ETN Neutral for traders, buy for dividend investors

Eaton Corporation (NYSE: ETN)                                                            11/21/2012

Last Price: $50.72

VIEW: NEUTRAL

Eaton Corporation operates as a diversified power management company worldwide. The company provides electrical components and systems for power quality, distribution, and control; hydraulics components, systems, and services for industrial and mobile equipment; aerospace fuel, hydraulics, and pneumatic systems for commercial and military use. Eaton has approximately 74,000 employees and sells products to customers in more than 150 countries.

Sector: Industrial Goods                                                Industry: Industrial Electrical Equipment

Highlights:

Eaton Corporation manufactures components and systems for use in automobiles, trucks, aerospace, agriculture, and fluid power systems. Once highly dependent on making drivetrains and other engine parts for the auto and heavy trucks sectors, Eaton has cut auto and truck related sales, shifting its focus to areas like power management, hydraulic systems, and aerospace and defense. ETN has a market cap of $17.14 billion. The stock closed yesterday’s trading session at $50.72. In the past year, the stock has hit a 52-week low of $36.38 and 52-week high of $53.06. Technical indicators for the stock are bullish, the stock is now trading at a higher level, regardless of the company’s weak earnings results

GROWTH AND BALANCE SHEET

Industrial manufacturer Eaton Corporation reported on its third quarter results earnings per share of $1.07 falling behind the year-ago figure of $1.08 per share. Eaton’s GAAP earnings during the third quarter were $1.02 per share versus $1.07 per share reported in the year ago quarter. Net quarterly revenue came at $3,950 million, down 4.2% from $4,123 million in the year ago quarter. Selling and administrative expenses climbed to $687 million from $668 million in the prior year. Operating profit fell by 12.9% year over year to $376 million from $432 million in the year-ago quarter. The total Debt/Equity of 50.00% is high enough but below the industry average, its quick ratio of 1.00 is weak and could be cause for future problems.

VALUATION

ETN has a PEG ratio of 1.35 above the industry average of 0.97. Current PE at ETN stands at 12.31, below the industry’s average of 14.16. The stock is currently trading 9% below its intrinsic value of $55 this suggests that ETN is undervalued at these levels. The beta of 1.77 implies high volatility of the stock with respect to the S&P 500. The company has a current annual dividend yield of 3.00% which makes the stock attractive for dividend lovers

RECOMMENDATION for next 6 months: We initiate our coverage with NEUTRAL. The company has demonstrated a pattern of bullish technical signs, Eaton may be a good candidate for the long term and for dividend lovers, but for short term we expect a correction as the stock has gained 23.00% year-to-date, well ahead of the S&P 500?s 7.6% year-to-date gain. Our overall score for ETN is 5.17

For options trading we suggest:

• Buy the January 2013 put with a strike of 47.50 priced at $0.80 per contract
• Net Debit to start: $0.80
• Maximum risk: Net debit

NEWS and CALENDAR

Tuesday November 20, 2012 – Eaton Announces Intention to Delist from the Chicago Stock Exchange

Thursday November 15, 2012 – Barclays to Eaton Lead $17.5 Billion of Bond Offerings in U.S.

Thursday November 1, 2012 – GE Premium Targeted by Eaton CEO After $12.8 Billion Deal

ETN Strengths

• Diverse Business
• Economies of Scale
• International Diversification

ETN Weakness

• Fuel prices
• Europe and China markets remain dull

Stock valuation model

The model rates stocks from 1 to 10, with 10 being the best using a system of advanced mathematics to determine a stock’s expected risk and return. I am using different fundamental and technical factors in order to rank a stock.

Intrinsic value of the stock

Investors should buy stocks selling at a discount to their intrinsic value, and then patiently wait for the fair value of their investments to be realized.

ETN’s intrinsic value is $55.00 the current price is $50.72, the stock trades 9% below its fair value.

Financials

The financial health of the company the higher the better, we evaluate all the financial ratios of the company.

Sentiment

Investor’s sentiment for the stock

Analyst ratings

The model assigns a value according to analyst’s recommendation for the stock.

Earnings Consistency

We are searching for EPS numbers that are better than the previous year’s. One dip is allowed, but the following year’s earnings should be higher than the previous year. ETN’s annual EPS for the last 5 years were 3.19, 3.25, 1.14, 2.74, 3.94 this type of earnings action is not favorable.

Total Debt/Equity

The company must have a low Debt/Equity ratio, which indicates a strong balance sheet. The Debt/Equity ratio should not be greater than 20% or should be less than the average Debt/Equity for its industry

ETN’s Total Debt/Equity of 49.90% is not acceptable.

EPS This Quarter VS Same Quarter Last Year

The EPS growth for this quarter relative to the same quarter a year earlier is above the minimum 15% that this model likes to see for a “good” growth company. Stocks with improving earnings are worthy of your extra attention.

ETN’s EPS growth for this quarter relative to the same quarter a year earlier is -5.60% well below our target.

Annual Earnings Growth

This stock valuation model looks for annual earnings growth above 12%, but prefers higher than 20%.

ETN’s annual earnings growth rate over the past five years is 6.00%, below our target growth rate.

Current Price Level

Investors should keep an eye open for stocks that are trading within 10% of their 52-week highs, as it is likely to continue in its upward trend.

ETN’s 52 week high is $53.06 current price is $50.72, is 5% below the 52 week high.

P/E Ratio

The Price/Earnings (P/E) ratio, based on the greater of the current PE or the PE using average earnings over the last 3 fiscal years, must be “moderate”, which in this model states is not greater than 15. Stocks with moderate P/Es are more defensive by nature.

The company has a P/E ratio of 12.31 the average industry P/E ratio is 14.16 and is also below the S&P 500 P/E ratio of 15.30.

Insider Ownership

When there is strong insider ownership which we define as 8% or more, management is more likely to act in the best interest of the company, as their interests are right in line with that of the shareholders.

Insiders own 0.45% of ETN stock. Management’s representation is not large enough. This does not satisfy our minimum requirement; companies that pass this test are more attractive to our valuation model.

Technical Analysis

The model is using several technical indicators (MACD, RSI, MFI, OBV, position Indicators) to forecast the trend of the stock for 6 and 12 months, and assign a value.

ETN is in an uptrend, is trading in the range of $44.36 – $50.94 in the past 30 days. The Commodity Channel Index (CCI) is bullish for ETN. ETN stock has been showing support around $47.30 and resistance in the $52.90 range. Our indicators give a bullish view on ETN.