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 | | | | Eaton (ETN): A Long-term Innovation Enabler and Beneficiary |
| When Mark Twain published The Gilded Age: A Tale of Today in 1873, his intention was to convey the idea of deep cultural rot beneath a shimmering veneer of prosperity. It was a satirical novel about corruption and inequality in post-Civil War America.
The phrase Gilded Age stuck with historians, however, who still use it to describe the general time frame extending from the 1870s to the start of World War I. Notwithstanding Twain’s piercing cultural observations, from a purely economic perspective, the decades that followed the book’s publication were marked by extraordinary wealth creation, industrialization and technological progress.
One of the most important breakthroughs in human history in fact took place just a few years after Twain’s book came out. On New Year’s Eve 1879, at his laboratory in Menlo Park, New Jersey, Thomas Edison treated some 3,000 visitors to a life-changing spectacle. His entire compound was illuminated with electric light, or as one reporter described it, “the flash of a thousand diamond facets.” |
|  | Menlo Park, NJ (12/31/1879) |
| Many great American companies emerged in the wake of Edison’s accomplishment. Among them was Eaton Corporation (ETN), a more than 100-year old company with a convoluted but impressive history that spans many phases of American industrial development.
Founded in 1911 in Bloomfield, New Jersey (less than 30 miles from Menlo Park), Eaton originally provided axles and gears to the burgeoning auto industry. Eaton’s links to Edison are now closer than ever as the company has become a key behind-the-scenes player within the AI-driven electrification wave sweeping the U.S. and much of the world.
We recently added Eaton to our American Resilience Model Portfolio based on its attractive positioning within the electrification mega trend and our confidence in the company’s long runway of future earnings growth.
Edison’s New Year’s Eve celebration came in the wake of a major discovery. He had been toiling for years to develop the right filament for an electric light bulb that could provide continuous illumination. Just a couple months prior, he finally found a solution using carbonized cotton thread.
Remarkably, Professor Henry Morton, the esteemed President of New Jersey’s Stevens Institute of Technology, called Edison’s breakthrough a “conspicuous failure.” Just three days prior to the light show, The New York Times ran a letter on its front page in which Professor Morton expressed doubts about the potential “utility” of Edison’s invention.
Morton, of course, could not have been more wrong in his assessment. Edison’s invention not only had tremendous direct utility, but it spawned a technological revolution. (Contemporary skeptics of artificial intelligence use cases should take note!)
The decades surrounding the turn of the 20th century were gilded in another sense as well. It was a rare moment in history in which a true international gold standard prevailed, between 1879 (the exact year of Edison’s breakthrough) and the outbreak of World War I in 1914.
Some students of economic history see this as more than a coincidence. Saifedean Ammous is among them.
In 2018, Ammous published The Bitcoin Standard, which is widely regarded as the most important book on the subject of Bitcoin ever written. The book is also a compelling articulation of how hard money regimes provide a crucial backdrop for economic progress. |
| | In the United States this era was called the Gilded Age, where economic growth boomed after the restoration of the gold standard in 1879 in the wake of the American Civil War…. With the majority of the world on one sound monetary unit, there was never a period that witnessed as much capital accumulation, global trade, restraint on government, and transformation of living standards worldwide. - Saifedean Ammous, The Bitcoin Standard |
| | While it remains to be seen if the world (whether through Bitcoin, gold or some combination thereof) is poised to return to a hard money system, we are clearly in the early stages of yet another technological and economic boom that is being driven by electrical power.
Artificial intelligence is to a large degree the scientific breakthrough propelling this wave. After Edison invented the light bulb, human beings spent the next 150 years making electrical power ubiquitous. Now, as a result of AI, our need to generate, transmit, store, preserve and consume electrical power is accelerating for the first time in decades.
Food and oxygen are the key ingredients that make human intelligence possible. As much as one-quarter of all calories consumed by humans are used by the brain. Electricity, on the other hand, is what makes artificial intelligence possible. The more electricity AI is fed, the more AI can do.
Up until recently, efficiency improvements have generally offset the positive impacts of economic and population growth on total electricity consumption. But previously flat electricity consumption in the U.S. is now inflecting upward. Data centers, which are increasingly being built to power AI-applications, are the main source of this growth.
Goldman Sachs, among many other forecasters, now anticipates substantial growth in U.S. electricity consumption. Goldman projects approximately 20% growth by 2030, with data center demand leading the way. |
|  | U.S. electricity consumption |
| Similarly, the Electric Power Research Institute (EPRI) expects data centers to consume more than 9% of U.S. electrical generation in 2030, versus 4% today, which represents a dramatic pick-up. |
| |  | | Many figures in the tech world are even pointing to electricity as the key variable in our ability to deploy and use AI technology. Tech leaders are now pleading with the federal government to get moving on power-related infrastructure investment and planning.
A few weeks ago, several top tech industry executives visited the White House to make their case for large-scale coordinated investment in America’s electrical energy infrastructure. Participants included Sam Altman, founder of OpenAI, and Jensen Huang of NVIDIA (NVDA).
Among the arguments they presented was that China is already committed to these energy-related investments. If we want to win the AI battle with China, we need to follow suit. The White House agreed to assemble a task force.
