment is more important as per on-going restructuring announcements related to the segment. So, I am just elaborating this segment's duties within the company.
The aerospace segment supplies aerospace fuel, hydraulic and pneumatic systems for commercial and military usage. Products offered though this segment include hydraulic power generation systems, electro-hydraulic pumps and power and load management systems, controls and sensing products and nose wheel steering systems. Additionally, the segment also deals in fluid conveyance products and fueling systems.
The following table will provide details about the company's top line performance with regard to its segments.
Source: ETN 10K Filing
From the table above, you can see that the aerospace segment contributed the least to the company's total revenues in 2010 and 2011. Contribution improved a bit in 2012 as the revenues from the segment witnessed growth of 4.3%. Identifiable net assets held by this segment are stated in the table below.
Source: ETN 10K Filing
The aerospace segment contributed the smallest proportion to the company's total identifiable net assets from 2010 to 2012. In monetary terms, the segment contributed $806 million in 2012, which is a slightly bigger figure compared than the 2011 figure. Out of these assets, the company will be selling some assets worth $270 million.
As far as the segment's contribution to the bottom line is concerned, you can have a look at the following chart that states some statistics regarding the operating profit's performance.
Source: ETN 10K Filing
From the table above you can see that the aerospace segment has been experiencing a decline in its contribution to the company's total operating profit. The proportion has declined from 12.9% in 2010 to 9.6% in 2012. The segment has also recorded a 12.7% decline in its operating profit in 2012.
The performance of the segment's top and bottom lines is not supportive of the company's success. That is why I favor the company's current decision to divest some of its businesses from this segment and concentrate more on segments that are exhibiting good growth and earning good profits, such as the company's electrical segments. Now let's have a look at the company's current year performance reported so far.
During the current fiscal year, the company restructured and reorganized its segments. I have made the following table to show the newly designed segments and compare the company's current year performance to the previous fiscal year.
Source: ETN 10Q Report
Considering the figures after restructuring, the aerospace segment was the only segment that recorded negative growth (- 4.5%) in its revenue during 3Q2013. The segment also made a single-digit contribution to the company's total revenue, which was a decline from the 10.7% contribution it made during 2012. The other segments contributed double-digit figures to the company's overall revenue. So, the aerospace segment can be seen as a weak segment compared to the others.
Investment of Proceeds; Favorable Impacts on the Company
Sales from the sold businesses were around $102 million in 2013, and the company will receive $270 million for disposing them.
Although the company did not disclose what it plans to do with the proceeds of this transaction, it is expected that the company will invest them in research and development as well as other strategic acquisitions.
Research and Development
Source: ETN 10K and 10Q Filings
The company is focusing on its fundamental competence by constantly investing in research and development activities as shown in the chart above. As a consequence, its expenses rose by 62.7% as disclosed during the last quarter. Although the company logged a minor growth in sales from its fundamental business, investments in research and development will bring sustainability for the company in the long run. Innovation and developing new products and technologies is crucial to maintaining a strong customer base and retaining clients.
The company has been actively expanding its business by making acquisitions like a mature company. Have a look at the following table that illustrates the company's strategic moves since the previous year.
Source: ETN 10Q Report
The table above shows that the company has made a majority of its acquisitions for its electrical segments. These segments have been recording growth in their contribution to the company's revenues and profits. Acquisitions will bring in further growth for the company through the expansion of its global footprint. The major recent acquisition made by the company in the previous year was Cooper Industries plc in November 2012. This acquisition is successfully adding synergies for the company, and benefits of up to $95 million are still in line for 2014.
As a result of these factors as well as the company's strong financial performance and position, stock analysts at Stifel Nicolaus increased the price target of the company's share from $83 to $90. This denotes a 17.11% upside potential for the company's stock at its current price. On average, the stock has been rated as a buy by a majority of analysts.
My analysis also favors the company's recent strategic moves that include the most to squeeze funds out of the aerospace business. The aerospace segment has been a fragile and underperforming segment in comparison to the other segments that have more growth potential. So, devoting more focus to the other segments as well as using the proceeds from this transaction to support its growing segments will bring in benefit for the company in the coming years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article.