Eaton Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 1, 2024

There are 14 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton 4th Quarter 2023 Conference Call. Instructions will be given at that time. As a reminder, your conference is being recorded. I would now like to turn the conference over to your host, Yan Jin. Please go ahead.

Speaker 1

Hey, good morning. Thank you all for joining us for Yiten's 4th quarter 2023 earnings call. With me today are Craig Arnold, our Chairman and CEO and Tom Oakray, Executive Vice President and Chief Financial Officer. Our agenda today includes opening remarks by Craig. Then I will turn it over to Tom, who will highlight the company's performance in the Q4.

Speaker 1

As we have done on our past calls, will be taking questions in Adrian and Craig's closing commentary. The press release and the presentation we will go through today have been posted on our website. The presentation includes adjusted earnings per share, adjusted free cash flow and other non GAAP measures. The reconciled in the appendix. A webcast of this call is accessible on our website and will be available for replay.

Speaker 1

I would like to remind you that our comments today will include statements relate to the expected future results of the company and are therefore forward looking statements. Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties that are described in our earnings release and the presentation. With that, I will turn it over to Craig.

Speaker 2

Okay. Thanks, Yan. And we're pleased to report our Q4 results and record performance for the year. Our team continued to deliver our commitments, supported by strong markets and good execution. So let me begin with some highlights of the quarter On Page 3, we generated adjusted EPS of $2.55 for the quarter $9.12 for the year, Both all time records.

Speaker 2

Adjusted EPS was up 24% and full year was up 20%. And we continued to post strong margins. Q4 was 22.8%, up 200 basis points and above the high end of our guidance. We also delivered strong incremental margins, 42% in the quarter, And we continue to see strong market activity. On a rolling 12 month basis, book to bill for Electrical and Aerospace was 1.1 and our backlog increased by 15% for Electrical and 13% for Aerospace.

Speaker 2

As you've read, we're initiating guidance for 2024 and expect another year of strong organic growth, double digit increases in adjusted EPS and continued strength in cash flow. And I'll go through the full guidance detail shortly. Lastly, we're announcing a multiyear restructuring program that will eliminate fixed costs and improve our overall efficiency. The program will cost $375,000,000 and deliver $325,000,000 of mature year benefits. So the combination of market tailwinds, our internal growth initiatives and our continued focus on operating efficiency will allow us to deliver outstanding results for years to come.

Speaker 2

And speaking of market tailwinds, let's turn to Slide 4. In the last couple of quarters, we shared our framework for how we think about key growth drivers for the company. The chart reflects the 6 secular growth trends that will positively impact our business today and for years to come. And we're stepping up our investment in R and D and capital ensure that we're well positioned to capture this growth. We think Eaton is uniquely positioned in that most of our businesses are expected to see an acceleration in market driven growth opportunities.

Speaker 2

In our prior two earnings calls, we provided a summary of progress on infrastructure spending, Re industrialization, Utility and Data Center Markets and Electrical and our Aerospace Business. Today, we'll provide an update on the impact from reindustrialization and how it continues to drive a record number of mega projects in North America. We'll also provide you with a framework for how to think about the timing impact on mega projects, from when a project is announced to a negotiation, to an order and eventually to a sale. So let's take a look at Slide 5 in the presentation. We've shared this data previously and it's a good proxy for the reindustrialization trend we're seeing.

Speaker 2

You'll recall, This summarizes the number of mega projects that we've announced since January of 2021. And a mega project once again is a project with announced value of $1,000,000,000 or more and have been 333 of those through the end of last year beginning in January 2021. Note that this is North America data, but we're seeing a similar trend in Europe, although the dollars are not as large. A few points to note. 1st, at $933,000,000,000 this number is 3x the normal rate And the increase translates directly into electrical markets.

Speaker 2

As a reminder, the electrical content on these projects is typically anywhere from 3% to 5%. 2nd, the number continues to grow and is up 9% from Q3. This will not go on forever, we're sure, but there continues to be strong momentum for U. S. Industrial Projects, and we're building a multiyear backlog.

Speaker 2

And 3rd, about 72% of these projects are still in the planning phases and only 18% have actually started. Some 10% have been canceled or significantly delayed, But this number is actually lower than historical rates. For those that have started, we won over $1,000,000,000 in orders with a win rate of approximately 40%. And we're in active negotiations on another $1,000,000,000 of electrical content on a small subset of these total projects. So as you can see, mega projects are a compelling reason to be optimistic about the future.

Speaker 2

Turning to Slide 6, we want to highlight the timing and the duration of these mega projects as they become opportunities for our electrical business. The primary conclusion is we've not seen a significant impact from the large step up in the number or size of mega projects yet, but it's coming. While each project is different, we put together our view of 3 representative examples of reindustrialization projects, including a semiconductor, an EV battery and a healthcare example. The slide indicates the number of months between an announcement of a mega project and the time we begin to negotiate it, the time from an announcement of an order the time from an announcement to an order and from an announcement to a shipment. As you can see, it takes on average 3 to 5 years from when a project is announced when it shows up in our revenue.

Speaker 2

So while the gratification is certainly delayed, this is what's showing up in our backlog and providing outstanding visibility to future growth. With over $1,000,000,000 of orders that we've already won, we expect revenues to be recognized over the next several years in line with each of these products' individual timelines. And just as a point of reference, our revenues in Electrical America for mega project 2023 was only about 3% of our total revenues. By contrast, they represent 16% of our negotiations and 6% of our orders. Hence, the conclusion that most of the impact from this significant step up in mega projects is still ahead of us.

Speaker 2

Now let me just turn it over to Tom. But before I do, I do want to take this opportunity to thank Tom. I mean, Tom has just been an outstanding leader for Eaton in his tenure with us. And I couldn't have asked for a better partner Our more effective CFO and Tom, we're absolutely disappointed to see you go. We fully understand the reason you made this decision.

