Industry: Energy and Utilities
September 21, 2008
DIVERSIFIED INDUSTRIAL FIRM
Henry Fund Research
EATON CORPORATION (ETN)
Investment Recommendation
HOLD
Current Price
$69.33
Target Price Range
$92.13
Sumit Mundhra [email protected]
INVESTMENT THESIS High diversity in business segments and geography is driving revenue growth for Eaton even in the midst of the ongoing credit crisis. We expect Eaton to do well in the near future because of its disciplined acquisition activities and ability to achieve organic growth within its business segments. Within the last 2 years, Eaton successfully executed its strategy of moving away from cyclical and commoditized businesses (Truck & Automotive) and adding high growth businesses with sustainable profitability in its portfolio (Aerospace, Electrical and Non-Residential Construction).
Source: http://yahoo.investor.reuters.com
Key Stock Statistics 52-Week Price Range
$62.51-101.82
Market Capitalization (B)
$11.52
Shares Outstanding (M)
166
Institutional Ownership
79.19%
60-Month Beta
1.42
Dividend Yield
2.0%
Price/Earnings (ttm)
9.75
Price/Book
0.73
Price/Sales
1.53
ROA (ttm)
5.65%
ROE(ttm)
18.02%
Projected 5-Year Growth
12.25%
EPS ($) Year EPS
2005 5.36
2006 6.32
2007 6.75
2008E 7.65
2009E 7.76
2010E 7.96
All earnings represent earnings from operations and have been filtered from net nonrecurring gains.
Valuation Models Discounted Cash Flow
$92.13
Economic Profit
$92.13
Relative P/E Dividend Discount Model
Eaton substantially enhanced its distribution network in the emerging markets and is now in the position to take advantage of the same. We expect the revenue contribution from the Non-US markets to increase to 47% in FY2008 and to more than 50 % beyond FY2009. Eaton has a huge backlog of orders for the second half of 2008 and 2009. We believe that the backlog will help Eaton to achieve its earnings guidance for the next 1-2 years even in the slowing economic environment within US, UK and traditional European countries. We believe Eaton’s current stock price is substantially undervalued and company’s stock is currently trading close to its 52 week low. Having said that, we believe the upside potential is significantly higher than its downside risk. Eaton undertook several acquisition activities in past 2 years and paid premium for companies. Failure to properly integrate acquired businesses would result in the loss of positive synergies and expected benefits.
$101.47 $87.51
Important disclosures appear on the last page of this report.
THE UNIVERSITY OF IOWA
Henry Fund Research
Henry B. Tippie School of Management of Eaton’s revenues and is one of the fastest growing business segments.
EXECUTIVE SUMMARY
Eaton Corporation is a diversified industrial conglomerate that caters to several sub-segments of The segment saw a 45% increase in revenues in the industrial sector and is expected to significantly first half of 2008 over 2007 primarily because of three acquisitions – Phoenixtec, Moeller and MGE small outperform the market in the near future. systems UPS business. Eaton has a huge backlog of orders for FY 2009 and we believe backlog will help Eaton to achieve its Electrical Segment earnings guidance. Moreover, Eaton is successful in slowly moving away from its automotive and trucking businesses and expanding in electrical and aerospace segments. Eaton has substantially increased its exposure to the Source: Annual Report 2007 non-US and emerging markets between FY2006 and FY2008 and we expect the trend to continue beyond Automotive FY2008. Eaton provides automotive engine air management We concluded that expected returns associated with systems, power train solutions and specialty controls for investing in Eaton Corporation far exceeded the automotives. Automotive segment caters to OEMs and associated potential risks of investment. Based on our after-market customers of passenger cars located analysis and DCF, Economic Profit, Relative P/E and globally. Eaton offers a wide array of products such as Dividend Discount Model valuations, we recommend a superchargers, engine valves, actuation systems, cylinder heads, differentials, transmission controls, BUY on Eaton Corporation. engine controls and fuel vapor components that are essential to fuel economy, performance and safety of COMPANY DESCRIPTION the auto motives. Because of the higher fuel prices, the Eaton is a diversified industrial manufacturer with 2007 segment saw shrinkage of around 5% in the end sales of $13 Billion. Eaton sells products to customers markets in the first half of 2008. This might result in the in 150 countries and reports its revenues by five decrease in revenues from this segment by 1.5% to business segments namely Electrical, Hydraulics, 2%. Automotive, Aerospace and Truck. The chart below provides the revenue break up for June 2008 followed Automotive by details of each business segment.
Source: Annual Report 2007 Aerospace Eaton offers products and services for the cockpit interface and circuit protection, fuel & hydraulic systems, motion control and propulsion sub-systems and air distribution. Aerospace segment caters to manufacturers of commercial and military aircrafts and related aftermarket customers. Eaton undertook strategic acquisitions such as Aerospace division of PerkinElmer, Inc. and Aerospace fluid and air division of Cobham PLC, in the aerospace segment that increased its revenues contribution from the division.
Source: Quarterly Report June 2008 Electrical Eaton manufactures electrical components and systems for power quality, distribution and control. Through electrical segment, Eaton caters to Industrial, Utility, Light Commercial, Residential and NonResidential Construction, Government and OEM markets. The segment contributes more than one third
Hydraulics Eaton also manufactures hydraulic power generation systems for industrial, mobile, automotive, and aerospace applications, including pumps, motors, hydraulic power units, hose and fittings, transaxles,
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transmissions, electro-hydraulic pumps, power and load management systems. The Hydraulics segment also includes Eaton’s Filtration, GolfGrip, Airflex, industrial clutch and brake businesses. Hydraulics division caters to original equipment manufacturers and after-market customers of off-highway and industrial equipment, as well as customers in oil and gas, fine chemicals, mining, metal forming, and food and beverage applications.
is financed by issuing equities. These acquisitions are expected to add $1.9 billion in incremental revenues in FY2008.
INDUSTRY TRENDS
As per the IBIS World forecasts, revenues in electrical equipment and components industry is expected to grow at average annualized real rate of 3.7% for the next five years. Strong global demand coupled with weak dollar will boost exports revenues for the industry Hydraulics segment is a strong growth division for in US. The growth in exports might be adversely Eaton because of wide range of applications and strong effected by an increase in import penetration to nearly global demand. 52% in 2012 from 43.4% in 2007. Power infrastructure is expected to see a growth trend due to several reasons. Rising energy prices and the issues with the future energy supply are encouraging investments in renewable energy and alternative energy sources. Increasing load coupled with ageing infrastructure will demand expansion and replacement Source: Annual Report 2007 in the near future. Several electric utilities companies are encouraging to increase efficiency in utility rate Truck determinants. With the global exposure Eaton enjoys in The Truck segment manufactures transmissions, the electrical segment, we expect this division to clutches, collision warning systems, mobile diagnostics increase its contribution to the total revenues. and hybrid electric power-train systems. Eaton sold The growth in the end markets for trucking is impacted primarily to heavy and medium duty OEMs, specialty by the high fuel prices and stronger emission and off-road OEMs, fleet management companies, standards. Weaker outlook for the North American distributors and aftermarket for the same. The division Class 8 truck in the second half of 2008 and early 2009 is impacted by the higher fuel cost in the first half of will be offset by the strong international demand 2008. especially from Brazil. Aerospace & Hydraulics
Truck
Ongoing credit crisis has lengthened auto-loan terms and this combined with weak consumer confidence, fluctuating oil prices and stiffened foreign competition have pressured the overall domestic vehicle sales. Similar situation exists in UK and other developed Source: Annual Report 2007 European markets. We expect that these factors should continue to weaken automotive industry in the developed markets for the next year and a half. As a RECENT DEVELOPMENTS result automakers are targeting China, Eastern Europe In aerospace, company completed mission critical and other emerging markets to position themselves for system development for multiple platforms such as the future growth opportunities. We expect the revenues new F-35 Joint Strike Fighter, Boeing 787, Airbus A380 from the automotive sector to shrink in FY 2008 and FY2009. and the Embraer very light Jet. In filtration, company introduced new filtration media Commercial aircraft demand is closely associated with that improve both the efficiency and longevity of our the long term passenger air traffic growth rate. As per International Air Transport Association, worldwide products. international passenger air traffic grew by 7.5% in the Eaton completed two major acquisitions in 2008 in the first 11 months of 2007 and is expected to grow by 5% electrical segment that will provide the company with in 2008. stronger distribution networks in Eastern Europe, Taiwan and China. Eaton committed around $2.5 billion for the acquisition of The Moeller Group and Phoenixtec Power Company in the first half of FY2008. The company issued long term debt of $750 million and rest
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Henry B. Tippie School of Management As per the forecast by Boeing, the world air cargo traffic is expected to triple by 2026. The air cargo market is predicted to grow by 6.1 percent per year. By 2026, the cargo fleet will double from 1,980 to 3,980 airplanes.
Source: S&P Industry Survey As per Avitas, a market research firm, global commercial aircraft fleet will grow at CAGR of 4.3% till 2025. The following chart shows the forecast of Boeing for new airplane deliveries. Source: Boeing We expect continued emphasis on defense spending because of ongoing war on terrorism and escalated tensions between Russia and US due to Russian invasion in Georgia. However, a slowdown in the US economy, declining tax revenues and Fed‘s subsequent efforts to help financial institutions will put additional budgetary pressure on Congress that might result in reduced defense spending. In addition, a Democratic Party president elected in 2008 elections will result in reduced spending on defense programs in favor of domestic programs, and in that case we see a increased risk to defense budgets.
Source: Boeing
The second value driver is the average age of the fleet. The average life of a commercial plane is around 20 years. The average fleet age in Europe is less than 10 MARKETS AND COMPETITION years, about 11 years in Asia and about 12 years in US in 2006. Hence, some US carriers are due for Eaton faces stiff competition from industrial investments in new fleet as actual age might be more conglomerates and niche firms in all of its business segments in the domestic and international markets. than the average age of 12. Through several divestitures and acquisitions, Eaton is successfully moving away from the commoditized (in case of Automotive segment) and cyclical businesses (in case of Truck segment) and focusing more on Aerospace, electrical, filtration and non-residential construction businesses.
The third important value driver is the overall profitability of the airline industry. If an airline is running into operating losses, new orders for commercial airplanes will be less regardless of the fleet age. However, soaring fuel prices pushed Aloha Airlines, ATA Airlines, Frontier Airlines, MAXJet Airways and Skybus Airlines into bankruptcy. International and discount carriers are doing better than the US based legacy airlines and orders in 2007 soared to 2340 from 1882 in 2006 and 2139 in 2005. We expect increased revenue contribution from aerospace segment in the next five years.
The company issued 07 Excel Program, in which Eaton announced several important plant closings in truck and automotive divisions located in U.S. and Europe. Rising commodity prices and slow domestic demand has created tough times moving ahead in 2008 for industrial machinery suppliers. However, diversification in core markets, product offerings and geographical
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ECONOMIC OUTLOOK
reach will provide Eaton with sustainable revenue growth and margin enhancements.
GDP
Eaton faces intense competition across its market segments. In the automotive segment, the company faces stiff competition from TRW Automotive Holdings, Germany-based INA, Borg Warner, Magna and Bosch. In the electrical segment, the company competes with Schneider, Emerson Electric, GE and Siemens. Major competitors of Eaton in the truck segment are Germany-based ZedF, Wabco, Allison transmission and ArvinMeritor. In the hydraulics and aerospace segment, the company competes with Parker-Hannifin, Germanybased Sauer Danfoss, Dana, Visteon, TI Automotive, Hamilton-Sundstrand, Crane and Honeywell International.
