Eaton 3Q16 Earnings Call Notes

Eaton Plc (ETN) Q3 2016 Results

Craig Arnold

Expecting continued industrial weakness

“If we take a look at the balance of the year, what we’re really seeing here is industrial weakness, and industrial weakness that is continuing. And so we now have updated our overall revenue forecast to be down 4% for the year, and so we’re really thinking that the year now comes in at the lower end of our guidance. And as you’ll note from the chart on page 10, we did in fact make a number of meaningful adjustments to our full-year outlook. And I’ll walk you through some of the detail here and some of the drivers.”

Lots of uncertainty for Q3

” all we’d really say about 2017 is that Q3 was certainly a bit of a disappointment when we took a look at a lot of our end markets and our order intake, and we expect that to continue into Q4. And we’re in such a period of uncertainty right now, with so much volatility in many of our end markets that it really is difficult to make a call on 2017. And so we made the decision to increase our restructuring, because we think this period of uncertainty will continue. But we do think it’s too early to make a call on what our revenues will be next year. I think once we get past the elections and a little bit of the uncertainty works its way through, we’ll be in a better position to make a call on revenue next year.”

Weakness in electrical end markets

” what I’d say, Ann, really throughout the summer months, we principally saw a weakness across most of our Electrical end markets. If you think about the markets that have been weak all along whether it’s oil and gas or whether it’s large industrial projects, industrial controls, we saw each of those markets essentially weaken up a little bit throughout the summer months, and that certainly cascaded through to the order input that we saw in our Electrical Systems and Services business, which, as we reported, was down 5%.”

Is everyone taking a pause to wait and see which direction the US is headed?

“you’re absolutely right that across all of those end markets we saw weakening this summer. Question – is that a function of all the uncertainty in the current environment? In manufacturing capital equipment, everybody’s taking a pause until the air clears a little bit here around which way the U.S. is headed, but it was principally in the U.S. that we saw the weakness and really across most of those markets.”

A lot of our end markets didn’t perform anywhere close to our expectations at the last strategic planning period

“one of the principal issues is if you take a look at the size of the company today versus what we had forecasted, let’s say, going back in the last strategic planning period, Eaton is a smaller company. A lot of our end markets over this period of time did not perform anywhere close to what our expectations were. So there’s a piece of what we’re doing that’s essentially rightsizing our company, given the current revenue and the certain size of commercial and economic activity across our enterprise.

You never end up with the company you would have with a clean sheet of paper when you build through acquisition

“And having said that, as you’re well aware as well, we built this company for the most part through a series of acquisitions. And when you acquire companies, you always acquire excess capacity in manufacturing. And if you’d said, do you have the ideal footprint, if you could start from a clean sheet of paper and redraw it, you never end up in that place if you grow a company through acquisition. And so we’re really taking some steps back and saying, what can we do, what would we do if we could start with a clean sheet of paper? How would we draw it up? And from that are coming new ideas and opportunities to do it smarter, to do it better, to do it more efficiently.”

Industrial has been weak, but seeing strength on the consumer side

” so we continue to see weakness on the industrial side of the house, but, having said that, we’re seeing strength on the consumer side. Residential housing, the lighting market continues to do well, the Vehicle markets around the world continue to perform well, the light end of non-resi construction, things that are really the small strip malls and really that are, I’d say, almost attached to household formations.”

Have seen strength in China

” Yeah, we too have seen the strength that other companies have talked about in China. We had a pretty strong Q3 overall in terms of our order bookings in China and we saw that in our Hydraulics business. We saw that in our Electrical business as well. So certainly, the government stimulus programs are helping. Their monetary policy is helping. Whether or not these structural improvements will continue into the future, I think it’s once again another one of these points of uncertainty. And they put the stimulus programs in effect for a reason. So they had some underlying concerns. But at this point we think China has certainly stabilized. I think the risk associated with China today is less than what it was probably the last time we had a conversation about China last quarter. So we’re feeling better about China but longer-term I think it remains a question mark.”

Light vehicle markets doing great, but would point out that incentives increasing in NA

“Yeah, I’d say so far the light vehicle markets have held up extraordinarily well. North America running flat at very high levels; China continuing to run very strongly at high-single-digit numbers; Europe doing better than what we imagined. So I’d say at this juncture, the light vehicle markets around the world, speaking about it globally, are actually holding up quite well. The one piece of caution in North America, we do see the incentives are increasing. And if you take a look at the incentives in Q3, they were up over Q2, and that always gives you a moment of pause or caution, but overall we think light vehicle markets globally are doing just fine.”

It’s understandable that companies would hesitate in an environment like this one

“And I’d say once again, we’re struggling with the data feeds very much like others, but we do think the thematic message that cuts through all these conversations is uncertainty, and if you think about any person running a business today and making a long-term capital commitment in the face of an economic environment and a presidential election that’s been as noisy as this one with as much uncertainty around the environment that we’re going to be dealing in, it’s, while disappointing, a little bit understandable that companies are basically pausing and waiting to see how things play out before they make a decision around major capital multi-year commitments.”

United Technologies (UTX) Q2 2016 Earnings

United Technologies (UTX) CFO Akhil Joori said recent data on the US economy is encouraging for their business

“Most recent data on the U.S. economy continues to be encouraging. Consumer spending remains strong and job creation, wage growth and unemployment trends point to a steady growth environment, although more likely in the 2% GDP growth range as opposed to the 3% plus that we would all like to see.”

Yet macroeconomic uncertainty and pension liability has the potential to weigh on their profits  going forward

“Looking beyond 2016, we continue to see macroeconomic uncertainty and pressures. Two watch items that have recently come on the radar screen after Brexit. One, general strengthening of the U.S. dollar, and second, lower yields on both long and short bonds. As you know, lower discount rates could have a significant impact on our pension expense for 2017 and beyond. While it is still too early, as a reminder, every 10 basis points change in the discount rate is around a $30 million profit impact.”

United Technologies (UTX) CEO Greg Hayes said they’ve sunk a ton of capital into developing their new jet engine but they hope to earn patiently earn a good return on their investment in the subsequent decades in the services aftermarket

“it’s an expensive game in the commercial engines business. And I’ve said before we’re going to invest or we have invested about $10 billion in CapEx and R&D over the last dozen years or so to bring the products to market. The good news is, at the end of the year, we should have all of the aircraft engines certified. Even though production rates will increase, costs will come down but that is a significant investment.  The good news of course is the aftermarket will come. As we saw this quarter on the V, when the engines get out there, that six-year, seven-year, eight-year timeframe, the engines do need to be overhauled. We will see the returns. But this is not a – it’s not a short-term gain. These are 30-year programs. The returns remain on track to what we had expected which is well in excess of our cost of capital. But it’s not for the faint of heart either, as you know, Howard. And we’re in for the long-term. We’ve got great engines. The performance has been phenomenal out of the box. Right now, our focus is just on delivering engines and then servicing them for the next 25 years or 30 years.”