Speaker 2

We wish you all the best of luck and thanks once again for this outstanding leadership over the last 3 years.

Speaker 3

Thanks, Craig. I'll start by reviewing how our fiscal year 2023 results compare to our original guidance. Throughout the year, we demonstrated the ability to execute on our commitments and raise guidance for all key metrics. We've delivered our 3rd consecutive year of double digit organic growth with a 20% increase in adjusted EPS, All time record margins and a 48% increase in free cash flow. Of particular note, organic growth And segment margins were up versus the original guidance 400 and 110 basis points, respectively.

Speaker 3

Further, adjusted EPS and free cash flow grew 11% and 4%, respectively, versus the original guide. On the next chart, we have a summary of our quarterly results, which includes several records. With respect to the top line, We posted an all time sales record of $6,000,000,000 up 11%. Organic growth continues to be strong, up 10% for the quarter. We have generated double digit organic growth in 7 of the last 8 quarters, with the last 7 quarters growing over 20% on a 2 year stack.

Speaker 3

We posted operating profit Q4 records on both a margin and absolute basis. Operating profit grew 22% And segment margin expanded 200 basis points to 22.8%. Incremental margin was very strong at 42%. Adjusted EPS of $2.55 increased by 24% over the prior year. This is an all time record and above the high end of our guidance range.

Speaker 3

This performance resulted in all time quarterly Operating and free cash flow records. Our $1,300,000,000 of operating cash flow was 9% higher than the prior year, generating 18% free cash flow margin and 103% free cash flow conversion. For the full year, we also set numerous records, including record sales, segment margins, adjusted EPS and earnings and operating and free cash flow. On Slide 9, We detail our Electrical Americas results. The Electrical Americas business continues to execute very well and delivered another very strong quarter.

Speaker 3

We set an all time record for sales, operating profit and margins. Organic sales growth remains strong at 16% with broad based growth in nearly all end markets. On a 2 year stack, organic growth is up 36%. Electrical Americas has generated double digit organic growth for 8 consecutive quarters. All time record operating margin of 28.5% was up versus prior year 480 basis points, benefiting primarily from higher volumes, effective management of price cost and improved manufacturing efficiency.

Speaker 3

Incremental margin was 58% for the segment. On a rolling 12 month basis, orders were down 4%. However, it's important to note that the dollar value of the orders remains high and the decline needs to be viewed in the context of the 34% order growth in Q4 of last year. As discussed in prior earnings calls, order intake is an important metric, but needs to be analyzed together with record backlog. Currently in our electrical sector, we have backlog coverage of almost 3 times our historical average.

Speaker 3

We've looked at multiple scenarios With meaningful order intake decline and are confident in those scenarios given our backlog coverage that we can generate robust organic growth for several quarters well into 2025. More specifically, Electrical Americas backlog increased 18% year over year and was also up sequentially, resulting in a book to bill ratio of 1.2 on a rolling 12 month basis. For orders, we had particular strength in data center, MOEM and institutional market. Also, our major project negotiations pipeline in Q4 was up 55% versus prior year and up 189% since Q4 2021. On a full year basis, Electrical Americas posted 19 percent organic growth with 26.5 percent margins, up 400 basis points over prior year.

Speaker 3

Electrical Americas posted records for full year sales along with profit on both a margin and absolute basis. With the tailwinds from secular trends, Strong execution and robust backlog, Electrical Americas is well positioned as we enter 2024. The next chart summarizes our results for the Electrical Global segment. Leveraging Q4 record revenue, Organic growth increased to 4% from flat in Q3. We had strength in data center, industrial In Commercial and Institutional Markets, operating margin of 18.8% was up 10% versus the prior year.

Speaker 3

Orders were up 1% on a rolling 12 month basis with strength in data center and IT, utility, MOEM and Industrial Markets. Importantly, book to bill continues to remain greater than 1. On a full year basis, Electrical Global posted 5% organic growth and 19.3% margins. The business posted records for both full year sales and operating profit. Before moving to our industrial businesses, I'd like to briefly recap the combined electrical segments.

Speaker 3

For Q4, we posted organic growth of 11%, incremental margin of 51% and segment margin of 25%, which was up 320 basis points over prior year. On a rolling 12 month basis, our book to bill ratio for our electrical sector remains very strong above 1.1. We remain quite confident in our positioning for continued growth with strong margins in our overall Electrical business. Chart 11 highlights our Aerospace segment. We posted an all time quarterly sales and Q4 operating profit record.

Speaker 3

Organic growth was 8% for the quarter, with a 2% contribution from foreign exchange. Growth was driven by broad strength across all markets with particular strength in defense aftermarket and both commercial OEM and commercial aftermarket, which were up 26%, 25% and 18%, respectively. Operating margin of 22.4% was down 10 basis points on a year over year basis, benefiting from higher volumes and effective management of price cost offset by unfavorable mix and favorable defense programs in the prior year. On a rolling 12 month basis, orders increased 7% with especially strong growth in commercial and defense aftermarket and commercial OEM. Year over year backlog increased 13% and was up 3% sequentially.

Speaker 3

On a rolling 12 month basis, our book to bill for our Aerospace segment remains strong at 1.1. Moving on to our Vehicle segment on Page 12. In the quarter, total revenue was up 2%, all from favorable foreign exchange. Vehicle end markets were down 500 basis points year over year, But the business was able to deliver outgrowth, primarily driven by higher aftermarket sales, stronger share in heavy duty transmissions and a new product launch of electrical vehicle gearing in China. Operating margin came in at 17.9%, 2 70 basis points above prior year, driven by effective management of price cost and improvement in manufacturing efficiencies.

