Eaton (ETN) is a diversified global electrical component and power management company. It has strong competitive positions in its markets and uses acquisitions to help fuel growth. A snap-shot of its 2011 operations are below.
|Net Sales||Operating Profit|
|Electrical Rest of World||2984||278|
Alexander Cutler has been CEO since 2000 and has done an excellent job. He was the COO from 1995 to 2000. Eaton was hit hard by the recession in 2001 and took a few years to recover, but EPS have grown from $1.63 in 2000 to an estimated $4.40 EPS for this fiscal year-a healthy 8.6% a year. That is very strong growth considering the U.S. had two recessions and the S&P 500 has returned close to zero percent over that time period.
How does Eaton use Free Cash Flow?
Eaton currently has a 3.9% dividend yield and has increased its annual dividend from $0.44 in 2002 to $1.56 today. In the past 3 years the dividend has grown 50%.
Shares outstanding have increased 10% over the past decade and management does not seem interested in large share buybacks. Management primarily uses free cash flow for acquisitions and dividends.
Eaton recently announced it is acquiring Cooper Industries (CBE) for $39.15 a share in cash and 0.77479 of a share of Eaton. The transaction equals approximately $11 billion at today's price.
Cooper Industries sells electrical products and, like Eaton, has experienced strong growth in the past decade. Eaton has three motivating factors for purchasing Cooper:
- Eaton will incorporate in Ireland, which will save an estimated $160 million a year in taxes for Eaton (that alone will boost earnings 10% for Eaton's current operations).
- The acquisition is expected to have good synergies and that seems probable given they both operate in electrical products. Management at Eaton expects $375 million in savings from operational synergies.
- The price is fair. Eaton is not getting Cooper Industries at a cheap price, but it is probably not overpaying either. Paying 16 times Cooper's expected earnings this year seems high, but with the synergies, tax savings, and growth in earnings from Cooper operations over time, it could turn out to be a strong strategic acquisition.
If we use $375 million in operational synergies and $160 million in tax savings, the newly combined Eaton/Cooper company should have earnings of $2.66 billion based on 2012 estimates.
|Eaton Shares Outstanding||336.5 million|
|Estimated 2012 Eaton Earnings||$1.48 billion|
|Cooper Shares Outstanding||159.07 million|
|Estimated 2012 Cooper Earnings||$690 million|
|Operational Synergies After-Tax||$330 million|
|Tax Savings||$160 million|
|Total Earnings||$2.66 billion|
With Cooper shareholders getting 0.77479 Eaton shares for each share they hold, Eaton's total shares outstanding will be 460 million. With the combined earnings of the companies being $2.66 billion, EPS of the combined companies will be $5.80. At Eaton's current share price of $38, that is a P/E of 6.6.
- Eaton will likely have one-time expenses to cover the acquisition.
- It will take a year or more for the synergies to be fully incorporated.
- Eaton is taking a $6.5 billion loan commitment to finance the deal.
- The deal may not get shareholder approval from both companies and the Irish courts.
- A deep recession in Europe will slow demand for Eaton products internationally.
Whether or not the deal with Cooper goes through, Eaton is a strong company that will likely continue to grow revenue and earnings at a strong pace over the next few years. They also operate in industries that have very durable demand in the long-term (i.e. electrical components and power).
At this valuation not only do investors get an attractive dividend that will likely grow at a good pace over time, they also get strong potential capital appreciation in a company that is strengthening its competitive position with the Cooper Industries acquisition.