Source: Bureau of Economic Analysis Emerson Electric Co. (EMR)
Real GDP growth in the second quarter of 2008 was Emerson Electric is a diversified manufacturing 2.8% at an annual rate. For the first quarter 2007, the company with a wide portfolio of products – process figure was 0.6%. management, industrial automation, network power, Henry Fund analysts forecasted the consensus climate technologies and appliances and tools. annualized real GDP growth rate of 0.8% for the next Between 2002 and 2007, CAGR for revenues in US is six months. The decline in the growth rate of real GDP 6.3% and for international is 15.2%. In FY 2006-07, will create a slight impact on the automobile sales. company recorded a net profit margin of 9.5% and However, even with the decline in automobile sales, increase in net income of 16% from 2006. The Eaton will continue to do well because of its operations company has a market capitalization of 40.47B and outside US and strong demand in the electrical, recorded revenues of 23.16B in FY 2006-07. hydraulics and aerospace segment. Purchasing Managers’ Index (PMI)
Siemens A G ADR (SI) Company offers a variety of products and services ranging from automation and control, lighting, medical, power, specialized businesses, transportation and water technologies and services. The company has a market capitalization of 116.97B and has a profit margin of 12.82%. Company operates in 190 countries across the globe. The company is actively involved in acquisitions, divestments and joint ventures. In 2007, company recorded revenues of 107.61B. ETN
SI
EMR
11.52B
104.10B
41.81B
Revenue
13B
117.76B
23.16B
Gross Margin Operating Margins Net Income EPS P/E
28.10% 8.00% 994M 6.75 9.75
29.30% 7.08% 6.58B 16.24 7.02
36.01% 15.69% 2.21B 2.817 18.89
Market Cap
Source: http://www.research.stlouisfed.org Value of PMI below 50% shows contraction in the manufacturing sector. A value below 41% shows contraction in overall economy. PMI went below 50 in December 2007 for the first time since January 2007 raising concerns about the expected recession in the US manufacturing sector. PMI in 2001 was consistently
Source: Yahoo Finance & Eaton Annual Report 2007
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below 50 for the entire year indicating a recession in the economy after the internet bubble burst. The five indicators in PMI are New Orders (30%), Production (20%), Employment (20%), Supplier Deliveries (15%) and Inventories (10%). According to the latest report on business (ROB) from Institute of Supply Management (ISM), PMI for August 2008 is 49.9%. PMI was below 50% for five out of first eight months of 2008 and that does not bode well for the US economy. However, high diversity in geography and business segments makes Eaton capable of doing well even in tough times in US economy. While moving ahead with the positive outlook, we want to keep a watch at PMI value for the next 3-6 months. Source: www.bullandbearwise.com Capacity Utilization With $400 million of outstanding commercial paper and short-term borrowings and $4 billion (mostly floating) long term debt, lower interest rates reduce the interest expense of Eaton and thereby benefit the company. Eaton actively engages in acquisition activities globally. In order to finance its bold acquisitions of The Moeller Group and Phoenixtec in first half of 2008, company issued $1.5 billion of equities and $750 million of long term debt paid in part in 2013 and in 2018. With good credit ratings Eaton is able to borrow money at the lower interest rates thereby making the expansion easier. Rising Commodity and Energy Prices Prices of energy and industrial metals were at their peak in the Q2 2008 and we expect them to remain at high levels for 2008 because of the increasing demand High levels of capacity utilization since January 2006 from emerging markets especially China and India. show good opportunity for capacity expansion. Rates consistently above 80% will require manufacturing Steel is one of the key raw materials for Eaton. The companies to increase their capacity. Historically rates steel prices are likely to rise in 2008 by 7% to 8%. The below 80 marked the beginning of recession. Because rise is the result of an increase in production costs, high of the slowdown in the US economy, capacity utilization consumer demand mainly from infrastructure and is consistently between 79% and 80% since April 2008. electronics consumer goods. Source: www.bullandbearwise.com
Learning a lesson from the mid 1990 capacity enhancements and subsequent low utilization rates between 2001 and 2005, companies will not commit investments in capacity enhancement within US. Within US, capacity enhancements are expected to come by increasing labor shifts and improving efficiency and productivity.
The demand would be driven by the BRIC countries (BRIC countries account for 41% of global steel demand), due to intense construction activity. These countries are expected to account for 71% growth in global consumption in 2008. The increase in steel prices would lead to increase in production costs which could negatively impact the future profitability and cash flows of the company.
Interest Rates The federal funds rate is currently residing at 2.0%. In July 2007, federal funds rate was 6.25%. Henry Fund analyst consensus for the federal funds rate for the next 6 months is 2.18%. We believe that the rate will remain constant or below the current level for the remainder of 2008.
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Globalization & Acquisitions
Source: Annual Report 2006 Company completed 9 acquisitions in FY2007 and 3 acquisitions till Q2 2008. All the three acquisitions are for electrical division. On July 31st 2008, Eaton also acquired Kirloskar Oil Engines Ltd. (India). Eaton acquired Moeller Group in April 2008. The Moeller Group is a German based supplier of electrical components for commercial and residential building applications, and industrial controls for industrial equipment applications. Company has strong operations in traditional European markets and growth markets of Eastern Europe and Asia and is expected to Source: S&P Industry Survey strengthen European distribution networks. The Eaton engages in long term, fixed price contracts with company is expected to add more than 1 Billion USD in suppliers and use forward commodity purchase revenues in FY 2008 to the electrical segment at Eaton. agreements with third parties to hedge its exposure to rising commodity prices. However, in the long run, rising commodity prices will adversely affect the profit margins of industrial machinery suppliers including Eaton.
CATALYSTS FOR GROWTH Innovative Product Offerings Higher fuel prices and tougher emissions regulations are increasing demand for the automated truck transmissions and industry-leading diesel electric hybrid power trains for commercial vehicles. Eaton’s hybrid power system technology increases the efficiency of commercial vehicles up to 60% and reduces emissions. In US company is developing hybrid trucks for CocaCola, Wal-Mart, Pepsi Bottling, FedEx, UPS and others. Source: Q2 2008 Report and Industrial Analyst’s Estimates
Fuel and environmental concerns have also accelerated the adoption of Automotive segments industry-leading engine air management solutions, and new safety regulations are boosting interest in Eaton’s vehicle traction control technologies.
Phoenixtec Power Company Ltd is acquired by Eaton in Feb 2008. Phoenixtec is a Taiwan based manufacturer of single and three-phase Uninterruptible power supply
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(UPS) systems. Company is expected to add more than construction). This will help the company to generate half Billion USD in revenues at the electrical division at top line revenue and profit growth. Eaton. Company is expected to strengthen global UPS business and significantly strengthen the channels in INVESTMENT POSITIVES Taiwan, China and Eastern Europe. Eaton has a strong management team and is considered globally as one of the most ethical We believe both of these acquisitions will provide Eaton companies. These factors boost the confidence of with stable revenue source in the coming future and will the shareholders, customers, suppliers and reduce the dependence on the cyclical North American employees. market. Eaton has been successfully moving away from cyclical and commoditized businesses by plant Going forward we are expecting to see an increasing closings and acquiring companies that have high revenue base from outside US and particularly from the revenue growth and high profit margins. emerging markets and Asia/Pacific region.
Prosperous Growth
Eaton has a backlog of orders sufficient to achieve earnings guidance for the next 1-2 years and this will help Eaton to achieve growth targets even in the midst of ongoing credit crisis.
Eaton has a very balanced portfolio of products that ensures one-third of businesses being early-cycle, one-third being mid-cycle and one-third being latecycle.
Strong distribution network within emerging markets such as Eastern Europe, Taiwan, China, India and Brazil will help Eaton to consistently achieve its top line growth.
INVESTMENT NEGATIVES Source: Annual Report 2006
Source: Q2 2008 Report Since 2006, Eaton is relying less on businesses that are cyclical and commoditized (Truck & Automotive) and will become less profitable in the future and is entering into businesses that provide the scope for organic growth and sustainable profitability in the long run (Electrical, Aerospace and Non-residential
During the first half of 2008, Eaton undertook two ambitious acquisitions in order to boost its revenue from the emerging markets. Failure to properly integrate these acquisitions will prevent Eaton from achieving desired benefits from these acquisitions.
Eaton issued equities worth $1.5 billion and long term debt worth $750 million in order to finance the above mentioned acquisitions. In order to finance future acquisitions, issuing more equity or debt will significantly increase the risk.
Further softening of the truck and automotive segment’s end markets within US might hurt the earnings of the company in the short term.
Currently Eaton enjoys effective tax rate between 15% - 17%. Significant increase in the effective tax rate in the coming years will have a negative impact on EPS and net income of the company.
VALUATION The revenue growth rate projected for FY 08 is 22.8% due to the acquisitions made in the first and second quarter of the year. The range of revenue growth rates for Eaton from 2009 to 2012 is from 10.6% to 12.9%.
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We forecasted modest double digit growth rates that are difficult to miss for a diversified company like Eaton. We forecasted the effective tax range between 2008 and 2012 as 10% to 23% as per the company guidance. The perpetual growth rate is assumed to be 3.5%, almost equivalent to the average US real GDP growth rate. Exhibit 1 shows the growth rate assumptions of several income statement and balance sheet items along with the revenues from each of the five business segments of Eaton Corporation. We expect the gross margins to expand in the future with the full implementation of Excel 07 program, successful integration of recent acquisitions and increase in sales volume and product offerings.
SELL DISCIPLINE We would like to keep a watch for certain future events including steep downturn in global economy and emerging markets. We would also like to keep an eye on the US defense spending budget and huge declines in the number of new aircraft deliveries and slowdown in aerospace market. We expect North American Class 8 truck sales to pick up in Q4 2008 and beyond. Steep deterioration in the vehicles sales within US and failure of one of the big three US auto giants would be a cause of concern for Eaton Corporation. Future ambitious acquisitions by issuing more debt or equity without proper prior acquisition integration would severely impact Eaton’s ability to achieve projected revenue growth required to justify the target price of the stock. Eaton enjoys favorable effective tax rate as a result of its Non-US operations and certain deferred tax assets. Steep increase in effective tax rate will have a huge impact on the EPS and will be a valid reason to reevaluate the stock. Currently Eaton does not have huge underfunded pension and post retirement benefit programs. We want to keep a closer look on these liabilities in the future.
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Henry Fund Research REFERENCES 1. Standard & Poor’s’ Industry Survey, Industrial Machinery, February 2008 2. Institute of Supply Management 3. Federal Reserve Board 4. IBIS World Reports 5. Yahoo.finance.com 6. US Bureau of Census 7. Bureau of Economic Analysis (BEA) 8. Henry Fund Analyst Consensus 9. Eaton Corporation Annual Report FY07 &FY06
Henry B. Tippie School of Management
IMPORTANT DISCLAIMER This report was created by a student(s) enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management. The intent of these reports is to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.
10. www.bondsonline.com 11. Standard & Poor’s company report on Eaton Corporation 12. Deutsche Report on Eaton Corporation, November 19, 2007 13. www.bloomberg.com 14. Bloomberg 15. Boeing Industry Forecast 16. S&P Industry Survey, Aerospace & Defense, January 31 2008 17. www.yahoo.finance.com 18. Eaton Corporation Quarterly Report June 2008
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Assumptions
Eaton Corp Revenue, Income Statement and Balance Sheet projections 2005 Fiscal Years Ending 12/31 Increase in Revenues by Business Segments Fluid Power Aerospace Hydraulics Automotive Truck Electrical
2006
2007
23%
12%
2008E
2009E
2010E
2011E
2012E
CV
13% 15% -2% 8% 12%
13% 15% 3% 10% 13%
15% 15% 3% 10% 14%
15% 15% 5% 10% 15%
3.5% 3.5% 3.5% 3.5% 3.5%
-8% 10% 11%
-2% -15% 14%
13% 16% -1% 3% 48%
11.3%
5.4%
22.8%
10.6%
11.9%
12.9%
13.6%
3.50%
72.1% 15.8% 2.6%
73.2% 15.7% 2.6%
72.0% 16.4% 2.6%
19.2%
7.8%
7.9%
72.0% 16.0% 2.6% 4.65% 5.5% 10.0%
72.0% 16.5% 2.6% 4.65% 5.5% 15.0%
71.5% 17.0% 2.6% 4.65% 5.5% 23.0%
71.5% 17.5% 2.6% 4.65% 5.5% 23.0%
71.5% 17.5% 2.6% 4.65% 5.5% 23.0%
71.5% 17.0% 2.6% 4.65% 5.5% 23.0%
Cash and cash equivalents as a % of Sales 3.0% Short-term investments Accounts receivable, net as a % of Sales 16% Inventories, net as a % of Sales 9.9% Y-Y change in Curent deferred income tax assets ($) other current assets as a % of Sales 1.0%
6.4%
5.0%
5.7%
6.7%
7.4%
6.4%
5.5%
9.8%
16% 10.5% 24 1.1%
17% 11.4% 24 1.1%
17% 11.50% 25 1.1%
17% 12.00% 25 1.1%
17% 12.00% 25 1.1%
17.5% 12.50% 25 1.1%
17.5% 12.00% 25 1.1%
17.5% 12.00% 25 1.1%
8.8% 31.2% 54.1%
9.0% 31.2% 55.5%
35
56
9.0% 31.2% 57.00% 200 130 1.9%
9.0% 31.5% 57.00% 200 65 2.00%
8.8% 31.5% 57.00% 200 65 2.00%
8.5% 31.0% 57.00% 200 65 2.00%
8.5% 30.5% 57.00% 200 65 2.00%
8.5% 30.5% 57.00% 200 65 2.00%
20.00% 2.8% 9.0% 552 10.5%
20.00% 2.8% 9.0% 552 11.0%
20.00% 3.0% 9.0% 314 11.5%
18.00% 3.0% 9.0% 314 12.0%
18.00% 3.0% 9.0% 1566 12.0%
(10) 10 6%
(10) 10 6.0%
(10) 10 6.5%
(10) 10 6.5%
(10) 10 6.5%
$1.89
75% (200) $2.08
80% (250) $2.29
85% (300) $2.52
85% (350) $2.77
85% (500) $3.05
$294
$322
$352
$385
$420
$455
Y-Y Revenue Growth (resulting) Cost of products sold Selling & administrative expenses Research & development Expenses Interest Expense as a % of ST Debt Interest Expense as a % of LT Debt Income Tax Expense as a % of EBT
Land & buildings Machinery & Equipments as a % of Sales Accu. Depreciation as a % of Depreciable assets Amoritization of Other intangible assets Y-Y change in deferred income tax assets ($) Operating Leases as % of assets
9.0% 32.9% 53.3%
Short-term Debt as % of Current Assets Accrued Compensation as % of Sales Other current liabilities as % of Sales Current portion of L-T debt Accounts payable as a % of Sales
12.2% 2.5% 8.5%
13.5% 2.5% 8.8%
20.0% 2.7% 8.8%
7.3%
8.5%
9.0%
20.00% 2.8% 8.8% 160 10.5%
10 6.00%
Y-Y change in Pension Liabilities Y-Y change in Post Retirement Benefits ($) Other liabilities as a % of Sales Long-term debt as a % of shareholders equity Share Repurchase ($) Y-Y Dividend per Share increase (@10%) 10% Amount Paid as dividend
4.3%
3.4%
5.5%
87.7% (450) $1.24
81.1% (386) $1.48
102.9% (340) $1.72
81.5%
Important disclosures appear on the last page of this report.