Speaker 3

Throughout 2023, we've demonstrated the ability to execute on operational improvements as shown by our 2 70 basis point we show results for our eMobility business. We generated another quarter of strong growth, including an all time sales record. Revenue was up 19%, 18% organically and 1% from favorable foreign exchange. Driven by the ramp up of new product launches, we outpaced the market, which grew 7%. However, due to program start up costs, the operating loss increased by $14,000,000 when compared to the prior year.

Speaker 3

On a full year basis, eMobility posted 18% organic growth on slightly lower margins as we continue to invest in the business. We remain very encouraged by the profitable growth prospects of the eMobility segment. In 2023, we won new programs with more than $1,000,000,000 of mature year revenue. Through these wins, we continue to find opportunities to leverage expertise and differentiated technologies across segments. Moving to Page 14, we show our electrical and aerospace backlog updated through Q4.

Speaker 3

As you can see, we continue to build backlog with electrical stepping up to $9,500,000,000 and aerospace reaching $3,200,000,000 for a total backlog of $12,700,000,000 Both businesses have increased their backlogs by significantly more than 100% since Q4 2020 with electrical growing almost 200%. Versus prior year, our backlogs have grown by 15% in Electrical and 13% in Aerospace, which exceeded our expectations as we began the year. As noted earlier, both Electrical and Aerospace have book to build ratios above 1.1. Our strong backlog to close the year gives us continued confidence in our growth outlook for 2024 and beyond. In addition to our strong backlog growth in 2023, the next page shows the acceleration in growth of our negotiations pipeline, which supports our expectation for stronger markets and structurally higher organic growth rate.

Speaker 3

In Electrical Americas, the pipeline doubled over the past 3 years and increased a further 29% in 2023. This is even stronger than the 19% organic growth in our Electrical Americas business, which suggests continued strength going forward. For 2023, we saw $6,200,000,000 of projects in our negotiations pipeline in Electrical Americas alone.

Speaker 1

Now I'll

Speaker 3

pass it back to Craig to walk through the guidance and wrap up the presentation.

Speaker 2

Thanks, Tom. Turning to Page 16, we lay out our end market assumptions for 2024. You'll recall that we provided an early look at our 2024 assumptions during our Q3 earnings call at the end of October. So today, we're updating those assumptions. And with the exception of residential markets, where we have increased our outlook from down slightly to flat.

Speaker 2

In commercial vehicles, where we have decreased our outlook from slightly declining to declining, All of our assumptions have remained the same. In contrast to what we're seeing in the macro economy, We continue to expect growth in about 80% of our end markets, and much of this growth is supported by large backlogs. Turning to Page 17. As you've read, we're announcing a new multiyear restructuring program to reduce fixed costs and enhance our efficiency. While we're structurally positioned to deliver higher levels of organic growth, we also have a vast number of opportunities to improve the way we run the company.

Speaker 2

And we're at a point in time where we have the organizational capacity to take on a number of these efficiency projects that have been in our pipeline for some time. The program will focus on reducing structural costs through the consolidation of rooftops, increasing shared services and deploying digital technologies. These actions will also free up time and resources in our businesses, allowing them to focus on growth and driving operational improvements. Overall, we expect $375,000,000 of restructuring costs over the next 3 years, with $325,000,000 of mature year savings in 2027. This includes approximately $175,000,000 charges in $20,200,000 $50,000,000 of savings, both of which are included in our 2024 guide, and I'll cover those in the next several slides.

Speaker 2

While the company is performing well, we see these actions as an important part of how we'll continue to do so for years to come. Moving to Page 18, we summarize our 2024 revenue and margin guidance. Our organic growth for 2024 is expected to be between While e mobility is expected to grow some 30% as new programs are launched and the electric vehicle market continues to see solid growth. And I'd also add that the healthy end markets combined with our large backlog provides actually better than normal visibility our 2024 outlook. For segment margins, our guidance range of 22.4 percent to 22.8% is an improvement of 60 basis points at the midpoint from our 2023 all time record of 22%.

Speaker 2

As we've communicated earlier, incremental margins of about 30% are what you should assume and that's what's reflected in our guidance. These incrementals are consistent with our plan to step up investments in R and D and with the investments we're making to expand our manufacturing capacity, all done to ensure future growth. On the next page, we have the balance of our guidance for 2024 and Q1. For 2024, our adjusted EPS is expected to be between $9.95 $10.35 a share, $10.15 at the midpoint and up some 11% from 2023. And for operating cash flow, our guidance is between $4,000,000,000 $4,400,000,000 up 17% at the midpoint.

Speaker 2

The key drivers here are really a combination of higher earnings and improved working capital. We also expect to repurchase between $1,500,000,000 $2,500,000,000 of our shares outstanding. And given our cash position at the end of the year, at the end of 'twenty three and our strong cash generation this year, we'll still have plenty of room for strategic M and A. For Q1, we expect organic growth to be between 6% 8%, segment margins between 21.3% and 21.7% and adjusted EPS in a range of $2.21 $2.31 per share. Let me just close here on Page 20.

Speaker 2

As we transition into 2024, I think we can all conclude that Eaton has proven that we're a changed company, a company that delivers higher growth, higher earnings and does so consistently. And we're proud of our team's record performance in 2023. But once again, we see opportunities to be better everywhere. As we look forward, we continue to experience powerful megatrends that are driving higher growth in our end markets. And we're investing to ensure that we're capturing these opportunities while gaining market share.

Speaker 2

We're also continuing to optimize the way we run the company, improving our operational execution, leveraging our scale and reducing our fixed costs. This is allowing us to invest like never before in R and D, in capacity expansion and in our people. So our expectations are high and our teams are looking forward to delivering another exceptional year. So with that, I'll open things up for any questions that you may have.

