Cyclical companies must maintain healthy balance sheets. If they unexpectedly fall on hard times and need to make substantial principal and interest payments, the dividend could become jeopardized.
Eaton’s balance sheet is in better shape than it has been in recent years, but it contains a little more debt than we prefer to see. The company’s pension plan is also underfunded by a couple billion dollars.
Fitch assigned a “BBB+” credit rating to Eaton in mid-2015, which seems about in line with our analysis. As long as the economy doesn’t fall off a cliff, Eaton should be just fine.
Source: Simply Safe Dividends
Overall, Eaton’s dividend looks pretty good for safety purposes. The company maintains reasonable payout ratios, generates consistent free cash flow, and has proven its commitment to shareholders with consecutive dividend payments since the early 1920s.
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Eaton’s Dividend Growth Score of 65 suggests that the company’s dividend growth potential is above average. The company only raised its dividend by 4% in 2016, reflecting the difficult macro environment, but has historically been a double-digit dividend grower.
As seen below, Eaton’s dividend has compounded at a 13.5% annual rate over its last 10 fiscal years and grown at a remarkably consistent clip.
Source: Simply Safe Dividends
While the business is not a member of the dividend aristocrats list, it has paid uninterrupted dividends for over 90 years while increasing its dividend each year since 2010.
We expect future dividend growth to be in the mid- to high-single digits, tracking the company’s earnings growth. This would keep Eaton’s payout ratios near 50%, which is reasonable for an economy-sensitive business.
Valuation
Eaton Corporation, PLC Ordinary Shares (NYSE:ETN) trades at a forward price-to-earnings multiple of 14.2 and has a dividend yield of 3.7%, which is higher than its five-year average dividend yield of 3.1%.
Eaton’s management team targets annual earnings per share growth of 8-9% from 2015 through 2020. Earnings growth is expected to be driven by restructuring actions (3-4%), share repurchases (3%), organic sales growth (1-2%), and acquisitions (1%).
If management’s assumptions are correct, the stock appears to offer annual total return potential of 11-13% per year.
The stock seems to be very reasonably priced, although it will remain tied to macroeconomic developments over the near term.
Conclusion
Eaton is a quality business that will remain relevant for many years to come. The company’s moat is driven by its long-standing market positions, extensive product portfolio, massive distribution channels, and leading technologies. Many of these qualities are shared with some of Warren Buffett’s best dividend stocks.
Eaton’s valuation also looks undemanding. Soft market conditions could keep a lid on earnings growth over the near term, but the company’s restructuring programs, bolt-on acquisitions, and presence in many large markets provide potential for better long-term results.
For dividend investors seeking a safe, relatively high yield with reasonable growth, Eaton may be an interesting candidate.
Disclosure: None