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Income Statement
Income Statement Fiscal Years Ending 12/31 Currency Scale Revenues by Business Segments Fluid Power
Aerospace Hydraulics Automotive Truck Electrical
2005 US Dollar Millions
2006 US Dollar Millions
3240
3983
2007 2008E 2009E US Dollar US Dollar US Dollar Millions Millions Millions
2010E US Dollar Millions
2011E US Dollar Millions
2012E US Dollar Millions
CV US Dollar Millions
4480
1829 2288 3758
1683 2520 4184
1647 2147 4759
3139 1975 1631 2211 7043
Total revenues
11115
12370
13033
15999
17692
19806
22359
25399
26288
Cost of products sold Research & development Expenses Interest Expense, Net Other (income) expense-net
8012 1757 287 90 (27)
9050 1946 321 104 (40)
9382 2139 335 147 (11)
11517 2560 411 221 (15)
12736 2919 455 209 (15)
14162 3367 509 220 (15)
15987 3913 575 233 (15)
18161 4445 653 225 (15)
18796 4469 676 212 (15)
Total costs, expenses & other
10119
11381
11992
14693
16304
18243
20693
23468
24138
Income (loss) before taxes
996
989
1041
1305
1388
1563
1667
1931
2150
Tax expense (benefit)
191
77
82
131
208
360
383
444
494
Income (loss) from continuing operations 805 Income (loss) from discontinued operations, net of taxes 0
912 38
959 35
1175 0
1180 0
1204 0
1284 0
1487 0
1655 0
Net income (loss)
805
950
994
1175
1180
1204
1284
1487
1655
150.20 5.36 $1.24
150.20 6.32 $1.48
147.30 6.75 $1.72
155 7.56 $1.89
155 7.63 $2.08
154 7.83 $2.29
153 8.41 $2.52
151 9.82 $2.77
149 11.08 $3.05
Selling & administrative expenses
Weighted average shares outstanding Net earnings (loss) per share Dividends per common share
12
3547 2271 1598 2388 7889
4008 2612 1646 2627 8914
4609 3003 1695 2890 10162
5300 3454 1780 3179 11686
5486 3575 1842 3290 12095
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Balance Sheet
Eaton Corp Balance Sheet Fiscal Years Ending 12/31 Currency Scale
2005 US Dollar Millions
2006 US Dollar Millions
2007 US Dollar Millions
2008E US Dollar Millions
2009E US Dollar Millions
2010E US Dollar Millions
2011E US Dollar Millions
2012E US Dollar Millions
CV US Dollar Millions
110 226 1,785 1,099 243 115 3,578
115 671 1,928 1,293 267 135 4,409
143 504 2,208 1,483 291 139 4,768
410 504 2,720 1,840 316 176 5,966
674 504 3,008 2,123 341 195 6,845
966 504 3,367 2,377 366 218 7,798
918 504 3,913 2,795 391 246 8,767
906 504 4,445 3,048 416 279 9,598
2,075 504 4,600 3,155 441 289 11,064
Goodwill Other intangible assets Deferrred income taxes & other assets Total assets
1,003 3,652 4,655 2,480 2,175 3,139 626 700 10,218
1,083 3,863 4,946 2,675 2,271 3,034 969 735 11,418
1,175 4,067 5,242 2,909 2,333 3,982 1,557 791 13,431
1440 4992 6,431 3666 2,766 6,181 1,847 921 17,680
1592 5573 7,165 4084 3,081 6,181 1,847 986 18,940
1743 6239 7,982 4550 3,432 6,181 1,847 1,051 20,309
1901 6931 8,832 5034 3,798 6,181 1,847 1,116 21,709
2159 7747 9,906 5646 4,259 6,181 1,847 1,181 23,066
2235 8018 10,252 5844 4,409 6,181 1,847 1,246 24,747
Accounts payable Short-term debt Accrued compensation Current portion of long-term debt Accrued income & other taxes Other current liabilities Total current liabilities
810 394 277 240 305 942 2,968
1,050 490 305 322 149 1,091 3,407
1,170 825 355 160 0 1,149 3,659
1680 1010 141 160 0 1408 4,400
1858 1133 159 552 0 1592 5,294
2179 1266 177 552 0 1783 5,956
2571 1469 220 314 0 2012 6,587
3048 1474 246 314 0 2286 7,367
3155 1527 255 1566 0 2366 8,868
Long-term debt Pension liabilities Other postretirement liabilities Other long-term liabilities Total Liabilities
1,830 632 537 473 6,440
1,774 942 766 422 7,311
2,432 681 772 714 8,258
3155 945 782 960 10,241
2842 935 792 1062 10,924
2938 925 802 1188 11,809
2993 915 812 1453 12,760
2838 905 822 1651 13,583
2572 895 832 1709 14,876
Common shares
2,087
2,188
2,364
3,870
3,789
3,672
3,521
3,338
3,025
Accumulated other comprehensive income (loss) Retained earnings Deferred compensation plans Total shareowners' equity
(649) 2,376 (36) 3,778
(849) 2,796 (28) 4,107
(423) 3,257 (25) 5,173
(544) 4,138 (25) 7,439
(544) 4,996 (225) 8,016
(544) 5,847 (475) 8,500
(544) 6,746 (775) 8,949
(544) 7,814 (1125) 9,483
(544) 9,014 (1625) 9,871
Total Liabilities and Shareholders Equity
10,218
11,418
13,431
17,680
18,940
20,309
21,709
23,066
24,747
Cash
Short-term investments Accounts receivable Inventories Deferred income taxes Other current assets Total current assets Land & buildings Machinery & equipment Gross property, plant & equipment
Accumulated depreciation Property, plant & equipment, net
13
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Common Size Income Statement
Eaton Corp Income Statement Fiscal Years Ending 12/31
2005
2006
2007
2008E
2009E
2010E
2011E
2012E
CV
0.0% 0.0% 16.5% 20.6%
0.0% 0.0% 13.6% 20.4%
0.0% 0.0% 12.6% 16.5%
19.6% 12.3% 10.2% 13.8%
20.0% 12.8% 9.0% 13.5%
20.2% 13.2% 8.3% 13.3%
20.6% 13.4% 7.6% 12.9%
20.9% 13.6% 7.0% 12.5%
20.9% 13.6% 7.0% 12.5%
Total revenues
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
Cost of products sold Research & development Expenses Interest Expense, Net Other (income) expense-net
72.08% 15.81% 2.58% 0.81% -0.24%
73.16% 15.73% 2.59% 0.84% -0.32%
71.99% 16.41% 2.57% 1.13% -0.08%
71.99% 16.00% 2.57% 1.38% -0.09%
71.99% 16.50% 2.57% 1.18% -0.08%
71.50% 17.00% 2.57% 1.11% -0.08%
71.50% 17.50% 2.57% 1.04% -0.07%
71.50% 17.50% 2.57% 0.88% -0.06%
71.50% 17.00% 2.57% 0.81% -0.06%
Total costs, expenses & other
91.04%
92.00%
92.01%
91.84%
92.15%
92.11%
92.55%
92.40%
91.82%
Income (loss) before taxes
8.96%
8.00%
7.99%
8.16%
7.85%
7.89%
7.45%
7.60%
8.18%
1.72% Tax expense (benefit) 7.24% Income (loss) from continuing operations Income (loss) from discontinued operations, net of taxes 0.31%
0.62% 7.37% 0.31%
0.63% 7.36% 0.27%
0.82% 7.34% 0.00%
1.18% 6.67% 0.00%
1.82% 6.08% 0.00%
1.71% 5.74% 0.00%
1.75% 5.86% 0.00%
1.88% 6.30% 0.00%
7.24%
7.68%
7.63%
7.34%
6.67%
6.08%
5.74%
5.86%
6.30%
Revenues by Business Segments Fluid Power
Aerospace Hydraulics Automotive Truck Electrical
Selling & administrative expenses
Net income (loss)
14
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Common Size Balance Sheet
Eaton Corp Balance Sheet Fiscal Years Ending 12/31
2005
2006
2007
2008E
2009E
2010E
2011E
2012E
CV
0.99% 2.03% 16.06% 9.89% 2.19% 1.03% 32.19%
0.93% 5.42% 15.59% 10.45% 2.16% 1.09% 35.64%
1.10% 3.87% 16.94% 11.38% 2.23% 1.07% 36.58%
2.56% 3.15% 17.00% 11.50% 1.98% 1.10% 37.29%
3.81% 2.85% 17.00% 12.00% 1.93% 1.10% 38.69%
4.88% 2.54% 17.00% 12.00% 1.85% 1.10% 39.37%
4.11% 2.25% 17.50% 12.50% 1.75% 1.10% 39.21%
3.57% 1.98% 17.50% 12.00% 1.64% 1.10% 37.79%
7.89% 1.92% 17.50% 12.00% 1.68% 1.10% 42.09%
Total assets
9.02% 32.86% 41.88% 22.31% 19.57% 28.24% 5.63% 6.30% 91.93%
8.76% 31.23% 39.98% 21.62% 18.36% 24.53% 7.83% 5.94% 92.30%
9.02% 31.21% 40.22% 22.32% 17.90% 30.55% 11.95% 6.07% 103.05%
9.00% 31.20% 40.20% 22.91% 17.29% 38.63% 11.54% 5.76% 110.51%
9.00% 31.50% 40.50% 23.09% 17.42% 34.94% 10.44% 5.57% 107.05%
8.80% 31.50% 40.30% 22.97% 17.33% 31.21% 9.33% 5.31% 102.54%
8.50% 31.00% 39.50% 22.52% 16.99% 27.64% 8.26% 4.99% 97.09%
8.50% 30.50% 39.00% 22.23% 16.77% 24.34% 7.27% 4.65% 90.81%
8.50% 30.50% 39.00% 22.23% 16.77% 23.51% 7.03% 4.74% 94.14%
Accounts payable Short-term debt Accrued compensation Current portion of long-term debt Accrued income & other taxes Other current liabilities Total current liabilities
7.29% 3.54% 2.49% 2.16% 2.74% 8.48% 26.70%
8.49% 3.96% 2.47% 2.60% 1.20% 8.82% 27.54%
8.98% 6.33% 2.72% 1.23% 0.00% 8.82% 28.07%
10.50% 6.32% 0.88% 1.00% 0.00% 8.80% 27.50%
10.50% 6.41% 0.90% 3.12% 0.00% 9.00% 29.92%
11.00% 6.39% 0.89% 2.79% 0.00% 9.00% 30.07%
11.50% 6.57% 0.99% 1.40% 0.00% 9.00% 29.46%
12.00% 5.80% 0.97% 1.24% 0.00% 9.00% 29.01%
12.00% 5.81% 0.97% 5.96% 0.00% 9.00% 33.74%
Long-term debt Pension liabilities Other postretirement liabilities Other long-term liabilities Total Liabilities
16.46% 5.69% 4.83% 4.26% 57.94%
14.34% 7.62% 6.19% 3.41% 59.10%
18.66% 5.23% 5.92% 5.48% 63.36%
19.72% 5.91% 4.89% 6.00% 64.01%
16.06% 5.28% 4.48% 6.00% 61.75%
14.83% 4.67% 4.05% 6.00% 59.62%
13.39% 4.09% 3.63% 6.50% 57.07%
11.17% 3.56% 3.24% 6.50% 53.48%
9.78% 3.40% 3.16% 6.50% 56.59%
Common shares Accumulated other comprehensive income (loss) Retained earnings Deferred compensation plans Total shareowners' equity
18.78% -5.84% 21.38% -0.32% 33.99%
17.69% -6.86% 22.60% -0.23% 33.20%
18.14% -3.25% 24.99% -0.19% 39.69%
24.19% -3.40% 25.86% -0.16% 46.50%
21.42% -3.07% 28.24% -1.27% 45.31%
18.54% -2.75% 29.52% -2.40% 42.92%
15.75% -2.43% 30.17% -3.47% 40.02%
13.14% -2.14% 30.76% -4.43% 37.34%
11.51% -2.07% 34.29% -6.18% 37.55%
Total Liabilities and Shareholders Equity
91.93%
92.30%
103.05%
110.51%
107.05%
102.54%
97.09%
90.81%
94.14%
Cash & cash equivalents Short-term investments
Accounts receivable Inventories Deferred income taxes Other current assets
Total current assets Land & buildings Machinery & equipment Gross property, plant & equipment Less-accumulated depreciation & amortization Property, plant & equipment, net Goodwill Other intangible assets, net Deferred income taxes
15
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Value Drivers
Eaton Corp Value Driver Calculations 2006 $ Mil
2007 $ Mil
2008E $ Mil
2009E $ Mil
2010E $ Mil
2011E $ Mil
2012E $ Mil
CV $ Mil
NOPLAT Pre-Tax Earnings Add: Interest Expense EBITA Less: Tax on EBITA Marginal Tax Rate Total Income Tax Provision Add: Tax Shield on Interest Expense Add: Tax Shield on Amoritization Less: Tax Shield on non-operating income Taxes on EBITA Add: Changes in Deferred Tax NOPLAT INVESTED CAPITAL Operating Working Capital Plus: Normal Cash * Plus: Receivables Plus: Inventory Plus: Other Current Assets Less: Accounts Payable Less: Other current liabilities Net Operating Working Capital Net Property Plant Equipment Add:Other Long Term Op. Assets Add: Operating Leases Net Invested Capital ROIC (Return on Invested Capital) NOPLAT Invested Capital (Beginning) ROIC (NOPLAT/Invested Capital) FREE CASH FLOWS NOPLAT