Speaker 1

Thanks, Craig. For the Q and A today, please limit your opportunity to one question and a follow-up.

Operator

And our first question will come from the line of Jeff Sprague from Vertical Research. Please go ahead.

Speaker 4

Thank you. Good morning, everyone. Good luck, Tom. Craig, first question for me is just on the restructuring itself. We tend to think of these things being kind of contra cyclical, right?

Speaker 4

Demand is weak. We're in a recession. We do a heavy restructuring. Seems, I don't know, odd or a little risky maybe to undertake a big move like this with such a strong demand Coal and Aero businesses. So can you maybe just address the risk mitigation and How you manage kind of maybe the capacity through this?

Speaker 4

I assume you're also trying to increase capacity while you restructure, but Love some additional thoughts on that.

Speaker 2

Thanks, Jeff. Appreciate the questions. And I'm not sure if everybody else is getting a little background noise on the call. I'm not sure. Okay, that's better.

Speaker 2

Hey, Jeff, we spent a lot of time as a company Sorting this one out in terms of whether or not it made sense to take on these restructuring projects at this time because to your point, things are going very well and we have perhaps more growth opportunities than we've ever had in the history of the company. But at the same time, we actually have more capacity today than we've had in a long time. As you'll certainly be aware, we haven't done many acquisitions over the last couple of years. In fact, we really haven't done any. And so we actually have more bandwidth as an organization today to take on these projects.

Speaker 2

And one of the things that we do as a company is that We always have a forward view of our opportunities to be better, to improve efficiencies, to eliminate redundancies, to Build scale to essentially leverage some of these new technologies that are coming forth. And so we today as an organization, as a leadership team, all agree that there's probably no better time than right now to take on these projects, to improve our cost position and really set the company up for margin expansion for the next 3 years on top of the growth that we're going to see as a business. So lots of confidence today in our ability to take it on And we have plenty of capacity as an organization to do so.

Speaker 3

And what I would just add, Jeff, to that is, I think it would actually be riskier if we didn't do it because the foundation of the restructuring program is simplification as well as well on elimination of waste, which frees up human resource time to focus on the shift that we've been making into growth. So it actually would be riskier if we didn't do it and it's great to lean forward and execute it at a time of strength.

Speaker 2

That's a great point, John. I said that in my upcoming commentary, this notion that essentially we're freeing up time in our operations So that they can focus on growth and improving our operational execution, while some of our corporate teams take on a number of these support services. So you're absolutely right, Tom. Thanks for that amplification.

Speaker 4

Yes, thanks. And just to follow-up, the background noise might be me. I'm dialing through my computer here juggling multiple phone calls and different cell phones going on a crazy day here. Unrelated question, just on backlog, obviously, it does provide a lot of visibility and comfort. But We've seen a couple of companies with big backlogs also have sales disappointments because the backlog is big, but it's not fungible, right?

Speaker 4

Air pockets develop here and there. Maybe just kind of address that risk. Do you kind of see any that you need to kind of navigate through from a timing standpoint, particularly given the way you illustrated the long kind of order conversion cycle on some of this project stuff that's in the backlog? Thank you.

Speaker 2

Yes. No, I appreciate that question, Jeff, and understand the nature of it. But I can just tell you based upon at least what we're And the nature of our backlog today and as I'm sure you're well aware of that, we as Eaton and really quite frankly as an industry, we've had more demand than we've had capacity largely over the last couple of years. And so we think we have plenty of ability to accelerate, deaccelerate if necessary, Backlog conversion to essentially keep the top line growing at an attractive rate in the event that you have some sort of order that would be moving in or out or there's some sort of lack of linearity in the order book itself. And so not a concern.

Speaker 2

We've not seen it to date. As we look at kind of the stratification of the backlog and when orders are due, we don't have that concern.

Speaker 4

Thank you very much.

Speaker 2

Thank you.

Operator

Thank you. And the next question is from Andrew Obin from Bank of America. Please go ahead.

Speaker 5

Hi, guys. Good morning. How are you?

Speaker 2

Good, Andrew. We're doing great. How about you? Good morning, Andrew.

Speaker 5

Yes. It seems like you guys are doing great, yes. Just a different way of asking, I guess, Jeff's question. Can you just talk, you mentioned capacity additions. Can you just and I appreciate that some of this is competitive, But what areas are you adding capacity?

Speaker 5

When will this capacity be available to really move the needle? And anything you're doing differently on geographies post the whole COVID experience? Thank you.

Speaker 2

Yes. No, I appreciate the question, Andrew. And one of the things we tried to We do in the last earnings calls, we've got a little bit of color around this $1,000,000,000 of investment that we're putting in as a company to support growth. And I would tell you, it's really pretty broad based. We talked about investments that we're making to support growth in utilities, In transformers and voltage regulators and our line insulation and protection equipment, we talked about obviously the huge growth that we're seeing in data centers and Versatile and institutional markets and the investments that we're making there in low and medium voltage assemblies and switchboards and panel boards.

Speaker 2

We've had to make investments in our core component circuit breaker capacity and obviously we're making big investments in e mobility as well. So I think it's actually fairly broad based with respect to the product lines. As it relates to the geography, we're clearly seeing Much bigger investments, much faster growth in the Americas and that's really where the principally a lot of these big investments have gone. But we and to your question about timing, what we're assuming in terms of own capacity, industry capacity is another issue as we work through suppliers and some of the others in the value chain. But we think a lot of this capacity for us begins to phase in this year and so sometime between, let's say, The Q2 and the end of the year when we'll have most of our investments done and it certainly gives us the capacity to do more, assuming there aren't other bottlenecks and restrictions, whether it be labor or others in the value chain.

