Eaton Corporation plc — 2024 Q1

No, we appreciate the question, Joe, and it's obviously one that we're spending a lot of time internally looking at, and it's one of the things that's quite frankly, tempering our outlook for the year is the fact that we do believe that labor continues to be a bottleneck in certain industries and really in the economy overall. And so at this point, I think it's really too early to say to what extent it's going to resolve itself.

Yes. I mean I think the short answer is absolutely. We would intend and anticipate to narrow the gap between those two businesses and narrow the gap the right way, which is the Global business needs to do significantly better. We have no expectations at all that we'd see retrenchment in our Americas business. And so -- but I will say, as you think about the restructuring program that we launched, $375 million of spending, $325 million of benefits. 2/3 of that, more or less, will be in the Electrical segment with a heavy concentration in Global. So we are clearly working hard to improve margins in the Electrical Global business.

Yes, I'd say that, to your point, Jeff, data center markets have been good and strong for a long time. And I think our data center numbers, I think we talked about growth in excess of 20%. But the order growth in the data center market, as we talked about, is much higher than that, much, much higher than that. And so if you think about a lot of these big mega projects, and where we're seeing this outsized growth in projects announced, in our negotiations, data centers is obviously one of the big contributors and the underlying rate of growth that we're seeing in negotiations and in orders is outstripping the very strong growth that we're seeing in our business.

What was the second question? I didn't...

I think -- and correct -- the team can correct me around the room if I'm wrong, I think data centers were embedded in that data. We gave you the aggregate data, I thought data centers were embedded in what we gave you.

Different kinds of projects. And we were showing you some examples of different kinds of projects, but embedded in the overall data, I think that definitely included data centers.

Yes, we can follow up after this call.

I'd say, as we look forward, as you know, we've made a number of announcements around capacity expansion. We're making some investments in commercial front end. We're making investments in technology. So there's a number of programs that we've made announcements last year and that we're investing in this year that will certainly be a bit of a gating factor in terms of margin expansion. I think the implied number is close to what it was in Q1, but I do take your point that we typically see margin expansion, we'll certainly see volume expansion in terms of the absolute revenue in the out quarters, but really it's more a function of spending and investments that we're making in the business.

Yes. The short answer is, Deane, it's absolutely yes. We are living in an environment right now where the market has a number of constraints, including electrical equipment. It's one of the reasons why we announced $1 billion of incremental investments that we're making in the company to deal with the specific bottlenecks that we have in our own manufacturing operations so that we can address the demand that we see in front of us. And quite frankly, given the demand that we're seeing even today in the business, those numbers will likely go up.

I'd say distribution is really an important part of our go-to-market strategy, and we have really strong distributor partnerships that will always be an important part of our formula in terms of the way we go to market. Now there are, in fact, some market dynamics that suggest that there are certain kinds of projects in certain markets that do tend to be more of a direct-serve market than a market that is served through distribution. In some cases, data centers are a great example of that, where there are certain data center customers who want to be served direct. And so I do think there'll be a bit of a mix shift, not so much because it's a function of strategically, we're changing our approach as much as it is because there are certain market segments that are growing, big mega projects being a piece of that, that tend to be more direct served markets.

Yes. I appreciate the question, Julian. I mean I'd say that we have, I would say, relatively modest growth assumptions for our Electrical Global segment. And we really, in Q1, performed largely in line with our expectations, a little weaker, quite frankly, in Europe than what we expected, but largely in line. And as I mentioned, in my outbound commentary, the comps get a bit easier as well in the second half of the year for Global. But today, I'd say we're growing in Asia. We had nice growth in our China and Asia Pacific business overall. Our GEIS business is growing, doing just fine.

Yes. No, I'd say that that's really what the difference is. There's nothing else -- it's embedded in our assumptions that would suggest that margins should fall off other than the incremental spending and investments that we're making in the business. As you saw in our Q1 results, very strong execution by the team, 60-plus percent incrementals. And so the team is really executing well. We anticipate that that execution will continue for the balance of the year, and it really is simply a reflection of the investments that we're making in the business for future growth.

Yes. I wouldn't call it an abrupt start-up cost. But as you know, we made some announcements last year around capacity expansions. And those new capacity expansions start to come online. So obviously, you turn on all the depreciation, you have start-up costs associated with commissioning new lines and new plants. We're making additional investments in some of these commercial opportunities to deal with the better growth outlook that we've talked about. And so in terms of the specifics, obviously, we're not going to give you an exact dollar amount. But I would tell you that it's really tied specifically to supporting the outlook for growth. And quite frankly, we could do better. I mean the reality is we did better in Q1. Our team is executing extremely well. So we could do better than what's currently reflected, but it is today reflective of our best thinking.

I would say that lead times have not pushed out further. We talked over the last couple of years, the fact that the surge that we're seeing in orders has, in fact, extended lead times and for many of our markets overall. And I would say today, depending upon the product line, we've made some progress in terms of lead times, but we've also seen, as you saw in the data, also a resurgence quite frankly, of orders with very strong orders in Q1 that I would say in backlogs that continue to grow. So I would say, in general, lead times have not changed materially. They've gotten not materially worse, they've gotten not that materially better.

Yes. I mean I'd say it varies depending upon which market segment. I mean there are -- in some cases, we are getting for some of the hyperscale data center guys are trying to get out in front and maybe placing some orders earlier than they normally would. But for the most part, there's been no significant change in the order pattern.

I mean, and as you can imagine, Scott, we're living in an environment today where these industries are growing much faster than they have historically, and the outlook for growth continues to strengthen and, in many cases, get better and where -- and you have capacity constraints. And so we are in a very different world today with respect to ensuring that we work with our customers and our suppliers on a multiyear basis to ensure that we have capacity to support the demand that's out in front of us. And that's really what's driving this change in the way we contract and partner with many of our customers.

