Eaton Corp Plc posted earnings of $0.99 a share in the first quarter ($1.01 if you exclude certain charges), up $0.07 from the previous year and a penny above consensus estimates. Revenues, meanwhile, were $5.2 billion, falling 5% short of the previous year and slightly below analyst expectations. Although the overall story at Eaton remains good, there are some negatives you should be aware of.
The bottom lineEaton Corp's top line was relatively weak in the first quarter, but a good portion of that had to do with currency exchange rates. In fact, according to the company, "organic" revenue growth was 1%, but the 6% currency headwind easily pushed overall revenues lower, which accounts for the top-line miss.
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However, the company was able to increase its operating margin slightly in the quarter, inching it up 10 basis points over the prior-year period to 14.6%, and it repurchased $170 million worth of shares. Both helped Eaton beat earnings estimates and the previous year on the bottom line.
When all was said and done, it wasn't a bad quarter for Eaton. In fact, the power management specialist also increased its dividend by 12%, which is a treat for shareholders. But there's more to look at when you dig a little deeper.
A look at the partsFirst and foremost, exchange rates were a problem for most of the company segments. The average negative impact was 6%, but it ranged from 3% at the Aerospace segment to 8% in the vehicle segment. And those rates are likely to remain an issue. For example, entering the year, Eaton was projecting a 4% headwind from foreign exchange rates, on average, in 2015. It's now projecting a 5% headwind. If things don't start to get better, though, that projection could prove too positive.
It isn't just currency issues that will limit the top line, though. Although organic growth came in at 1%, Eaton had been projecting 3%-4% organic growth for the year. With one quarter behind it, it's now projecting 2%-3%. Once again, if organic growth doesn't start to improve, 2%-3% could prove overly positive. In fact, the company dropped its full-year earnings projection from the $4.75 -$5.05 a share range to $4.65-$4.95. The only major changes being a slowdown in organic growth and a worse-than-expected headwind from exchange rates. These are clearly two issues to keep an eye on.
That said, margin improvement remains the company's strong point. Overall, the quarter saw a slight improvement, year over year, on the operating margin front. Not every segment participated, though. For example, hydraulics (roughly 13% of revenues) remains a weak spot, with margins falling 4.2 percentage points year over year. The ongoing downturn in demand from the agriculture and Chinese construction markets were largely to blame for the weakness here.
The electrical products group (32% of revenues) was also weak, though margins only fell about 50 basis points. There were multiple reasons for this, including the sales mix and inter-company costs. The later issue goes back to exchange rates, since it involved products made in the United States that were shipped for use in the company's Canadian operations. The electrical products group's weakness, however, was partially offset by the electrical services group (28%), where margins were up 30 basis points, though inter-company costs were an issue here, too.
The real margin expansion came from the company's vehicle (18% of revenues) and aerospace (9%) segments. Margins expanded two percentage points and 3.2 percentage points, respectively, year over year at these businesses. That said, aerospace is currently beating its full-year margin projection while the electrical group isn't. So, don't be surprised if aerospace starts to weaken a little, and watch closely to ensure the electric products group starts to head the right way.
You'll want to watch the electrical services group, too. Although the 30 basis point margin improvement year over year is a clear positive, it too is hitting below full-year projections. The two electrical groups make up about 60% of the company's top line, so these are both important businesses. Management is working to control the inter-company expense issue and the first quarter is typically a relatively weak period. So management is confident about the rest of the year. Aiding that outlook is the fact that bookings picked up toward the end of the quarter. That said, if these two businesses don't pick up, it will have an outsized impact on overall results.
Trust, but verifyWhen all is said and done, management was right to paint a positive picture of the quarter when it released results. There are some key issues, though, that caused Eaton to trim its full-year forecast; keep an eye on those. If currency headwinds worsen and/or key segments don't see expected margin improvement, Eaton will probably have to reduce its full-year projections again. And that will likely be a bad thing for shares.
The article Eaton Corp Plc Earnings: An Earnings Beat With a Negative Twist originally appeared on Fool.com.
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