Speaker 5

Got you. And just a follow-up, I guess, natural builds on the first answer. In terms of your supply chain, what are the biggest challenges are you still experiencing and what has gotten better over the past 3, 6 months And what's still a problem? Thank you. Yes.

Speaker 2

What I would tell you is in many ways, Andrew, we're really Back to where we've been historically and we've never lived in a world where we didn't have the intermittent supply chain issues. So I would say by and large, we've seen fairly significant progress every place. It used to be that Electronics were a major bottleneck in issue. Most of those issues are now behind us. We still have pockets of individual challenges in various suppliers with various components.

Speaker 2

But I would say today, It is really more episodic and unique than it is, I'd say, a pattern or a broader, let's say, capacity constraint and in particular commodity. And so we like in our own investments, we've been working hard to Build capacity internally, we've also been working with our suppliers, giving them lead time and visibility into our growth over the next multiple years to ensure That they too are making investments in capacity to keep up with our demand. And so I would say today, it's largely The episodic issue as opposed to a systemic issue. Just to

Speaker 3

jump in, Andrew, on that last point. I think that's really been key of partnering with the suppliers So we can grow together with them and we've gotten much more efficient probably as a result of the pandemic understanding what we need a go forward demand basis.

Speaker 5

Got you. Well, Tom, thanks so much for all your help. You'll be missed and congratulations.

Speaker 2

Thank you, Andrew. Thank you.

Operator

Thank you. Our next question is from Chris Snyder from UBS. Please go ahead.

Speaker 6

Thank you. So obviously mega projects have become a big driver of the Eaton story and an important driver of the So appreciate all the information you guys provided there. But if we step back and look and even look through the low single digit mega project tailwind in 2023, I think you said it was 3% of total of Americas revenue. Organic growth has still grown at a double digit rate for the last 8 quarters. Can you just talk about why underlying demand has been so strong?

Speaker 6

Because I think when most investors see the huge growth numbers, Everyone just assumes it's the mega project opportunity already playing out. Thank you.

Speaker 2

No, I appreciate the question. And then I think, I'd say long before we were talking about mega projects, we were talking about secular growth drivers. We were talking about energy transition. We were talking about the electrification of the economy. We were talking about digitalization.

Speaker 2

You think about today's mega projects deal with these big projects above $1,000,000,000 announcements, but we've seen very similar growth in projects that are well below the $1,000,000,000 threshold. And Re industrialization of the U. S. And other markets where today you have production Moving back in and a big investment taking place. And so the trends are much broader than mega projects.

Speaker 2

The reason we put this emphasis on mega projects is because it's a great indicator of the multi year runway that we have and the chance to give the investor community visibility into the outlook over multiple years. But you're absolutely right. We're seeing broad based growth in our business much beyond This mega project emphasis, but the mega projects will become a bigger piece of our future. That's why we talked about 3% of sales, 6% of orders, 16% of negotiations, that continues to be a tailwind, a real impetus for future growth.

Speaker 3

Yes. And Chris, if I can just throw in on that. We talked about in the prepared remarks at high level, our major projects, our large project negotiations and that's much less than these mega projects. And just some of the numbers, if you look at year over year for data centers, growing over 160% in terms of negotiation volume, Institutions over 40%, governments, and healthcare over 30%. So it's really, really broad based as Craig says.

Speaker 3

The mega projects if you like Just really put the cherry on top and give us just a long runway going forward.

Speaker 6

Yes. No, absolutely appreciate the durability and sustainability that it brings. And then just kind of on that same topic, My back of the envelope math suggests that this ramp in mega projects, which drives about a $25,000,000,000 incremental market opportunity over the next few years. So a pretty massive ramp for an industry that is already having trouble keeping up with demand. So I guess the question is, do you see a pathway forward for the industry to meet this demand?

Speaker 6

And how does that impact your multiyear your expectations for ability to push price and drive margins higher? Thank you.

Speaker 2

I think your back to the envelope map is pretty good actually. It does create a very large growth opportunity for the electrical industry. And I would say to the question around whether or not the industry is going to have enough capacity and bandwidth to capture these opportunities. I think One of the restrictions today on growth in general is the fact that there is not enough capacity in the industry, which is why we're making Fairly sizable investments in our own manufacturing facilities and working with our suppliers to do the same, So that we can try to get out in front of some of this demand and continue to grow the company. And then on top of that, perhaps the greatest limiter On growth, maybe the labor constraint in terms of finding enough skilled trades people to deal with the significant backlog of demand.

Speaker 2

And so what we think fundamentally is going to happen is that the growth will be there, but the cycle will be extended Because we simply will not have enough capacity and labor to deal with all the demand and the timeframe in which it's requested. And so the cycle will simply be expanded out multiple years beyond where it normally would reside.

Speaker 6

Thank you. Appreciate that.

Operator

Thank you. The next question is from the line of Steve Tusa from JPMorgan. Please go ahead.

Speaker 7

Hey, good morning.

Speaker 2

Hey, Steve.

Speaker 7

Tom, congrats on going out with a bang here. Great results.

Speaker 8

Thanks,

Speaker 2

man. Appreciate it.

Speaker 7

Just the pricing dynamics, What are you guys assuming for in your electrical businesses for price roughly in 2024 embedded in your guidance?

Speaker 2

Yes, Steve, as you probably are aware, we don't provide specific price guidance. We don't separate price and volume. I will tell you that on a relative basis, when you compare, let's say, 2024 with 2023, 2022, The price will contribute a much smaller piece of our growth than volume will. And that's so we're going to be probably back to a more of an historical level of price realization in terms of 2024. And that's really a function of the fact that we're not seeing inflation.

Speaker 2

We had to essentially work the price lever fairly significantly over the last couple of years as we dealt with This inflation that was in the system, we still have some inflation principally on the labor side. So we will still get price, But its contribution to our growth will be significantly less than it had been in prior years.