989 104 1,093
1,041 147 1,188
1,305 221 1,526
1,388 209 1,597
1,563 220 1,784
1,667 233 1,900
1,931 225 2,156
2,150 212 2,362
7.79% 77 8 15 3 103 (59) 931
7.88% 82 12 18 1 113 (80) 995
10.00% 131 22 76 2 230 (155) 1,141
15.00% 208 31 63 2 305 (90) 1,203
23.00% 360 51 107 3 521 (90) 1,173
23.00% 383 54 111 3 552 (90) 1,258
23.00% 444 52 141 3 640 (90) 1,426
23.00% 494 49 45 3 592 (90) 1,680
115 1,928 1,293 135 (1,050) (1,091) 1,330 2,271 286 3,887
391 2,208 1,483 139 (1,170) (1,149) 1,902 2,333 286 4,521
480 2,720 1,840 176 (1,680) (1,408) 2,128 2,766 286 5,179
531 3,008 2,123 195 (1,858) (1,592) 2,406 3,081 205 5,692
594 3,367 2,377 218 (2,179) (1,783) 2,595 3,432 135 6,162
671 3,913 2,795 246 (2,571) (2,012) 3,041 3,798 87 6,925
762 4,445 3,048 279 (3,048) (2,286) 3,200 4,259 53 7,513
789 4,600 3,155 289 (3,155) (2,366) 3,312 4,409 25 7,746
931
995 3,887 25.60%
1,141 4,521 25.24%
1,203 5,179 23.22%
1,173 5,692 20.61%
1,258 6,162 20.41%
1,426 6,925 20.59%
1,680 7,513 22.36%
1,141 658 483
1,203 513 690
1,173 470 702
1,258 763 495
1,426 588 838
1,680 233 1,447
10.14% -
3,887 25.60% 10.14% 601
4,521 25.24% 10.14% 683
5,179 23.22% 10.14% 678
5,692 20.61% 10.14% 596
6,162 20.41% 10.14% 633
6,925 20.59% 10.14% 724
7,513 22.36% 10.14% 919
786 115 671
647 391 256
914 480 434
1178 531 648
1470 594 876
1422 671 752
1410 762 648
2579 789 1790
671
256
434
648
876
752
648
1790
931
995 634 361
Net Investment (Change in Invested Capital)
Free Cashflows (NOPLAT - NI) ECONOMIC PROFIT Invested Capital (Beginning) ROIC WACC EP (Invested Capital*(ROIC - WACC)) NON-OPERATING ASSETS Cash on Hand "Normal" Cash Excess Cash Investments & LT Recievables Non-Operating Assets
16
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DCF Valuation
Eaton Corp Valuation Calculations Fiscal Years Ending Dec 31st
DCF Model FCF PV(FCF) PV(FCF) + PV(Non-Oper) - PV(Debt + Op. Leases) - PV(ESOP) PV(Equity) Shares Outst. Target Price Target Price EP Model ROIC EP PV(EP) PV(EP) Invested Capital PV(Operations) + PV(Non-Oper) - PV(Debt + Op. Leases) - PV(ESOP) PV(Equity) Shares Outst. Target Price Target Price
$ $ $ $ $ $ $
WACC CV Growth Rate CV ROIC Cost of Equity
15,563 256.0 2,718 264 12,837 154 83.19 92.13
2008E
2009E
2010E
2011E
2012E
CV
483 438
690 569
702 526
495 336
838 517
21353 13176
20.59% 724 447
22.36% 13840 8540
As of Last FY End As of 11/24/2008 (growth at cost of Equity)
25.24% 683 620 $ $ $ $ $ $ $ $ $
11,042 4,521 15,563 256 2,718 264 12,837 154 83.19 92.13
10.14% 3.50% 22.36% 12.03%
23.22% 678 559
20.61% 596 446
20.41% 633 430
As of Last FY End As of 11/24/2008 (growth at cost of Equity)
17
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Relative P/E
Relative P/E Analysis Ticker GE PH UTX EMR HON ITT JCI DHR ABB
Company Price General Electric $ 26.75 Parker Hannifin Corporation $ 61.25 United Technologies $ 64.46 Emerson Electric $ 44.20 Honeywell International$ 47.55 ITT Corporation $ 61.25 Jhonson Controls Inc. $ 32.93 Danaher Corp $ 76.91 ABB Ltd. $ 21.33
ETN
Eaton Corp
Implied Value: Relative P/E (EPS08) Relative P/E (EPS09) PEG Ratio (EPS08) PEG Ratio (EPS09) CAGR
$ 71.45
EPS 2008E $2.21 $5.90 $4.95 $3.10 $3.82 $4.18 $2.33 $4.39 $1.74
EPS 2009E $2.35 $6.40 $5.49 $3.40 $4.28 $4.68 $2.56 $4.94 $2.04 Average
$7.56
$7.63
$ 101.47 $ 92.17 $ 61.11 $ 55.68
P/E 08 12.1 10.4 13.0 14.3 12.4 14.7 14.1 17.5 12.3 13.4 9.4
P/E 09 11.4 9.6 11.7 13.0 11.1 13.1 12.9 15.6 10.5 12.1 9.4
Est. 5yr Gr. 11.0 12.7 11.6 12.8 11.0 13.0 13.0 13.8 21.7
PEG 08 1.10 0.82 1.12 1.11 1.13 1.13 1.09 1.27 0.57 1.0
8
(average PEG ratio * growth * EPS)
0.08
18
1.2
PEG 09 1.03 0.76 1.01 1.01 1.01 1.01 0.99 1.13 0.48 0.9 1.2
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DDM
Eaton Corp Dvidend Discount Model 2008E EPS
$7.56
2009E
2010E
$7.63
$7.83
2011E $8.41
2012E $9.82
CV $11.08
Key Assumptions WACC CV ROIC CV Growth Cost of Equity
10.14% 22.36% 3.50% 12.03%
Future Cash Flows P/E Mutliple EPS Next Period Stock Price Div idend FCF DCF Target Price Target Price
10.3 $11.08 $114.17 $2.77 $116.94 72.16
$1.89 $1.89 1.72
$2.08 $2.29 $2.52 $2.08 $2.29 $2.52 1.72 1.71 1.71 79.02 As of last FY End 87.51 As of ######## (Growth at Cost of Equity)
19
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WACC Eaton Corp Weighted Average Cost of Capital (WACC) Estimation
Ticker
Key Assumptions for Honeywell's Valuation Model ETN (NYSE)
Current Stock Price Shares Outstanding Effective Tax Rate Normal Cash (% of Revenue) CV Growth Rate Risk-Free Rate Inflation Rate Real Risk Free Rate Market Risk Premium Beta (2 Year Weekly) WACC
71.45 154300000 8.0% 3.0% 3.50% 4.32% 5.60% -1.29% 4.82% 1.600 10.14%
(30 Yr Treasury)
COMPUTATION OF WACC Capital Structure
Proportion
Equity (MV) Debt (BV) Op. Lease Total WACC
11,025 3,417 286 14,728 10.14%
Cost of Equity Risk Free Rate Market Risk Premium Beta Cost of Equity
4.32% 4.82% 1.60 12.03%
Cost of Debt Corporate Bond Rating Cost of debt before taxes Cost of Debt After taxes Cost of Debt after taxes
A 6.00% 4.51% 4.51%
74.86% 23.20% 1.94%
Cost 12.03%
4.51%
Bloomberg
20
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Operating Leases
PV of Operaing Leases
PV of Operating Leases PV of Operating Leases
2008 102 96.2
2009 77 68.5
2010 55 46.2
2011 38 30.1
2012 26 19.4
CV 34 25.4
Total Y-Y PV of Operating Lease
285.9
204.61
135.43
86.70
53.43
25.41
ESOP
VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol Current Stock Price Risk Free Rate Current Div idend Yield Annualized St. Dev. of Stock Returns
Range of Number Outstanding Options of Shares (M) 11.20
Total
11.20 $
ETN 71.45 4.32% 2.00% 22.00%
Av erage Ex ercise Price 56.83
Av erage Remaining Life (yrs) 6.00 $
56.83
6.00 $
21
B-S Value Option of Options Price Granted (M) 23.60 $ 264.32
30.30
$
264.32
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Share Change
Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding Number of Options Outstanding (shares): Average Time to Maturity (years): Expected Annual Number of Options Exercised: Current Average Strike Price: Cost of Equity: Current Stock Price:
$ $
Increase in Shares Outstanding: Average Strike Price: Increase in Common Stock Account:
$
Change in Treasury Stock Expected Price of Repurchased Shares: Number of Shares Repurchased:
$
Shares Outstanding (beginning of the year) Plus: Shares Issued Through ESOP Less: Shares Repurchased in Treasury Shares Outstanding (end of the year)
11 6.00 2 56.83 12.03% 71.45 2008E 2 56.83 $ 106
2009E 2 63.66 $ 119
2010E 2 71.32 $ 133
2011E 2 79.90 $ 149
2012E CV 2 2 89.51 $ 100.27 167 187
0 71.45 $ -
200 80.04 $ 2
250 89.67 $ 3
300 100.45 $ 3
350 500 112.54 $ 126.07 3 4
154 2 155
155 2 2 155
155 2 3 154
154 2 3 153
22
153 2 3 151
151 2 4 149
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Sensitivity Analysis CV Growth Rate& Beta
$
92.13 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2
1.50% 143.58 132.61 122.93 114.35 106.67 99.76 93.52 87.85 82.68 77.94 73.58 69.56 65.85 62.39
2.00% 154.53 141.82 130.75 121.03 112.41 104.73 97.84 91.61 85.97 80.83 76.13 71.82 67.84 64.16
2.50% 167.97 152.98 140.10 128.93 119.14 110.50 102.81 95.92 89.72 84.11 79.00 74.34 70.06 66.12
3.00% 184.87 166.76 151.48 138.42 127.14 117.28 108.60 100.90 94.02 87.84 82.25 77.18 72.55 68.31
3.50% 206.76 184.21 165.62 150.04 136.78 125.37 115.44 106.72 99.01 92.13 85.97 80.41 75.37 70.78
4.00% 236.22 207.03 183.68 164.58 148.65 135.18 123.63 113.62 104.86 97.13 90.26 84.11 78.57 73.56
4.50% 278.01 238.16 207.55 183.30 163.62 147.33 133.62 121.92 111.82 103.01 95.26 88.39 82.25 76.74
5.00% 341.91 283.11 240.55 208.33 183.08 162.77 146.07 132.09 120.23 110.03 101.17 93.40 86.53 80.41
Sensitivity Analysis
Marginal Tax rate & Risk Free Rate $
92.13 2.6% 2.8% 3.0% 3.2% 3.4% 3.6% 3.8% 4.0% 4.2% 4.4% 4.6% 4.8% 5.0% 5.2% 5.4% 5.6%
23.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
24.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
25.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
26.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
27.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
23
28.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
29.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
30.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
31.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
32.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
33.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
34.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
35.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
DIVERSIFIED INDUSTRIAL FIRM
Henry Fund Research
EATON CORPORATION (ETN)
Investment Recommendation
HOLD
Current Price
$69.33
Target Price Range
$92.13
Sumit Mundhra [email protected]
INVESTMENT THESIS High diversity in business segments and geography is driving revenue growth for Eaton even in the midst of the ongoing credit crisis. We expect Eaton to do well in the near future because of its disciplined acquisition activities and ability to achieve organic growth within its business segments. Within the last 2 years, Eaton successfully executed its strategy of moving away from cyclical and commoditized businesses (Truck & Automotive) and adding high growth businesses with sustainable profitability in its portfolio (Aerospace, Electrical and Non-Residential Construction).
