While market participants are busy snatching up stocks in anticipation of earnings (something we planned for weeks ago), focusing on the all unimportant Goldman market upgrade and the CIT news – we are focused on a little publicized event that is, in my opinion, far more important than anything else reported today: Eaton’s earnings. Although they are not a huge company ($10B market cap) they serve as a pivotal component of the economic supply chain. Plus, they are a magnificently managed company and their earnings have always served as a clear sign of economic strength or weakness. I am not going to get into the details of revenues and net income compared to analyst estimates. Cutting right to the chase, the financials are increadibly weak though “better than expected”. The focus should be on the guidance and Chairman Cutler’s comments:
Alexander M. Cutler, Eaton chairman and chief executive officer, said, “Our sales in the second quarter were only slightly higher than in the first quarter of 2009, reflecting little improvement in the challenging global economic conditions. Despite the sluggish revenues, which came in $100 million lower than projected in our initial quarterly guidance, we were successful in substantially lowering our cost structure, which allowed us to generate earnings about equal to our guidance for the quarter.
“Sales in the second quarter declined 32 percent compared to the second quarter of 2008, with a decline of 6 percent from exchange rates and a decline of 26 percent in core sales,” said Cutler. “Our end markets declined 26 percent in the quarter. It is clear that significant destocking and inventory liquidation continued in virtually all of our segments during the quarter.
“Despite the challenging market conditions, our operating cash flow for the quarter was $361 million, just slightly lower than last year, and our free cash flow was $313 million, $68 million higher than last year,” said Cutler. “In the last three quarters, our operating cash flow has totaled $1.1 billion. We are maintaining our dividend for the second quarter at $0.50 per share, to be distributed in mid August.
“As we survey our end markets, the year is shaping up to be considerably weaker than we had forecast in April,” said Cutler. “We now anticipate our overall end markets will decline by between 21 and 22 percent versus our earlier forecast of a decline between 15 and 16 percent. We see our U.S. markets declining by 25 percent, while our non-U.S. markets are expected to decline by 19 percent.
“We anticipate net income per share for the third quarter of 2009 to be between $0.80 and $0.90,” said Cutler. “Operating earnings per share, which exclude charges to integrate our recent acquisitions, are anticipated to be between $0.90 and $1.00 in the third quarter of 2009.
“We are lowering our guidance for the full year due to the further reduction in our expectations for market growth, which we expect to be partially offset by an additional $120 million of savings from our cost-reduction initiatives. Accordingly, we now anticipate 2009 net income per share of between $1.65 and $1.85, and 2009 operating earnings per share of between $2.00 and $2.20,” said Cutler.
Naturally, the stock closed up higher because the estimates were simply too low, however, it is quite clear, from the comments above, that the economic recovery is tepid at best and perhaps at risk of retrenching….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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