Eaton Looks Like a Good Investment For Dividend Hunters
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Some stocks just go out of favor for no clear reason, and high-yielding Eaton Corp (NYSE: ETN) looks like one of them -- the stock trades near the bottom of its peer group in terms of valuation. However, management's guidance calls for ongoing margin expansion and strong free cash flow (FCF) generation in the coming years. With a well-supported current dividend yield of 3.6%, investors might want to ask what's going on, and whether Eaton's stock is due a revaluation.
Eaton looks like a good value on a relative basis
Compared to its peers Eaton looks undervalued. As you can see in the chart below the company trades toward the bottom of its peer group on an FCF-based valuation.
It's true that Eaton faces cyclically risk, but then again so does a company like 3M (NYSE: MMM) which the market seems willing to give the benefit of the doubt when it comes to growth prospects. 3M has a lot of short-cycle business which could slow given any deterioration in the economy.
Eaton's yield will attract income-seeking investors. Image source: Getty Images
Moreover, Rockwell Automation (NYSE: ROK) had a good first quarter of 2019 and maintained full-year guidance, but the stock is still dependent on capital spending trends in the industrial sector -- the first thing that gets cut in a slowdown.
Furthermore, if you are worried about long-term growth and margin prospects in Eaton's core electrical products and electrical systems and services segments, then it's not clear why Schneider Electric, Legrand, or even ABB should trade at a premium to Eaton.
ETN Price to Free Cash Flow (TTM) data by YCharts
All told, Eaton looks undervalued compared to its peers.
Eaton also looks like a good absolute value
The recent investor day presentations saw management affirm that the company was on track to hit its 2015-2020 aims. You can see the key parts of the guidance below.
| Metric | 2015-2020 Targets | 2019 Guidance |
|---|---|---|
| Annual Revenue Growth | 2%-4% | 4%-5% |
| Earnings before interest and taxes (EBIT) margin | 14%-15% | 14%-14.5% |
| FCF from sales | >10% | 11%-12% |
| Annual EPS growth | 8%-9% | 9% |
Data source: Eaton Corporation presentations.
Moreover, management expects to generate $8 billion in FCF in the next three years -- a figure that will cover the expected dividend payout of $3.5 billion 2.3 times over, meaning there are no worries about the sustainability of its dividend. In addition, it will have around $1.5 billion left over annually to buy back shares or make earnings-enhancing acquisitions. Put another way, Eaton expects to generate 24% of its market cap in FCF in the next three years.