Why we're looking past this AI play's mixed earnings results and ho-hum guidance

CNBC Finance

5 min read

Electrical equipment supplier Eaton reported another mixed quarter on Tuesday, but the long-term growth story management shared with investors is buoying shares. Revenue in the fourth quarter ended Dec. 31 advanced 13% year over year to a record $7.06 billion, but came up short versus expectations of $7.09 billion, according to estimates compiled by data provider LSEG. Organic growth was 9%, with an additional 2 percentage points attributable to acquisitions and foreign exchange dynamics. Earnings per share (EPS) increased 17.7% year over year to $3.33, also a record result for Eaton, edging out the $3.32 estimate, according to LSEG. ETN 1Y mountain Eaton 1-year return Bottom line The market is looking past the mixed headline results and ho-hum guidance, with shares flat in midday trading. Investors are instead focused on the bullish commentary management provided during the conference call and on what Eaton will look like in 2027, when management will spin off its mobility business, which makesÂ transmissions and clutches for the U.S. heavy-duty and commercial vehicle market and components for electric vehicles. The spin will allow the remaining company to concentrate on its electrical and aerospace end markets, the two areas that drove all the growth in the reported quarter. Indeed, the team expects the separation to be immediately accretive to Eaton's organic growth rate and operating margin. We're most bullish on the electrical business, which is essential to the artificial intelligence buildout. CEO Paulo Ruiz provided an update on the company's megaprojects. "There is a clear correlation between the acceleration of these projects and [Eaton's] future order growth. The megaproject backlog increased 30% year over year to $3 trillion, with Eaton involved in 866 projects. Data center demand is driving growth. For example, management said its construction backlog is up to 206 gigawatts (GW), according to the Dodge Construction Network, a data and analytics provider covering the North American commercial construction industry. That amounts to about 11 years' worth of projects based on 2025 build rates. For reference, the Hoover Dam has a maximum power-generating capacity of about 2 GW, Importantly, management also reaffirmed Eaton's 40% win rate for megaprojects. The combined backlog of Eaton's electrical and aerospace businesses grew to $19.6 billion, a 26% increase from the end of 2024, and an acceleration from the 23% growth for full-year 2024. The suboptimal earnings outlook is likely the result of the company ramping up capacity investments to meet the incredible demand. "As we scale capacity in our largest business, [we're] incurring higher than typical ramp-up costs to start the year, with improvement anticipated in each quarter," Ruiz said. "We have great confidence in the acceleration in both revenue and margins from this starting point." We deduce from these comments that spending is front-loaded, which explains why the first-quarter guide was so much lower than expectations and why the full-year guide was more in line. Why we own it Eaton is exposed to several important megatrends, including electrification, the energy transition, and infrastructure spending. It is also a player in generative AI, where data centers use its power management solutions and electrical equipment to meet the heightened demand for computing power. We see a long runway for growth. Competitors : Parker-Hannifin , DuPont ,Â and Honeywell Most recent buy : April 3, 2025 Initiated : Nov. 15, 2023 After listening to the call with investors, it's clear that the long-term drivers of earnings growth remain intact and appear stronger than ever. As a result, we are nudging up our Eaton price target to $410 from $400, but are maintaining our 2 rating, which means we'll wait for a pullback before buying more. Guidance The first-quarter outlook came up short versus expectations: 5% to 7% organic growth versus 7.3% expected, according to FactSet. 22.2% to 22.6% segment margins versus 22.7% expected. Adjusted earnings per share are projected between $2.65 and $2.85, versus $3.02 expected, according to LSEG. Management's full-year outlook was more in line with expectations: 7% to 9% organic growth versus 7.8% expected, according to FactSet. 24.6% to 25% segment margins versus 24.8% expected. Operating cash flow of $5 to $5.4 billion versus $5.45 billion expected. Free cash flow of $3.9 to $4.3 billion versus $4.33 billion expected. Adjusted earnings per share are projected between $13 and $13.50, versus $13.48 expected, according to LSEG. Driving management's full-year forecast is strong growth in the data centers, distributed IT, electric vehicles, and commercial aerospace end markets. Growth is also expected in the utility and defense aerospace end markets. Modest growth is expected in the commercial, institutional, and machinery/MOEM end markets. Slight growth expected in ICE light vehicles, commercial vehicles, and industrial facilities. The residential end market is expected to be flat for the year. (See here for a full list of the stocks in Jim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. 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