Source: http://yahoo.investor.reuters.com
Key Stock Statistics 52-Week Price Range
$62.51-101.82
Market Capitalization (B)
$11.52
Shares Outstanding (M)
166
Institutional Ownership
79.19%
60-Month Beta
1.42
Dividend Yield
2.0%
Price/Earnings (ttm)
9.75
Price/Book
0.73
Price/Sales
1.53
ROA (ttm)
5.65%
ROE(ttm)
18.02%
Projected 5-Year Growth
12.25%
EPS ($) Year EPS
2005 5.36
2006 6.32
2007 6.75
2008E 7.65
2009E 7.76
2010E 7.96
All earnings represent earnings from operations and have been filtered from net nonrecurring gains.
Valuation Models Discounted Cash Flow
$92.13
Economic Profit
$92.13
Relative P/E Dividend Discount Model
Eaton substantially enhanced its distribution network in the emerging markets and is now in the position to take advantage of the same. We expect the revenue contribution from the Non-US markets to increase to 47% in FY2008 and to more than 50 % beyond FY2009. Eaton has a huge backlog of orders for the second half of 2008 and 2009. We believe that the backlog will help Eaton to achieve its earnings guidance for the next 1-2 years even in the slowing economic environment within US, UK and traditional European countries. We believe Eaton’s current stock price is substantially undervalued and company’s stock is currently trading close to its 52 week low. Having said that, we believe the upside potential is significantly higher than its downside risk. Eaton undertook several acquisition activities in past 2 years and paid premium for companies. Failure to properly integrate acquired businesses would result in the loss of positive synergies and expected benefits.
$101.47 $87.51
Important disclosures appear on the last page of this report.
THE UNIVERSITY OF IOWA
Henry Fund Research
Henry B. Tippie School of Management of Eaton’s revenues and is one of the fastest growing business segments.
EXECUTIVE SUMMARY
Eaton Corporation is a diversified industrial conglomerate that caters to several sub-segments of The segment saw a 45% increase in revenues in the industrial sector and is expected to significantly first half of 2008 over 2007 primarily because of three acquisitions – Phoenixtec, Moeller and MGE small outperform the market in the near future. systems UPS business. Eaton has a huge backlog of orders for FY 2009 and we believe backlog will help Eaton to achieve its Electrical Segment earnings guidance. Moreover, Eaton is successful in slowly moving away from its automotive and trucking businesses and expanding in electrical and aerospace segments. Eaton has substantially increased its exposure to the Source: Annual Report 2007 non-US and emerging markets between FY2006 and FY2008 and we expect the trend to continue beyond Automotive FY2008. Eaton provides automotive engine air management We concluded that expected returns associated with systems, power train solutions and specialty controls for investing in Eaton Corporation far exceeded the automotives. Automotive segment caters to OEMs and associated potential risks of investment. Based on our after-market customers of passenger cars located analysis and DCF, Economic Profit, Relative P/E and globally. Eaton offers a wide array of products such as Dividend Discount Model valuations, we recommend a superchargers, engine valves, actuation systems, cylinder heads, differentials, transmission controls, BUY on Eaton Corporation. engine controls and fuel vapor components that are essential to fuel economy, performance and safety of COMPANY DESCRIPTION the auto motives. Because of the higher fuel prices, the Eaton is a diversified industrial manufacturer with 2007 segment saw shrinkage of around 5% in the end sales of $13 Billion. Eaton sells products to customers markets in the first half of 2008. This might result in the in 150 countries and reports its revenues by five decrease in revenues from this segment by 1.5% to business segments namely Electrical, Hydraulics, 2%. Automotive, Aerospace and Truck. The chart below provides the revenue break up for June 2008 followed Automotive by details of each business segment.
Source: Annual Report 2007 Aerospace Eaton offers products and services for the cockpit interface and circuit protection, fuel & hydraulic systems, motion control and propulsion sub-systems and air distribution. Aerospace segment caters to manufacturers of commercial and military aircrafts and related aftermarket customers. Eaton undertook strategic acquisitions such as Aerospace division of PerkinElmer, Inc. and Aerospace fluid and air division of Cobham PLC, in the aerospace segment that increased its revenues contribution from the division.
Source: Quarterly Report June 2008 Electrical Eaton manufactures electrical components and systems for power quality, distribution and control. Through electrical segment, Eaton caters to Industrial, Utility, Light Commercial, Residential and NonResidential Construction, Government and OEM markets. The segment contributes more than one third
Hydraulics Eaton also manufactures hydraulic power generation systems for industrial, mobile, automotive, and aerospace applications, including pumps, motors, hydraulic power units, hose and fittings, transaxles,
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transmissions, electro-hydraulic pumps, power and load management systems. The Hydraulics segment also includes Eaton’s Filtration, GolfGrip, Airflex, industrial clutch and brake businesses. Hydraulics division caters to original equipment manufacturers and after-market customers of off-highway and industrial equipment, as well as customers in oil and gas, fine chemicals, mining, metal forming, and food and beverage applications.
is financed by issuing equities. These acquisitions are expected to add $1.9 billion in incremental revenues in FY2008.
INDUSTRY TRENDS
As per the IBIS World forecasts, revenues in electrical equipment and components industry is expected to grow at average annualized real rate of 3.7% for the next five years. Strong global demand coupled with weak dollar will boost exports revenues for the industry Hydraulics segment is a strong growth division for in US. The growth in exports might be adversely Eaton because of wide range of applications and strong effected by an increase in import penetration to nearly global demand. 52% in 2012 from 43.4% in 2007. Power infrastructure is expected to see a growth trend due to several reasons. Rising energy prices and the issues with the future energy supply are encouraging investments in renewable energy and alternative energy sources. Increasing load coupled with ageing infrastructure will demand expansion and replacement Source: Annual Report 2007 in the near future. Several electric utilities companies are encouraging to increase efficiency in utility rate Truck determinants. With the global exposure Eaton enjoys in The Truck segment manufactures transmissions, the electrical segment, we expect this division to clutches, collision warning systems, mobile diagnostics increase its contribution to the total revenues. and hybrid electric power-train systems. Eaton sold The growth in the end markets for trucking is impacted primarily to heavy and medium duty OEMs, specialty by the high fuel prices and stronger emission and off-road OEMs, fleet management companies, standards. Weaker outlook for the North American distributors and aftermarket for the same. The division Class 8 truck in the second half of 2008 and early 2009 is impacted by the higher fuel cost in the first half of will be offset by the strong international demand 2008. especially from Brazil. Aerospace & Hydraulics
Truck
Ongoing credit crisis has lengthened auto-loan terms and this combined with weak consumer confidence, fluctuating oil prices and stiffened foreign competition have pressured the overall domestic vehicle sales. Similar situation exists in UK and other developed Source: Annual Report 2007 European markets. We expect that these factors should continue to weaken automotive industry in the developed markets for the next year and a half. As a RECENT DEVELOPMENTS result automakers are targeting China, Eastern Europe In aerospace, company completed mission critical and other emerging markets to position themselves for system development for multiple platforms such as the future growth opportunities. We expect the revenues new F-35 Joint Strike Fighter, Boeing 787, Airbus A380 from the automotive sector to shrink in FY 2008 and FY2009. and the Embraer very light Jet. In filtration, company introduced new filtration media Commercial aircraft demand is closely associated with that improve both the efficiency and longevity of our the long term passenger air traffic growth rate. As per International Air Transport Association, worldwide products. international passenger air traffic grew by 7.5% in the Eaton completed two major acquisitions in 2008 in the first 11 months of 2007 and is expected to grow by 5% electrical segment that will provide the company with in 2008. stronger distribution networks in Eastern Europe, Taiwan and China. Eaton committed around $2.5 billion for the acquisition of The Moeller Group and Phoenixtec Power Company in the first half of FY2008. The company issued long term debt of $750 million and rest
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Henry B. Tippie School of Management As per the forecast by Boeing, the world air cargo traffic is expected to triple by 2026. The air cargo market is predicted to grow by 6.1 percent per year. By 2026, the cargo fleet will double from 1,980 to 3,980 airplanes.
Source: S&P Industry Survey As per Avitas, a market research firm, global commercial aircraft fleet will grow at CAGR of 4.3% till 2025. The following chart shows the forecast of Boeing for new airplane deliveries. Source: Boeing We expect continued emphasis on defense spending because of ongoing war on terrorism and escalated tensions between Russia and US due to Russian invasion in Georgia. However, a slowdown in the US economy, declining tax revenues and Fed‘s subsequent efforts to help financial institutions will put additional budgetary pressure on Congress that might result in reduced defense spending. In addition, a Democratic Party president elected in 2008 elections will result in reduced spending on defense programs in favor of domestic programs, and in that case we see a increased risk to defense budgets.
Source: Boeing
The second value driver is the average age of the fleet. The average life of a commercial plane is around 20 years. The average fleet age in Europe is less than 10 MARKETS AND COMPETITION years, about 11 years in Asia and about 12 years in US in 2006. Hence, some US carriers are due for Eaton faces stiff competition from industrial investments in new fleet as actual age might be more conglomerates and niche firms in all of its business segments in the domestic and international markets. than the average age of 12. Through several divestitures and acquisitions, Eaton is successfully moving away from the commoditized (in case of Automotive segment) and cyclical businesses (in case of Truck segment) and focusing more on Aerospace, electrical, filtration and non-residential construction businesses.
The third important value driver is the overall profitability of the airline industry. If an airline is running into operating losses, new orders for commercial airplanes will be less regardless of the fleet age. However, soaring fuel prices pushed Aloha Airlines, ATA Airlines, Frontier Airlines, MAXJet Airways and Skybus Airlines into bankruptcy. International and discount carriers are doing better than the US based legacy airlines and orders in 2007 soared to 2340 from 1882 in 2006 and 2139 in 2005. We expect increased revenue contribution from aerospace segment in the next five years.
The company issued 07 Excel Program, in which Eaton announced several important plant closings in truck and automotive divisions located in U.S. and Europe. Rising commodity prices and slow domestic demand has created tough times moving ahead in 2008 for industrial machinery suppliers. However, diversification in core markets, product offerings and geographical
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ECONOMIC OUTLOOK
reach will provide Eaton with sustainable revenue growth and margin enhancements.
GDP
Eaton faces intense competition across its market segments. In the automotive segment, the company faces stiff competition from TRW Automotive Holdings, Germany-based INA, Borg Warner, Magna and Bosch. In the electrical segment, the company competes with Schneider, Emerson Electric, GE and Siemens. Major competitors of Eaton in the truck segment are Germany-based ZedF, Wabco, Allison transmission and ArvinMeritor. In the hydraulics and aerospace segment, the company competes with Parker-Hannifin, Germanybased Sauer Danfoss, Dana, Visteon, TI Automotive, Hamilton-Sundstrand, Crane and Honeywell International.