Speaker 7

Right. And I guess just on the cash flow statement, I think like I'm not sure if I'm seeing this $2,000,000,000 of share repo in 24,000,000 I mean I think that's a pretty decent sized number. Anything going on specifically there?

Speaker 8

No, no. No. You're doing

Speaker 2

it at the midpoint. Okay. Go ahead, Tom.

Speaker 3

Yes. No, we finished 2023 with $2,600,000,000 in cash. And given how we're guiding and given how we are doing a better job of Managing working capital given the supply chain constraints are going away. We're going to have a very good year of generating cash in 2024. So we go to our capital allocation tenants and we're very clear we're not going to collect cash on the balance sheet.

Speaker 3

So at the midpoint, we've got $2,000,000,000 As was said in the prepared remarks, so this gives us plenty of dry powder, to do strategic M and A. So even with that $2,000,000,000 And the final thing I would end with is our net leverage on the balance sheet, which you probably know Steve is 1.3. So We've got a very strong balance sheet, just a ton of flexibility from a capital allocation perspective.

Speaker 7

Right. So 2% lift from share count in general embedded in the guidance for EPS growth Ish.

Speaker 3

Relatively minor, a couple of pennies versus consensus, yes.

Speaker 7

Okay, got it. All right. Thanks a lot.

Speaker 2

Thank you.

Operator

Thank you. Our next question is from the line of Joe Ritchie from Goldman Sachs.

Speaker 9

So I think Chris kind of touched on this In his question, but maybe to ask it more explicitly. As you think about that first $1,000,000,000 plus in mega projects that you've won, Just what's the margin profile of those wins? And how we should be thinking about that ultimately Materializing in the P and L?

Speaker 2

Yes. I would say that the margin profile on these mega projects is not going to be terribly different than The margin profile on the underlying business. We are in a position, as you can imagine, when your capacity constraint To be selective around where you win. And so we would not expect Even though they're big projects and oftentimes you find with large projects, your margins take a bit of a haircut. You should not expect that as these mega projects translate into revenue.

Speaker 9

Got it. That's great to hear, Craig. And then I guess, look, the funnel keeps on growing now for the last couple of quarters at a pretty material rate. There's a lot of concern with the election coming that perhaps this first wave of projects that have broken ground continues, But maybe you get a stall in the second wave. Just any thoughts around that?

Speaker 9

I know you kind of touched on the potential for labor constraints, but I'm really more Any other thoughts that you would have on just continuing to grow the funnel and then making sure that that actually we actually see that ultimately in your outlook?

Speaker 2

Yes. No, I appreciate the question and the concern. I mean, given The upcoming elections in many ways, it's kind of an unknowable in terms of how the election is going to Turn out and then quite frankly, even with the change in the administration, difficult to know what position they will take with respect to A lot of these stimulus spending that is essentially underlying and supporting these mega projects. And I will tell you what gives us Fairly high level of confidence that it's not going to change materially is that a lot of these projects are going into red states. And Despite what may happen kind of on the political front, the benefactor of a lot of these projects are actually Those red states and so we'll have to wait and see how it plays.

Speaker 2

And we don't think today it's going to have a material impact. Today, we are looking at More demand than we have capacity to serve. So even if there was a little bit of give back, the business is still in great shape and to support the long term growth assumptions for the company, but in many ways, it's kind of the unknowable. We just don't know how the elections are going to unfold and then what happens afterwards.

Speaker 9

That's helpful, Craig, and best wishes, Tom. Thank you.

Speaker 2

Appreciate it. Thank you.

Operator

Thank you. The next question is from Julian Mitchell from Barclays. Please go ahead.

Speaker 10

Thanks very And thanks a lot, Tom, for all the help. Maybe just The first question would be around, when you think about sort of the mega projects and the impact on North America orders, orders. So you had a sort of a book to bill well over one times in 2023, Even with those trading 12 month orders being down somewhat off the high base, when you look at 2024, is it sort of a similar construct where I suppose you could have

Speaker 8

orders down, but

Speaker 10

the book to bill I suppose you could have orders down, but the book to bill still over one times, just because of the capacity constraints. And then more broadly, any concerns that you and your peers collectively adding Maybe too much capacity in electrical output?

Speaker 2

I appreciate the question, Julien. And Certainly, it's one of the things that we spend a lot of time thinking about as well in terms of what will the tender of 2024 look like. But I think the short answer to the question is yes. I mean, it's very much possible that you could continue to see a moderation of orders and a book to bill on the total backlog that it doesn't change. In fact, when we came into 2023, We actually expected to be able to eat into the backlog and the backlog grew by some 15%.

Speaker 2

And so The industry continues to be constrained and obviously, but for industry constraints, we would post Bigger growth numbers than we provided in the guidance. The demand is there to grow faster than 7.5% that we've talked about it at the midpoint of our guidance. So that absolutely it's possible that you could essentially Orders could still moderate and your backlog could continue to be record highs or continue to grow. Yes. And just to add a little bit more color

Speaker 3

to that. And Julien, we've talked about this in previous calls and tried to put it in the prepared remarks, but think it's very important for everyone on the call. We have modeled year over year Order decline, meaningful order decline. And in those scenarios, given Our backlog coverage, as we said in the prepared remarks, we are able to have robust organic growth well into 2025. So that gives us great confidence that even if year over year orders continue to declining in meaningful ways, we still got a good runway.

Speaker 10

That's helpful. Thanks very much. And then just a quick follow-up, maybe switching to eMobility. You'd raised that medium term revenue guide a few months back. The noise or the news in the EV world is Very, very uneven.

Speaker 10

So maybe just sort of tell us how you see it for the growth rates of that business. We can see a very high growth rate dialed in for eMobility this year. Maybe just any sort of perspectives on that and maybe how you're outperforming the industry?