Yes, I'd say that we really haven't run the math, to be honest with you, Scott, in terms of what percent. I will tell you that maybe an easy way to think about it is that the long cycle parts of our portfolio generally today, we have capacity constraints on the long-cycle stuff and on the short-cycle stuff, not so much. And I think our split is roughly 75-25 between long cycle and short cycle. So maybe that's a good proxy for where we're actually at capacity or close to sold out and where we're not.

I appreciate the question, Nicole. And obviously, it was a really strong start to the year for our Electrical Americas business, and they posted really, really positive numbers. And I'd say maybe it's early in the year. And we have one quarter behind us, and we just thought it's prudent at this point, given the fact that it's early in the year to let's see how the rest of the year unfolds. Certainly, if things continue with what we've seen, there could be upside to that number. I would say as well that as you think about as the year goes on, the comps get in some cases, a little bit more challenging. There's a little bit less contribution from price in some of the subsequent quarters. But once again, the business outperformed our expectation across the board most of which is obviously on the volume side in Q1. And so there is certainly the potential that the business does better than what we're currently forecasting.

No, I'd say largely, it's early in the year. And just really, we just thought it's prudent at this juncture not to take the number up. We'll obviously revisit it as we get through Q2, but it's just early in the year.

No, I appreciate the question, Andrew. And I would say our China business continues to perform very well. In fact, we grew high single digits in Q1 in our China business. And to your point, we do have a very specific strategy for how we play the China market specifically through joint ventures. And in many cases, as you know, these are minority joint ventures. And our joint ventures, by the way, if you just take a look at our joint venture performance, we obviously don't consolidate this revenue, but they grew some 35% in 2023. So we're getting a lot of great growth in the joint ventures in China.

Yes. I would say that, once again, I think inventories are largely well balanced and well aligned right now. I mean, as you can tell by the growth in our backlogs, our backlogs continue to grow and lead times are not getting better and our book-to-bill, 1.2 in Electrical, which I think is a great indicator of where we sit today with respect to inventory in the channel. So today, I would say that it's obviously going to be the odd product line or 2 where the dealer inventories could be a little long. But overall, inventories, I think, today are very well balanced and given the backlogs that we continue to build and certainly all the conversations that I'm in with our distributors and customers is that they're looking for more stuff sooner, and they're looking for shorter lead times than we can currently deliver to.

I would say that what we've seen since we posted those other numbers, which were quite frankly a little bit stale, was that we certainly have seen just fundamental data center market independent of what's happening with AI has been accelerating. The world, as we've talked about before, just continue to generate processed or increasing amounts of data. And then on top of that, you have this explosive trend in AI and these AI training data centers just require and consume just orders of magnitude more power than a traditional data center, and we're obviously starting to see those orders and those negotiations come through now. And so that's really what's driving the change in the outlook for the market, not so much that we've decided that the labor constraints have been resolved, particularly or any particular power constraints overall have been resolved. It's really simply a function of the fact that what we're seeing in our negotiations, what we're seeing in our orders have just accelerated that much between the old number and the new number.

We do start to see, as I mentioned, in terms of kind of what holds the margin expansion back a little bit is the fact that we are, in fact, bringing on and starting up new lines and new facilities beginning certainly, a lot of the spending in Q1, but certainly in the second half of the year, we start to see some of that capacity come free to the point where we actually have the ability to deliver more. So it's really second half of this year and then into 2025 in earnest.

I appreciate the question. And as you can imagine, we're spending a lot of time right now internally reassessing and reevaluating whether or not we're doing enough. The $1 billion, by the way, that's an incremental number that's on top of the base. So I just want to make sure I clarify that. But we don't -- we don't intend to be the bottleneck here. We want to make sure that we have all of the capacity in place to deal with the growth that we see, the forecast that we're getting from our customers. So we are not constraining ourselves with respect to the investments. .

Yes. No. I mean, not particularly. I mean everybody is obviously adding capacity. The market is good for everyone right now. One of the things that we tried to give you a sense for how we're doing is that by providing some of these win rate numbers that we showed you from mega projects, some of the win rate numbers that we showed you for non-res construction projects is an indicator of the fact that we think we're doing very well in the context of this expanding market. And so I'm not -- I don't anticipate dramatic share shifts in the market, especially in a period of time when the industry is sold out in so many places.

Yes. The answer is yes and yes. Negotiation would be a place where we are actually in an active negotiation in response to an RFP, request for proposal a request for quote. And certainly, if you think about data centers and others, once again, these projects tend to be already permitted down the road. As I did mention in some of the outbound data, there's always been a level of cancellations, especially when you look at some of these mega projects, and we talked about in my outbound commentary that the cancellation rate that we're seeing is around 10%. That rate is actually below what we've seen historically, but there's always going to be a certain level of cancellations in any of these projects, but they -- absolutely these tend to be or generally approved projects before we get to a negotiation.

Yes. I mean I think it varies depending upon which product line you're talking about. In some cases, it is, in fact, us adding a line in existing footprint because we do have capacity to do it. In some cases, it's adding additional shifts, utilizing existing assets. But in some cases, it means a new greenfield facility, and we've had to, in fact, stand up some additional manufacturing plants to deal with the growth that we're seeing. So it's really a combination of all of those and varies depending upon which particular product line or business you're referring to.

Okay. Thanks, guys. We have reached to the end of the call. As always, our team will be available to address any follow-up questions. Thanks for joining us, and have a great day, guys.

All right. Thank you.