Source: Bureau of Economic Analysis Emerson Electric Co. (EMR)
Real GDP growth in the second quarter of 2008 was Emerson Electric is a diversified manufacturing 2.8% at an annual rate. For the first quarter 2007, the company with a wide portfolio of products – process figure was 0.6%. management, industrial automation, network power, Henry Fund analysts forecasted the consensus climate technologies and appliances and tools. annualized real GDP growth rate of 0.8% for the next Between 2002 and 2007, CAGR for revenues in US is six months. The decline in the growth rate of real GDP 6.3% and for international is 15.2%. In FY 2006-07, will create a slight impact on the automobile sales. company recorded a net profit margin of 9.5% and However, even with the decline in automobile sales, increase in net income of 16% from 2006. The Eaton will continue to do well because of its operations company has a market capitalization of 40.47B and outside US and strong demand in the electrical, recorded revenues of 23.16B in FY 2006-07. hydraulics and aerospace segment. Purchasing Managers’ Index (PMI)
Siemens A G ADR (SI) Company offers a variety of products and services ranging from automation and control, lighting, medical, power, specialized businesses, transportation and water technologies and services. The company has a market capitalization of 116.97B and has a profit margin of 12.82%. Company operates in 190 countries across the globe. The company is actively involved in acquisitions, divestments and joint ventures. In 2007, company recorded revenues of 107.61B. ETN
SI
EMR
11.52B
104.10B
41.81B
Revenue
13B
117.76B
23.16B
Gross Margin Operating Margins Net Income EPS P/E
28.10% 8.00% 994M 6.75 9.75
29.30% 7.08% 6.58B 16.24 7.02
36.01% 15.69% 2.21B 2.817 18.89
Market Cap
Source: http://www.research.stlouisfed.org Value of PMI below 50% shows contraction in the manufacturing sector. A value below 41% shows contraction in overall economy. PMI went below 50 in December 2007 for the first time since January 2007 raising concerns about the expected recession in the US manufacturing sector. PMI in 2001 was consistently
Source: Yahoo Finance & Eaton Annual Report 2007
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below 50 for the entire year indicating a recession in the economy after the internet bubble burst. The five indicators in PMI are New Orders (30%), Production (20%), Employment (20%), Supplier Deliveries (15%) and Inventories (10%). According to the latest report on business (ROB) from Institute of Supply Management (ISM), PMI for August 2008 is 49.9%. PMI was below 50% for five out of first eight months of 2008 and that does not bode well for the US economy. However, high diversity in geography and business segments makes Eaton capable of doing well even in tough times in US economy. While moving ahead with the positive outlook, we want to keep a watch at PMI value for the next 3-6 months. Source: www.bullandbearwise.com Capacity Utilization With $400 million of outstanding commercial paper and short-term borrowings and $4 billion (mostly floating) long term debt, lower interest rates reduce the interest expense of Eaton and thereby benefit the company. Eaton actively engages in acquisition activities globally. In order to finance its bold acquisitions of The Moeller Group and Phoenixtec in first half of 2008, company issued $1.5 billion of equities and $750 million of long term debt paid in part in 2013 and in 2018. With good credit ratings Eaton is able to borrow money at the lower interest rates thereby making the expansion easier. Rising Commodity and Energy Prices Prices of energy and industrial metals were at their peak in the Q2 2008 and we expect them to remain at high levels for 2008 because of the increasing demand High levels of capacity utilization since January 2006 from emerging markets especially China and India. show good opportunity for capacity expansion. Rates consistently above 80% will require manufacturing Steel is one of the key raw materials for Eaton. The companies to increase their capacity. Historically rates steel prices are likely to rise in 2008 by 7% to 8%. The below 80 marked the beginning of recession. Because rise is the result of an increase in production costs, high of the slowdown in the US economy, capacity utilization consumer demand mainly from infrastructure and is consistently between 79% and 80% since April 2008. electronics consumer goods. Source: www.bullandbearwise.com
Learning a lesson from the mid 1990 capacity enhancements and subsequent low utilization rates between 2001 and 2005, companies will not commit investments in capacity enhancement within US. Within US, capacity enhancements are expected to come by increasing labor shifts and improving efficiency and productivity.
The demand would be driven by the BRIC countries (BRIC countries account for 41% of global steel demand), due to intense construction activity. These countries are expected to account for 71% growth in global consumption in 2008. The increase in steel prices would lead to increase in production costs which could negatively impact the future profitability and cash flows of the company.
Interest Rates The federal funds rate is currently residing at 2.0%. In July 2007, federal funds rate was 6.25%. Henry Fund analyst consensus for the federal funds rate for the next 6 months is 2.18%. We believe that the rate will remain constant or below the current level for the remainder of 2008.
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Globalization & Acquisitions
Source: Annual Report 2006 Company completed 9 acquisitions in FY2007 and 3 acquisitions till Q2 2008. All the three acquisitions are for electrical division. On July 31st 2008, Eaton also acquired Kirloskar Oil Engines Ltd. (India). Eaton acquired Moeller Group in April 2008. The Moeller Group is a German based supplier of electrical components for commercial and residential building applications, and industrial controls for industrial equipment applications. Company has strong operations in traditional European markets and growth markets of Eastern Europe and Asia and is expected to Source: S&P Industry Survey strengthen European distribution networks. The Eaton engages in long term, fixed price contracts with company is expected to add more than 1 Billion USD in suppliers and use forward commodity purchase revenues in FY 2008 to the electrical segment at Eaton. agreements with third parties to hedge its exposure to rising commodity prices. However, in the long run, rising commodity prices will adversely affect the profit margins of industrial machinery suppliers including Eaton.
CATALYSTS FOR GROWTH Innovative Product Offerings Higher fuel prices and tougher emissions regulations are increasing demand for the automated truck transmissions and industry-leading diesel electric hybrid power trains for commercial vehicles. Eaton’s hybrid power system technology increases the efficiency of commercial vehicles up to 60% and reduces emissions. In US company is developing hybrid trucks for CocaCola, Wal-Mart, Pepsi Bottling, FedEx, UPS and others. Source: Q2 2008 Report and Industrial Analyst’s Estimates
Fuel and environmental concerns have also accelerated the adoption of Automotive segments industry-leading engine air management solutions, and new safety regulations are boosting interest in Eaton’s vehicle traction control technologies.
Phoenixtec Power Company Ltd is acquired by Eaton in Feb 2008. Phoenixtec is a Taiwan based manufacturer of single and three-phase Uninterruptible power supply
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(UPS) systems. Company is expected to add more than construction). This will help the company to generate half Billion USD in revenues at the electrical division at top line revenue and profit growth. Eaton. Company is expected to strengthen global UPS business and significantly strengthen the channels in INVESTMENT POSITIVES Taiwan, China and Eastern Europe. Eaton has a strong management team and is considered globally as one of the most ethical We believe both of these acquisitions will provide Eaton companies. These factors boost the confidence of with stable revenue source in the coming future and will the shareholders, customers, suppliers and reduce the dependence on the cyclical North American employees. market. Eaton has been successfully moving away from cyclical and commoditized businesses by plant Going forward we are expecting to see an increasing closings and acquiring companies that have high revenue base from outside US and particularly from the revenue growth and high profit margins. emerging markets and Asia/Pacific region.
Prosperous Growth
Eaton has a backlog of orders sufficient to achieve earnings guidance for the next 1-2 years and this will help Eaton to achieve growth targets even in the midst of ongoing credit crisis.
Eaton has a very balanced portfolio of products that ensures one-third of businesses being early-cycle, one-third being mid-cycle and one-third being latecycle.
Strong distribution network within emerging markets such as Eastern Europe, Taiwan, China, India and Brazil will help Eaton to consistently achieve its top line growth.
INVESTMENT NEGATIVES Source: Annual Report 2006
Source: Q2 2008 Report Since 2006, Eaton is relying less on businesses that are cyclical and commoditized (Truck & Automotive) and will become less profitable in the future and is entering into businesses that provide the scope for organic growth and sustainable profitability in the long run (Electrical, Aerospace and Non-residential
During the first half of 2008, Eaton undertook two ambitious acquisitions in order to boost its revenue from the emerging markets. Failure to properly integrate these acquisitions will prevent Eaton from achieving desired benefits from these acquisitions.
Eaton issued equities worth $1.5 billion and long term debt worth $750 million in order to finance the above mentioned acquisitions. In order to finance future acquisitions, issuing more equity or debt will significantly increase the risk.
Further softening of the truck and automotive segment’s end markets within US might hurt the earnings of the company in the short term.
Currently Eaton enjoys effective tax rate between 15% - 17%. Significant increase in the effective tax rate in the coming years will have a negative impact on EPS and net income of the company.
VALUATION The revenue growth rate projected for FY 08 is 22.8% due to the acquisitions made in the first and second quarter of the year. The range of revenue growth rates for Eaton from 2009 to 2012 is from 10.6% to 12.9%.
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We forecasted modest double digit growth rates that are difficult to miss for a diversified company like Eaton. We forecasted the effective tax range between 2008 and 2012 as 10% to 23% as per the company guidance. The perpetual growth rate is assumed to be 3.5%, almost equivalent to the average US real GDP growth rate. Exhibit 1 shows the growth rate assumptions of several income statement and balance sheet items along with the revenues from each of the five business segments of Eaton Corporation. We expect the gross margins to expand in the future with the full implementation of Excel 07 program, successful integration of recent acquisitions and increase in sales volume and product offerings.
SELL DISCIPLINE We would like to keep a watch for certain future events including steep downturn in global economy and emerging markets. We would also like to keep an eye on the US defense spending budget and huge declines in the number of new aircraft deliveries and slowdown in aerospace market. We expect North American Class 8 truck sales to pick up in Q4 2008 and beyond. Steep deterioration in the vehicles sales within US and failure of one of the big three US auto giants would be a cause of concern for Eaton Corporation. Future ambitious acquisitions by issuing more debt or equity without proper prior acquisition integration would severely impact Eaton’s ability to achieve projected revenue growth required to justify the target price of the stock. Eaton enjoys favorable effective tax rate as a result of its Non-US operations and certain deferred tax assets. Steep increase in effective tax rate will have a huge impact on the EPS and will be a valid reason to reevaluate the stock. Currently Eaton does not have huge underfunded pension and post retirement benefit programs. We want to keep a closer look on these liabilities in the future.
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Henry Fund Research REFERENCES 1. Standard & Poor’s’ Industry Survey, Industrial Machinery, February 2008 2. Institute of Supply Management 3. Federal Reserve Board 4. IBIS World Reports 5. Yahoo.finance.com 6. US Bureau of Census 7. Bureau of Economic Analysis (BEA) 8. Henry Fund Analyst Consensus 9. Eaton Corporation Annual Report FY07 &FY06
Henry B. Tippie School of Management
IMPORTANT DISCLAIMER This report was created by a student(s) enrolled in the Applied Securities Management (Henry Fund) program at the University of Iowa’s Tippie School of Management. The intent of these reports is to provide potential employers and other interested parties an example of the analytical skills, investment knowledge, and communication abilities of Henry Fund students. Henry Fund analysts are not registered investment advisors, brokers or officially licensed financial professionals. The investment opinion contained in this report does not represent an offer or solicitation to buy or sell any of the aforementioned securities. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Henry Fund may hold a financial interest in the companies mentioned in this report.
10. www.bondsonline.com 11. Standard & Poor’s company report on Eaton Corporation 12. Deutsche Report on Eaton Corporation, November 19, 2007 13. www.bloomberg.com 14. Bloomberg 15. Boeing Industry Forecast 16. S&P Industry Survey, Aerospace & Defense, January 31 2008 17. www.yahoo.finance.com 18. Eaton Corporation Quarterly Report June 2008
10
Assumptions
Eaton Corp Revenue, Income Statement and Balance Sheet projections 2005 Fiscal Years Ending 12/31 Increase in Revenues by Business Segments Fluid Power Aerospace Hydraulics Automotive Truck Electrical
2006
2007
23%
12%
2008E
2009E
2010E
2011E
2012E
CV
13% 15% -2% 8% 12%
13% 15% 3% 10% 13%
15% 15% 3% 10% 14%
15% 15% 5% 10% 15%
3.5% 3.5% 3.5% 3.5% 3.5%
-8% 10% 11%
-2% -15% 14%
13% 16% -1% 3% 48%
11.3%
5.4%
22.8%
10.6%
11.9%
12.9%
13.6%
3.50%
72.1% 15.8% 2.6%
73.2% 15.7% 2.6%
72.0% 16.4% 2.6%
19.2%
7.8%
7.9%
72.0% 16.0% 2.6% 4.65% 5.5% 10.0%
72.0% 16.5% 2.6% 4.65% 5.5% 15.0%
71.5% 17.0% 2.6% 4.65% 5.5% 23.0%
71.5% 17.5% 2.6% 4.65% 5.5% 23.0%
71.5% 17.5% 2.6% 4.65% 5.5% 23.0%
71.5% 17.0% 2.6% 4.65% 5.5% 23.0%
Cash and cash equivalents as a % of Sales 3.0% Short-term investments Accounts receivable, net as a % of Sales 16% Inventories, net as a % of Sales 9.9% Y-Y change in Curent deferred income tax assets ($) other current assets as a % of Sales 1.0%
6.4%
5.0%
5.7%
6.7%
7.4%
6.4%
5.5%
9.8%
16% 10.5% 24 1.1%
17% 11.4% 24 1.1%
17% 11.50% 25 1.1%
17% 12.00% 25 1.1%
17% 12.00% 25 1.1%
17.5% 12.50% 25 1.1%
17.5% 12.00% 25 1.1%
17.5% 12.00% 25 1.1%
8.8% 31.2% 54.1%
9.0% 31.2% 55.5%
35
56
9.0% 31.2% 57.00% 200 130 1.9%
9.0% 31.5% 57.00% 200 65 2.00%
8.8% 31.5% 57.00% 200 65 2.00%
8.5% 31.0% 57.00% 200 65 2.00%
8.5% 30.5% 57.00% 200 65 2.00%
8.5% 30.5% 57.00% 200 65 2.00%
20.00% 2.8% 9.0% 552 10.5%
20.00% 2.8% 9.0% 552 11.0%
20.00% 3.0% 9.0% 314 11.5%
18.00% 3.0% 9.0% 314 12.0%
18.00% 3.0% 9.0% 1566 12.0%
(10) 10 6%
(10) 10 6.0%
(10) 10 6.5%
(10) 10 6.5%
(10) 10 6.5%
$1.89
75% (200) $2.08
80% (250) $2.29
85% (300) $2.52
85% (350) $2.77
85% (500) $3.05
$294
$322
$352
$385
$420
$455
Y-Y Revenue Growth (resulting) Cost of products sold Selling & administrative expenses Research & development Expenses Interest Expense as a % of ST Debt Interest Expense as a % of LT Debt Income Tax Expense as a % of EBT
Land & buildings Machinery & Equipments as a % of Sales Accu. Depreciation as a % of Depreciable assets Amoritization of Other intangible assets Y-Y change in deferred income tax assets ($) Operating Leases as % of assets
9.0% 32.9% 53.3%
Short-term Debt as % of Current Assets Accrued Compensation as % of Sales Other current liabilities as % of Sales Current portion of L-T debt Accounts payable as a % of Sales
12.2% 2.5% 8.5%
13.5% 2.5% 8.8%
20.0% 2.7% 8.8%
7.3%
8.5%
9.0%
20.00% 2.8% 8.8% 160 10.5%
10 6.00%
Y-Y change in Pension Liabilities Y-Y change in Post Retirement Benefits ($) Other liabilities as a % of Sales Long-term debt as a % of shareholders equity Share Repurchase ($) Y-Y Dividend per Share increase (@10%) 10% Amount Paid as dividend
4.3%
3.4%
5.5%
87.7% (450) $1.24
81.1% (386) $1.48
102.9% (340) $1.72
81.5%
Important disclosures appear on the last page of this report.