Speaker 2

Yes. Appreciate the question, Julien. And as you know, as we talked on our guidance, we're anticipating 30% growth in our eMobility business. And I can tell you that 30% number is Today, dialed back from what our customers are asking us for. We do recognize that the industry itself has gone through a little bit of a, I'd say, a wake up call with respect to the underlying demand for EVs.

Speaker 2

By the way, still great demand, still good growth from 20%, I think in the Q4 for us. But overall, A slower rate of growth than perhaps what people were anticipating maybe 12 months ago. So we think the industry will continue to grow and grow nicely. And what we try to do as we build our own plans and our guidance is to make sure we're appropriately hedged back to ensure that we're able to deliver our commitments. But at the same time, we have the flexibility to respond In the event that some of these customer forecasts and their outlooks are actually they actually come to fruition.

Speaker 2

So yes, we took about 1,500,000,000 11% return on sales. We are absolutely still see line of sight and committed to those goals and our forecast have not changed.

Speaker 3

Yes. And just one other thing I would add, Julie, and Taking you back to the prepared remarks, in eMobility, the market grew 7%, we grew 18%. So we're winning some good business there.

Speaker 2

Yes. And to your point, Tom, it really is and I think this was maybe your question, Julie, as well. It really is platform specific and our growth really comes from the launching of new e mobility platforms that we have content on. And that's why our growth we think will clearly be well above the industry's growth rate.

Speaker 10

That's great. Thank you.

Speaker 2

Thank you. Thanks.

Operator

The next question comes from Steve Volkmann from Jefferies. Please go ahead.

Speaker 11

Great. Thanks fitting me in. I want to go back to the cost cutting program, the $325,000,000 of benefits in 2027. Should we think of that as kind of net in terms of margin or will you have some increased investments that offset some of that?

Speaker 2

No, I mean, the way we talked about it, we're going to spend $375,000,000 restructuring to deliver $325,000,000 of mature year benefits and that is the way you should think about it. We'll spend Those restructuring dollars over the next few years, and we had embedded as we talked about In our 2024 guidance, dollars 175,000,000 of spending and $50,000,000 of benefits, But those benefits will fall through to the bottom line with no offsetting expenses.

Speaker 11

Yes, perfect. Thanks for that. Sorry, Tom, go ahead.

Speaker 3

Yes. And I was just going to say in the cash associated with it is in our cash guidance as well.

Speaker 11

Understood. So, my guess is it's probably a little more Europe centric since these things tend to be, but any guidance on sort of where we'll see these results

Speaker 2

I appreciate the question. I think you can just think about it. It's going to be pretty widespread And you can think about the total kind of allocation of the benefits being pretty much aligned with the company. 2 thirds will be in electrical, 1 third will be in industrial. We'll be focused on taking out rooftops in the company, Driving some shared services, leveraging digital, but a lot of these benefits will really cut across the company.

Speaker 3

Yes. What I would also say is, you've described it as cost cutting And there is an element of that, but I really want to come back to it's a smarter way of doing business as well. I mean, we've got a number of sites. We're very complex organization with 5 reportable segments. And we've got opportunities With our central functions to be more efficient and take work off of the business units and allow opportunity cost for leveraging resources, leveraging talent, leveraging, and capital as well.

Speaker 3

So there's it's not just pure cost It's a smarter, more efficient way of doing business as well.

Speaker 11

Great. Okay. Appreciate the nuance.

Speaker 2

And it's the way we have to fund the growth, right? It's the way we're funding increases in investments in R and D and other things that we need to do to grow the company.

Speaker 11

Thanks guys.

Speaker 2

Appreciate it.

Operator

Thank you. The next question It's Nigel Coe from Wolfe Research. Please go ahead. Mr. Coe, your line is open.

Speaker 12

Sorry about that. Meat button problems. So good afternoon, everyone. Thanks for the question. So a couple of grounds, but coming back to this capacity issue of flat expansions, I mean the 9% to 11% growth in The Americas, Craig.

Speaker 12

I mean, it feels like given the backlog build, obviously orders continue to add to that. It feels like that could be relatively So just wondering if there's any kind of capacity constraints that are getting that growth forecast. Are you assuming there's going to be some backlog burn or conversion as we go through the year? I mean, any sense there?

Speaker 2

Yes. And I think I mentioned also in my commentary, Nigel, that there's certainly enough demand in the marketplace to post higher growth than we're reflecting in our guidance. And we're making investments to eliminate capacity bottlenecks. And we think by the time we get to the end of the year, we'll be in great shape. But as you know, we're participating in an industry Where you have a lot of players in the value chain, where you have fairly sizable labor constraints around skilled trades.

Speaker 2

And so I do think there's going to be a governor on growth based upon these factors that prevent us in the industry from growing much faster than that. You think about this 9% to 11%, this is on top of some 30% plus growth over the last 2 years. And so I would say that today, we'll see what happens with the terms of The backlog growth and how much the backlog we can burn or can't, once again difficult to really say, there's a lot of variables in that. Once again, we thought we were going to burn backlog in 2023 and we actually increased it by some 15% The market continues to perform even better than what we imagined. But there are very real capacity constraints in the industry that we think become the governor around this 9% to 11% growth in our electrical business in the Americas.

Speaker 12

Yes, yes, I appreciate that. And then it just feels like data center is the obviously that's probably going to be your strongest growth vertical in 20 And I think you mentioned negotiations up 160 percent of a pretty high base. So just thinking about capacity in that single end market, I mean, Is that a concern? And does the $1,000,000,000 even in the does that have the kind of growth that we should see coming through in 2024, 2025 then?

