This High-Yield Stock Has a New $4 Billion Revenue Opportunity

When Eaton Corporation plc (NYSE: ETN) reported first-quarter earnings, it presented a new breakdown of its business, adding the eMobility division to its collection of operating segments. The change was pretty small for the quarter, but the longer-term implications are much larger. Here’s what this new division is all about, and what it means for Eaton long term.

From five to six

Eaton’s business has historically been broken up between electrical products (roughly 33% of first quarter revenues), electrical systems & services (26%), hydraulics (13.5%), aerospace (around 9%), and vehicle (17%). All of these businesses are focused on helping customers make the most efficient use of power. This quarter, though, as Eaton’s industrial business appears to have turned back toward growth after a period of weakness, Eaton introduced a new business unit called eMobility.

Image source: Getty Images.

This new division is intended to serve the electric vehicle market, with a focus on trucks. First-quarter revenue for the eMobility segment was little more than a rounding error, at about 1% or so of total sales. The new division wasn’t exactly built from scratch, though. Eaton has long served the original equipment manufacturing segment of the heavy truck industry and is well versed in electrical products. It simply pulled together the parts of its vehicle and electrical products businesses that made sense to create the new division. In other words, Eaton moved the chairs around a little bit, but nothing major changed at the company.

How big is the opportunity?

Eaton plans to focus on two segments of electric vehicles, power electronics & conversion and power distribution & circuit protection. The company has a lot of experience with both of these things. That said, it has plans to spend $500 million on research and development over the next five years to tailor its products to better serve the electric vehicle market. The business has around 1,200 employees and is already working with customers on new electric vehicle programs.

The new eMobility division was, essentially, created by pulling from Eaton’s other divisions. Image source: Eaton Corporation plc.

Although the eMobility division didn’t exist in 2017, Eaton says it would have generated around $283 million in sales if it had. It’s projecting around 13% revenue growth in 2018 off of that pro forma number. That’s still just a rounding error for a company the size of Eaton, but the long-term outlook is far more interesting.

Eaton believes the eMobility division could generate as much as $4 billion a year in revenue by 2030, with a low-end estimate of $2 billion. (The company estimates the industry is roughly $33 billion in size today, and growing.) That revenue range will make it a relatively small division for the company compared to its core Electrical Products and Electrical Systems & Services businesses. However, $2 billion to $4 billion would make it as large or larger than the company’s other divisions, all of which were within or close to that range in 2017.

The industrial company is projecting operating margins for the division to fall between 12% and 13% in 2018. That’s lower than its other divisions. In fact, Eaton estimates that the eMobility division’s operating margin would have fallen from an estimated 17.5% in the first quarter of 2017 (if it had existed) to 14.3% in the first quarter of this year. So, there’s farther to fall from here, margin-wise. However, that’s largely driven by the research and development spending that is planned for the new division.

Eaton is dedicating a lot of time and energy to its new eMobility division, but there’s a lot of growth potential. Image source: Eaton Corporation plc.

The drop in margins is also a function of scale, which eMobility has yet to achieve. However, assuming Eaton gets its eMobility products into OEM vehicles, it will start to create annuity-like revenue streams. Once an original equipment manufacturer builds a part into their production process, they don’t like to change it. It’s also likely that a replacement parts business will also start to emerge.

A division worth watching

The electric vehicle market is still relatively small, but there’s a huge amount of potential as the world increasingly looks to reduce the use of carbon-based fuels. Eaton is trying to tap into this opportunity with its new eMobility division. The division is small today, and capital spending will likely depress financial results over the near term. That said, revenue growth should be notable and well worth keeping an eye on as Eaton works to expand its business into a new market from the ground up.

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Reuben Gregg Brewer owns shares of Eaton. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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