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Income Statement
Income Statement Fiscal Years Ending 12/31 Currency Scale Revenues by Business Segments Fluid Power
Aerospace Hydraulics Automotive Truck Electrical
2005 US Dollar Millions
2006 US Dollar Millions
3240
3983
2007 2008E 2009E US Dollar US Dollar US Dollar Millions Millions Millions
2010E US Dollar Millions
2011E US Dollar Millions
2012E US Dollar Millions
CV US Dollar Millions
4480
1829 2288 3758
1683 2520 4184
1647 2147 4759
3139 1975 1631 2211 7043
Total revenues
11115
12370
13033
15999
17692
19806
22359
25399
26288
Cost of products sold Research & development Expenses Interest Expense, Net Other (income) expense-net
8012 1757 287 90 (27)
9050 1946 321 104 (40)
9382 2139 335 147 (11)
11517 2560 411 221 (15)
12736 2919 455 209 (15)
14162 3367 509 220 (15)
15987 3913 575 233 (15)
18161 4445 653 225 (15)
18796 4469 676 212 (15)
Total costs, expenses & other
10119
11381
11992
14693
16304
18243
20693
23468
24138
Income (loss) before taxes
996
989
1041
1305
1388
1563
1667
1931
2150
Tax expense (benefit)
191
77
82
131
208
360
383
444
494
Income (loss) from continuing operations 805 Income (loss) from discontinued operations, net of taxes 0
912 38
959 35
1175 0
1180 0
1204 0
1284 0
1487 0
1655 0
Net income (loss)
805
950
994
1175
1180
1204
1284
1487
1655
150.20 5.36 $1.24
150.20 6.32 $1.48
147.30 6.75 $1.72
155 7.56 $1.89
155 7.63 $2.08
154 7.83 $2.29
153 8.41 $2.52
151 9.82 $2.77
149 11.08 $3.05
Selling & administrative expenses
Weighted average shares outstanding Net earnings (loss) per share Dividends per common share
12
3547 2271 1598 2388 7889
4008 2612 1646 2627 8914
4609 3003 1695 2890 10162
5300 3454 1780 3179 11686
5486 3575 1842 3290 12095
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Balance Sheet
Eaton Corp Balance Sheet Fiscal Years Ending 12/31 Currency Scale
2005 US Dollar Millions
2006 US Dollar Millions
2007 US Dollar Millions
2008E US Dollar Millions
2009E US Dollar Millions
2010E US Dollar Millions
2011E US Dollar Millions
2012E US Dollar Millions
CV US Dollar Millions
110 226 1,785 1,099 243 115 3,578
115 671 1,928 1,293 267 135 4,409
143 504 2,208 1,483 291 139 4,768
410 504 2,720 1,840 316 176 5,966
674 504 3,008 2,123 341 195 6,845
966 504 3,367 2,377 366 218 7,798
918 504 3,913 2,795 391 246 8,767
906 504 4,445 3,048 416 279 9,598
2,075 504 4,600 3,155 441 289 11,064
Goodwill Other intangible assets Deferrred income taxes & other assets Total assets
1,003 3,652 4,655 2,480 2,175 3,139 626 700 10,218
1,083 3,863 4,946 2,675 2,271 3,034 969 735 11,418
1,175 4,067 5,242 2,909 2,333 3,982 1,557 791 13,431
1440 4992 6,431 3666 2,766 6,181 1,847 921 17,680
1592 5573 7,165 4084 3,081 6,181 1,847 986 18,940
1743 6239 7,982 4550 3,432 6,181 1,847 1,051 20,309
1901 6931 8,832 5034 3,798 6,181 1,847 1,116 21,709
2159 7747 9,906 5646 4,259 6,181 1,847 1,181 23,066
2235 8018 10,252 5844 4,409 6,181 1,847 1,246 24,747
Accounts payable Short-term debt Accrued compensation Current portion of long-term debt Accrued income & other taxes Other current liabilities Total current liabilities
810 394 277 240 305 942 2,968
1,050 490 305 322 149 1,091 3,407
1,170 825 355 160 0 1,149 3,659
1680 1010 141 160 0 1408 4,400
1858 1133 159 552 0 1592 5,294
2179 1266 177 552 0 1783 5,956
2571 1469 220 314 0 2012 6,587
3048 1474 246 314 0 2286 7,367
3155 1527 255 1566 0 2366 8,868
Long-term debt Pension liabilities Other postretirement liabilities Other long-term liabilities Total Liabilities
1,830 632 537 473 6,440
1,774 942 766 422 7,311
2,432 681 772 714 8,258
3155 945 782 960 10,241
2842 935 792 1062 10,924
2938 925 802 1188 11,809
2993 915 812 1453 12,760
2838 905 822 1651 13,583
2572 895 832 1709 14,876
Common shares
2,087
2,188
2,364
3,870
3,789
3,672
3,521
3,338
3,025
Accumulated other comprehensive income (loss) Retained earnings Deferred compensation plans Total shareowners' equity
(649) 2,376 (36) 3,778
(849) 2,796 (28) 4,107
(423) 3,257 (25) 5,173
(544) 4,138 (25) 7,439
(544) 4,996 (225) 8,016
(544) 5,847 (475) 8,500
(544) 6,746 (775) 8,949
(544) 7,814 (1125) 9,483
(544) 9,014 (1625) 9,871
Total Liabilities and Shareholders Equity
10,218
11,418
13,431
17,680
18,940
20,309
21,709
23,066
24,747
Cash
Short-term investments Accounts receivable Inventories Deferred income taxes Other current assets Total current assets Land & buildings Machinery & equipment Gross property, plant & equipment
Accumulated depreciation Property, plant & equipment, net
13
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Common Size Income Statement
Eaton Corp Income Statement Fiscal Years Ending 12/31
2005
2006
2007
2008E
2009E
2010E
2011E
2012E
CV
0.0% 0.0% 16.5% 20.6%
0.0% 0.0% 13.6% 20.4%
0.0% 0.0% 12.6% 16.5%
19.6% 12.3% 10.2% 13.8%
20.0% 12.8% 9.0% 13.5%
20.2% 13.2% 8.3% 13.3%
20.6% 13.4% 7.6% 12.9%
20.9% 13.6% 7.0% 12.5%
20.9% 13.6% 7.0% 12.5%
Total revenues
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
100.00%
Cost of products sold Research & development Expenses Interest Expense, Net Other (income) expense-net
72.08% 15.81% 2.58% 0.81% -0.24%
73.16% 15.73% 2.59% 0.84% -0.32%
71.99% 16.41% 2.57% 1.13% -0.08%
71.99% 16.00% 2.57% 1.38% -0.09%
71.99% 16.50% 2.57% 1.18% -0.08%
71.50% 17.00% 2.57% 1.11% -0.08%
71.50% 17.50% 2.57% 1.04% -0.07%
71.50% 17.50% 2.57% 0.88% -0.06%
71.50% 17.00% 2.57% 0.81% -0.06%
Total costs, expenses & other
91.04%
92.00%
92.01%
91.84%
92.15%
92.11%
92.55%
92.40%
91.82%
Income (loss) before taxes
8.96%
8.00%
7.99%
8.16%
7.85%
7.89%
7.45%
7.60%
8.18%
1.72% Tax expense (benefit) 7.24% Income (loss) from continuing operations Income (loss) from discontinued operations, net of taxes 0.31%
0.62% 7.37% 0.31%
0.63% 7.36% 0.27%
0.82% 7.34% 0.00%
1.18% 6.67% 0.00%
1.82% 6.08% 0.00%
1.71% 5.74% 0.00%
1.75% 5.86% 0.00%
1.88% 6.30% 0.00%
7.24%
7.68%
7.63%
7.34%
6.67%
6.08%
5.74%
5.86%
6.30%
Revenues by Business Segments Fluid Power
Aerospace Hydraulics Automotive Truck Electrical
Selling & administrative expenses
Net income (loss)
14
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Common Size Balance Sheet
Eaton Corp Balance Sheet Fiscal Years Ending 12/31
2005
2006
2007
2008E
2009E
2010E
2011E
2012E
CV
0.99% 2.03% 16.06% 9.89% 2.19% 1.03% 32.19%
0.93% 5.42% 15.59% 10.45% 2.16% 1.09% 35.64%
1.10% 3.87% 16.94% 11.38% 2.23% 1.07% 36.58%
2.56% 3.15% 17.00% 11.50% 1.98% 1.10% 37.29%
3.81% 2.85% 17.00% 12.00% 1.93% 1.10% 38.69%
4.88% 2.54% 17.00% 12.00% 1.85% 1.10% 39.37%
4.11% 2.25% 17.50% 12.50% 1.75% 1.10% 39.21%
3.57% 1.98% 17.50% 12.00% 1.64% 1.10% 37.79%
7.89% 1.92% 17.50% 12.00% 1.68% 1.10% 42.09%
Total assets
9.02% 32.86% 41.88% 22.31% 19.57% 28.24% 5.63% 6.30% 91.93%
8.76% 31.23% 39.98% 21.62% 18.36% 24.53% 7.83% 5.94% 92.30%
9.02% 31.21% 40.22% 22.32% 17.90% 30.55% 11.95% 6.07% 103.05%
9.00% 31.20% 40.20% 22.91% 17.29% 38.63% 11.54% 5.76% 110.51%
9.00% 31.50% 40.50% 23.09% 17.42% 34.94% 10.44% 5.57% 107.05%
8.80% 31.50% 40.30% 22.97% 17.33% 31.21% 9.33% 5.31% 102.54%
8.50% 31.00% 39.50% 22.52% 16.99% 27.64% 8.26% 4.99% 97.09%
8.50% 30.50% 39.00% 22.23% 16.77% 24.34% 7.27% 4.65% 90.81%
8.50% 30.50% 39.00% 22.23% 16.77% 23.51% 7.03% 4.74% 94.14%
Accounts payable Short-term debt Accrued compensation Current portion of long-term debt Accrued income & other taxes Other current liabilities Total current liabilities
7.29% 3.54% 2.49% 2.16% 2.74% 8.48% 26.70%
8.49% 3.96% 2.47% 2.60% 1.20% 8.82% 27.54%
8.98% 6.33% 2.72% 1.23% 0.00% 8.82% 28.07%
10.50% 6.32% 0.88% 1.00% 0.00% 8.80% 27.50%
10.50% 6.41% 0.90% 3.12% 0.00% 9.00% 29.92%
11.00% 6.39% 0.89% 2.79% 0.00% 9.00% 30.07%
11.50% 6.57% 0.99% 1.40% 0.00% 9.00% 29.46%
12.00% 5.80% 0.97% 1.24% 0.00% 9.00% 29.01%
12.00% 5.81% 0.97% 5.96% 0.00% 9.00% 33.74%
Long-term debt Pension liabilities Other postretirement liabilities Other long-term liabilities Total Liabilities
16.46% 5.69% 4.83% 4.26% 57.94%
14.34% 7.62% 6.19% 3.41% 59.10%
18.66% 5.23% 5.92% 5.48% 63.36%
19.72% 5.91% 4.89% 6.00% 64.01%
16.06% 5.28% 4.48% 6.00% 61.75%
14.83% 4.67% 4.05% 6.00% 59.62%
13.39% 4.09% 3.63% 6.50% 57.07%
11.17% 3.56% 3.24% 6.50% 53.48%
9.78% 3.40% 3.16% 6.50% 56.59%
Common shares Accumulated other comprehensive income (loss) Retained earnings Deferred compensation plans Total shareowners' equity
18.78% -5.84% 21.38% -0.32% 33.99%
17.69% -6.86% 22.60% -0.23% 33.20%
18.14% -3.25% 24.99% -0.19% 39.69%
24.19% -3.40% 25.86% -0.16% 46.50%
21.42% -3.07% 28.24% -1.27% 45.31%
18.54% -2.75% 29.52% -2.40% 42.92%
15.75% -2.43% 30.17% -3.47% 40.02%
13.14% -2.14% 30.76% -4.43% 37.34%
11.51% -2.07% 34.29% -6.18% 37.55%
Total Liabilities and Shareholders Equity
91.93%
92.30%
103.05%
110.51%
107.05%
102.54%
97.09%
90.81%
94.14%
Cash & cash equivalents Short-term investments
Accounts receivable Inventories Deferred income taxes Other current assets
Total current assets Land & buildings Machinery & equipment Gross property, plant & equipment Less-accumulated depreciation & amortization Property, plant & equipment, net Goodwill Other intangible assets, net Deferred income taxes
15
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Value Drivers
Eaton Corp Value Driver Calculations 2006 $ Mil
2007 $ Mil
2008E $ Mil
2009E $ Mil
2010E $ Mil
2011E $ Mil
2012E $ Mil
CV $ Mil