Speaker 2

Data centers will certainly be a very strong growth market for us in 2024 as well and into 2025, we talked about in terms of our own forecast for the industry, we said the data center market we think grows at a compounded growth rate of 16% over the next 5 years or so. And that is certainly more than supported by orders. We grew up 20% in Q4. We in revenue orders on rolling 12 were up 30%, Negotiations were up a lot more than that. So we continue to see just an acceleration in the data center market in terms of greater growth.

Speaker 2

And once again, because this industry too is capacity constrained, Is labor constrained? We think what you ultimately end up happening as a growth cycle that just extends or could be for a decade at very attractive growth levels.

Speaker 12

Yes, a decade. That's a long time. 24%, do you think 24% will be in that 20% then or even better?

Speaker 2

Yes. I mean, we'll see, but we're not providing guidance per se for individual end markets today, but you can certainly assume that within that 9% to 11%, That our assumption for data centers is going to be on the higher end of that.

Speaker 12

Right. Okay. Thanks, Craig.

Speaker 2

Yes. Just to add,

Speaker 3

the chart for the end markets, we have data centers and distributed IT growing Strong double digits. So and everything from an order perspective, as Craig said, points to very robust growth in 2024.

Speaker 12

Yes, it's vertical. Thanks Tom and congratulations. Thank you.

Operator

Thank you. The next question is from Tim from Citigroup. Please go ahead.

Speaker 8

Yes, great. Thanks. I'll just fire 1 in here. But I guess to start, after spending some time with Mike Yelton, I guess it was around this time last year, I guess I can better understand why it was in such a good mood. But just On the mix in electrical, I would guess just given the strength in these big projects that there has been A trend, I guess, is it Americas comment, but you've seen kind of this continued shift from More of the growth coming from systems versus products.

Speaker 8

How do you in years past that there's been times when that's given you challenges in terms of kind of managing the profitability of that. But I guess maybe your outlook in terms of that mix dynamic in 'twenty four and again your confidence in terms of managing to the extent that continues more of the growth coming from systems relative to products? Thank you.

Speaker 2

Yes. And I appreciate question. I know we kind of created this monster a little bit, but we're trying to get the investor community to move away from this Systems versus products distinction, because practically speaking, they're all connected. So anytime you sell an electrical system, it encompasses all of our products and components. And so for us, we really think about the right way to think about the company is to really take a look at the end markets that we laid out, Data centers, utilities, industrial facilities, commercial facilities and that will be perhaps the most informative way to think about the company in the context of where growth is going.

Speaker 2

And I can just tell you in general from a profitability standpoint today, There is not a significant difference today between the profitability of systems and the components that go into the systems. Now There was a time inside the company back when let's say we were in we started the lighting business for example, and lighting was considered a product business, With a relatively large business with relatively lower margins than the rest of Electrical. And there was a meaningful difference perhaps held back by lighting that drove different profitability between the 2. But today, we don't have a significant difference in profitability. And we really think the right way to think about the company is really the function of these end markets that we've laid out Once again on Slide 16.

Speaker 8

Okay. Yes, for sure. And real quick, Craig, on the aero piece within commercial, is there you expect Much difference in terms of the growth between OEM and aftermarket in 2024 or are those both similar projected growth

Speaker 2

Yes. No, and it's an important question because as you know, there is a very different profit profile on an OE order versus an aftermarket order. Both will grow nicely in 2024. We do expect OE to grow slightly faster than aftermarket, which holds margins back a little bit, which has been reflected in our guidance. But we expect to see very strong growth in both commercial as well as the aftermarket piece of the business, commercial OE and aftermarket.

Speaker 8

Okay, great. Thanks for squeezing me

Speaker 2

in. Thanks.

Operator

Thank you. And our next question is from Deane Dray from RBC Capital Markets. Please go ahead.

Speaker 13

Yes. Good afternoon. Thanks for fitting me in.

Speaker 2

Hey, Dean.

Speaker 13

And congrats, Tom. Best of luck. And for I don't know if you can parse this out, but is there any way you can frame your expectations on North America Electrical, what would be going through distribution versus direct ship? I'm not sure how precise you can get there, but any color would be helpful.

Speaker 2

Yes. I would say, Deane, that In North America specifically, a lot of what we do goes through distribution. And that number order of magnitude, I think it's about 70% or so. So it's a fairly sizable piece. And as these mega projects continue to grow as perhaps data centers, hyperscalers continue to grow.

Speaker 2

Some of that tends to be perhaps more direct just by virtue of the nature, but a lot of our business today Those through distribution and our distributors are just, I'd say, I've always said, they're perhaps our greatest asset. We are committed to distribution, they add Tremendous value. We have a very strong distribution network. So yes, it's one of the real assets of the company.

Speaker 13

Great. And I don't think I heard the word destocking come up at all today. So it did create a chuckle there. But Is there any destocking, any pockets of it? You all seem to have steered clear of any of that over the past 4 months 4 quarters, but just any color there would be helpful.

Speaker 2

We did talk about a little bit destocking that we saw in our European business, which quite frankly, it really began at the beginning of 2023. We started to see destocking in Europe specifically. Fortunately, the good news is that we're beyond that. But in the Americas business specifically, other than the oddballs and pockets of places, we've not really seen destocking in the Americas and that's largely because these markets as we've talked about continue to grow pretty dramatically. But we did have a little bit of it in Europe, but it's fortunately behind us now.

Speaker 7

Got it. Thank you.

Operator

Thank you. And at this time, there are no further questions. Thank you. Mr. Jin, please ahead with closing remarks.

Speaker 1

Hey, thanks guys. I know it's a busy day and we do appreciate everybody's question. As always, the IR team is available To address your follow-up calls, have a good day. Thanks for joining us. Bye.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today.

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Earnings Conference Call
Eaton Q4 2023
00:00 / 00:00