NOPLAT Pre-Tax Earnings Add: Interest Expense EBITA Less: Tax on EBITA Marginal Tax Rate Total Income Tax Provision Add: Tax Shield on Interest Expense Add: Tax Shield on Amoritization Less: Tax Shield on non-operating income Taxes on EBITA Add: Changes in Deferred Tax NOPLAT INVESTED CAPITAL Operating Working Capital Plus: Normal Cash * Plus: Receivables Plus: Inventory Plus: Other Current Assets Less: Accounts Payable Less: Other current liabilities Net Operating Working Capital Net Property Plant Equipment Add:Other Long Term Op. Assets Add: Operating Leases Net Invested Capital ROIC (Return on Invested Capital) NOPLAT Invested Capital (Beginning) ROIC (NOPLAT/Invested Capital) FREE CASH FLOWS NOPLAT
989 104 1,093
1,041 147 1,188
1,305 221 1,526
1,388 209 1,597
1,563 220 1,784
1,667 233 1,900
1,931 225 2,156
2,150 212 2,362
7.79% 77 8 15 3 103 (59) 931
7.88% 82 12 18 1 113 (80) 995
10.00% 131 22 76 2 230 (155) 1,141
15.00% 208 31 63 2 305 (90) 1,203
23.00% 360 51 107 3 521 (90) 1,173
23.00% 383 54 111 3 552 (90) 1,258
23.00% 444 52 141 3 640 (90) 1,426
23.00% 494 49 45 3 592 (90) 1,680
115 1,928 1,293 135 (1,050) (1,091) 1,330 2,271 286 3,887
391 2,208 1,483 139 (1,170) (1,149) 1,902 2,333 286 4,521
480 2,720 1,840 176 (1,680) (1,408) 2,128 2,766 286 5,179
531 3,008 2,123 195 (1,858) (1,592) 2,406 3,081 205 5,692
594 3,367 2,377 218 (2,179) (1,783) 2,595 3,432 135 6,162
671 3,913 2,795 246 (2,571) (2,012) 3,041 3,798 87 6,925
762 4,445 3,048 279 (3,048) (2,286) 3,200 4,259 53 7,513
789 4,600 3,155 289 (3,155) (2,366) 3,312 4,409 25 7,746
931
995 3,887 25.60%
1,141 4,521 25.24%
1,203 5,179 23.22%
1,173 5,692 20.61%
1,258 6,162 20.41%
1,426 6,925 20.59%
1,680 7,513 22.36%
1,141 658 483
1,203 513 690
1,173 470 702
1,258 763 495
1,426 588 838
1,680 233 1,447
10.14% -
3,887 25.60% 10.14% 601
4,521 25.24% 10.14% 683
5,179 23.22% 10.14% 678
5,692 20.61% 10.14% 596
6,162 20.41% 10.14% 633
6,925 20.59% 10.14% 724
7,513 22.36% 10.14% 919
786 115 671
647 391 256
914 480 434
1178 531 648
1470 594 876
1422 671 752
1410 762 648
2579 789 1790
671
256
434
648
876
752
648
1790
931
995 634 361
Net Investment (Change in Invested Capital)
Free Cashflows (NOPLAT - NI) ECONOMIC PROFIT Invested Capital (Beginning) ROIC WACC EP (Invested Capital*(ROIC - WACC)) NON-OPERATING ASSETS Cash on Hand "Normal" Cash Excess Cash Investments & LT Recievables Non-Operating Assets
16
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DCF Valuation
Eaton Corp Valuation Calculations Fiscal Years Ending Dec 31st
DCF Model FCF PV(FCF) PV(FCF) + PV(Non-Oper) - PV(Debt + Op. Leases) - PV(ESOP) PV(Equity) Shares Outst. Target Price Target Price EP Model ROIC EP PV(EP) PV(EP) Invested Capital PV(Operations) + PV(Non-Oper) - PV(Debt + Op. Leases) - PV(ESOP) PV(Equity) Shares Outst. Target Price Target Price
$ $ $ $ $ $ $
WACC CV Growth Rate CV ROIC Cost of Equity
15,563 256.0 2,718 264 12,837 154 83.19 92.13
2008E
2009E
2010E
2011E
2012E
CV
483 438
690 569
702 526
495 336
838 517
21353 13176
20.59% 724 447
22.36% 13840 8540
As of Last FY End As of 11/24/2008 (growth at cost of Equity)
25.24% 683 620 $ $ $ $ $ $ $ $ $
11,042 4,521 15,563 256 2,718 264 12,837 154 83.19 92.13
10.14% 3.50% 22.36% 12.03%
23.22% 678 559
20.61% 596 446
20.41% 633 430
As of Last FY End As of 11/24/2008 (growth at cost of Equity)
17
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Relative P/E
Relative P/E Analysis Ticker GE PH UTX EMR HON ITT JCI DHR ABB
Company Price General Electric $ 26.75 Parker Hannifin Corporation $ 61.25 United Technologies $ 64.46 Emerson Electric $ 44.20 Honeywell International$ 47.55 ITT Corporation $ 61.25 Jhonson Controls Inc. $ 32.93 Danaher Corp $ 76.91 ABB Ltd. $ 21.33
ETN
Eaton Corp
Implied Value: Relative P/E (EPS08) Relative P/E (EPS09) PEG Ratio (EPS08) PEG Ratio (EPS09) CAGR
$ 71.45
EPS 2008E $2.21 $5.90 $4.95 $3.10 $3.82 $4.18 $2.33 $4.39 $1.74
EPS 2009E $2.35 $6.40 $5.49 $3.40 $4.28 $4.68 $2.56 $4.94 $2.04 Average
$7.56
$7.63
$ 101.47 $ 92.17 $ 61.11 $ 55.68
P/E 08 12.1 10.4 13.0 14.3 12.4 14.7 14.1 17.5 12.3 13.4 9.4
P/E 09 11.4 9.6 11.7 13.0 11.1 13.1 12.9 15.6 10.5 12.1 9.4
Est. 5yr Gr. 11.0 12.7 11.6 12.8 11.0 13.0 13.0 13.8 21.7
PEG 08 1.10 0.82 1.12 1.11 1.13 1.13 1.09 1.27 0.57 1.0
8
(average PEG ratio * growth * EPS)
0.08
18
1.2
PEG 09 1.03 0.76 1.01 1.01 1.01 1.01 0.99 1.13 0.48 0.9 1.2
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DDM
Eaton Corp Dvidend Discount Model 2008E EPS
$7.56
2009E
2010E
$7.63
$7.83
2011E $8.41
2012E $9.82
CV $11.08
Key Assumptions WACC CV ROIC CV Growth Cost of Equity
10.14% 22.36% 3.50% 12.03%
Future Cash Flows P/E Mutliple EPS Next Period Stock Price Div idend FCF DCF Target Price Target Price
10.3 $11.08 $114.17 $2.77 $116.94 72.16
$1.89 $1.89 1.72
$2.08 $2.29 $2.52 $2.08 $2.29 $2.52 1.72 1.71 1.71 79.02 As of last FY End 87.51 As of ######## (Growth at Cost of Equity)
19
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WACC Eaton Corp Weighted Average Cost of Capital (WACC) Estimation
Ticker
Key Assumptions for Honeywell's Valuation Model ETN (NYSE)
Current Stock Price Shares Outstanding Effective Tax Rate Normal Cash (% of Revenue) CV Growth Rate Risk-Free Rate Inflation Rate Real Risk Free Rate Market Risk Premium Beta (2 Year Weekly) WACC
71.45 154300000 8.0% 3.0% 3.50% 4.32% 5.60% -1.29% 4.82% 1.600 10.14%
(30 Yr Treasury)
COMPUTATION OF WACC Capital Structure
Proportion
Equity (MV) Debt (BV) Op. Lease Total WACC
11,025 3,417 286 14,728 10.14%
Cost of Equity Risk Free Rate Market Risk Premium Beta Cost of Equity
4.32% 4.82% 1.60 12.03%
Cost of Debt Corporate Bond Rating Cost of debt before taxes Cost of Debt After taxes Cost of Debt after taxes
A 6.00% 4.51% 4.51%
74.86% 23.20% 1.94%
Cost 12.03%
4.51%
Bloomberg
20
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Operating Leases
PV of Operaing Leases
PV of Operating Leases PV of Operating Leases
2008 102 96.2
2009 77 68.5
2010 55 46.2
2011 38 30.1
2012 26 19.4
CV 34 25.4
Total Y-Y PV of Operating Lease
285.9
204.61
135.43
86.70
53.43
25.41
ESOP
VALUATION OF OPTIONS GRANTED IN ESOP
Ticker Symbol Current Stock Price Risk Free Rate Current Div idend Yield Annualized St. Dev. of Stock Returns
Range of Number Outstanding Options of Shares (M) 11.20
Total
11.20 $
ETN 71.45 4.32% 2.00% 22.00%
Av erage Ex ercise Price 56.83
Av erage Remaining Life (yrs) 6.00 $
56.83
6.00 $
21
B-S Value Option of Options Price Granted (M) 23.60 $ 264.32
30.30
$
264.32
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Share Change
Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding Number of Options Outstanding (shares): Average Time to Maturity (years): Expected Annual Number of Options Exercised: Current Average Strike Price: Cost of Equity: Current Stock Price:
$ $
Increase in Shares Outstanding: Average Strike Price: Increase in Common Stock Account:
$
Change in Treasury Stock Expected Price of Repurchased Shares: Number of Shares Repurchased:
$
Shares Outstanding (beginning of the year) Plus: Shares Issued Through ESOP Less: Shares Repurchased in Treasury Shares Outstanding (end of the year)
11 6.00 2 56.83 12.03% 71.45 2008E 2 56.83 $ 106
2009E 2 63.66 $ 119
2010E 2 71.32 $ 133
2011E 2 79.90 $ 149
2012E CV 2 2 89.51 $ 100.27 167 187
0 71.45 $ -
200 80.04 $ 2
250 89.67 $ 3
300 100.45 $ 3
350 500 112.54 $ 126.07 3 4
154 2 155
155 2 2 155
155 2 3 154
154 2 3 153
22
153 2 3 151
151 2 4 149
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Sensitivity Analysis CV Growth Rate& Beta
$
92.13 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2
1.50% 143.58 132.61 122.93 114.35 106.67 99.76 93.52 87.85 82.68 77.94 73.58 69.56 65.85 62.39
2.00% 154.53 141.82 130.75 121.03 112.41 104.73 97.84 91.61 85.97 80.83 76.13 71.82 67.84 64.16
2.50% 167.97 152.98 140.10 128.93 119.14 110.50 102.81 95.92 89.72 84.11 79.00 74.34 70.06 66.12
3.00% 184.87 166.76 151.48 138.42 127.14 117.28 108.60 100.90 94.02 87.84 82.25 77.18 72.55 68.31
3.50% 206.76 184.21 165.62 150.04 136.78 125.37 115.44 106.72 99.01 92.13 85.97 80.41 75.37 70.78
4.00% 236.22 207.03 183.68 164.58 148.65 135.18 123.63 113.62 104.86 97.13 90.26 84.11 78.57 73.56
4.50% 278.01 238.16 207.55 183.30 163.62 147.33 133.62 121.92 111.82 103.01 95.26 88.39 82.25 76.74
5.00% 341.91 283.11 240.55 208.33 183.08 162.77 146.07 132.09 120.23 110.03 101.17 93.40 86.53 80.41
Sensitivity Analysis
Marginal Tax rate & Risk Free Rate $
92.13 2.6% 2.8% 3.0% 3.2% 3.4% 3.6% 3.8% 4.0% 4.2% 4.4% 4.6% 4.8% 5.0% 5.2% 5.4% 5.6%
23.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
24.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
25.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
26.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
27.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
23
28.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
29.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
30.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
31.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
32.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
33.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
34.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
35.00% 121.05 116.99 113.14 109.49 106.02 102.72 99.58 96.58 93.72 90.99 88.37 85.86 83.46 81.16 78.94 76.82