Earlier this year, in a fireside chat presentation at Harvard, Sam Altman identified energy as the key constraint on AI development. He described a scenario in which AI has a seemingly insatiable appetite for energy. He is also optimistic that scientists, aided by AI, are positioned to make extraordinary breakthroughs in energy generation, including nuclear fusion. |
|  | OpenAI’s Sam Altman at Harvard |
| | So energy and AI are the two things I’ve been most interested in for a long time.… I really think those are the two key inputs, if you get them right… you can do almost anything else. What I didn’t realize and got totally lucky with is how much they’re the same problem. Eventually the cost of intelligence should approximate the cost of energy.… I expect, if we fast forward many years, energy is the biggest constraint on the cost of AI and the ability to deliver a lot of it and continue progress. - Sam Altman (5/1/2024) |
| | To fuel what he refers to as “techno-abundance,” Sam Altman foresees a future of enormous electrical power generation and consumption. This vision is a stark contrast to the reality that 32-year old Thomas Edison occupied when he hosted his light show on the last day of 1879.
Of course, prior to the invention of the light bulb, there was no electrical grid. Edison had to manufacture his own electricity. He built a steam-powered generator, or dynamo, using large bipolar magnets. She was given the nickname “long-legged Mary Ann.”
Edison’s inventions produced a cascade of innovation. Humanity was finally able to harness the power of electricity in a meaningful way. This created all kinds of entrepreneurial opportunities for those willing to seize them. To Saifedean Ammous’ point, they were also operating in an environment of relative financial stability.
Eaton is born
It was at was at the tail end of this multi-decade stretch of peace, prosperity and scientific advancement that the company we know today as Eaton Corporation was born. In 1911, Joseph O. Eaton II founded Torbensen Gear and Axle Company with his brother-in-law Henning O. Taube and inventor Viggo Torbensen, who held a patent on an internal-gear truck axle. |
| Shortly after its formation, Eaton relocated from New Jersey to Ohio to get closer to the center of the automobile industry. The market for automobiles and trucks was growing rapidly, in no small part because of the progress made possible in all realms of manufacturing by Edison’s advances in electrical power.
The arrival of World War I catapulted demand for truck axles and gears, and the company grew rapidly. In the decades that followed, there were several transitions. Eaton and Torbensen even sold the original company a few years after relocating to Ohio, only to buy it back in 1922, forming Eaton Axle and Spring Co.
Through both World Wars, Eaton played a crucial role as a supplier of automotive parts to the U.S. military. Notably, during World War II, as much as 10% of the company’s work force was female. |
|  | An Eaton factory worker circa 1942 |
| While Eaton began life in the automotive sector, after World War II, the company started to diversify and made its first foray into electrical power. In 1946, Eaton acquired Dynamatic Corporation, a manufacturer of electromagnetic drives.
In the decades that followed, Eaton would continue to grow in the electrical industry, largely through acquisition. In 1994, Eaton acquired Westinghouse Electric’s distribution and control business for over $1 billion, which changed the complexion of the company significantly.
In 2012, Eaton undertook a transformative transaction, acquiring Cooper Industries, in a cash-and-stock deal that had approximately $12 billion in equity value. Based in Dublin, Ireland, Cooper was a global manufacturer of electrical components and tools with a history that dated back to 1833.
As a result of the transaction, Eaton reincorporated as an Irish company and became Eaton Corporation plc, its legal name today. The reincorporation was largely tax-driven—a popular move at the time as many companies undertook “tax inversion strategies” to benefit from more favorable corporate income tax treatment. Eaton remains, from a legal perspective, an Irish company, but its operational headquarters still sit in Cleveland.
The most important aspect of the Cooper deal is that it solidified Eaton’s transition from a diversified industrial company into a focused power management solutions business.
Eaton today
Investors in Eaton today own a company that is predominantly oriented around the electrical business with more than 90% of current year operating earnings connected with its U.S. or global electrical segments.
Eaton’s electrical businesses serve several highly attractive end markets that are not only growing nicely but should continue to grow well far into the future. More than a quarter of Eaton’s sales are now going to data center and electric utility customers (who are struggling to keep up with demand from their own data center customers).
Within its electrical segment, Eaton sells a wide range of products and solutions, from more mundane (but still highly needed) circuit breakers, switchgear and inverters to more advanced systems related to uninterruptible power supplies and power distribution.
Eaton’s U.S. electrical segment, which alone represents approximately 70% of current year operating profits, is performing especially well. Consensus estimates call for some 25% growth in the segment this year, which was validated in the most recently reported quarterly results from August, which demonstrated 28% segment operating profit growth.
The order backlog is swelling and has more than quadrupled over the past five years. The company reports that orders are approximately 40% driven by data center and utility demand but also large scale industrial projects that are typically in the early phase of multi-year buildouts. |
|  | | While the electrical segment is the star of the show, Eaton also plays in aerospace and vehicles and has been developing an eMobility business.
The eMobility business leverages the company’s historical strength in the automotive sector to develop solutions for electric and hybrid vehicles. The segment is currently unprofitable but has long-term promise.
The aerospace segment is the next largest outside of the electrical segment and is likewise benefiting from a number of favorable long-term demand trends. |
|  | | Performance and valuation
We have been monitoring Eaton for some time. We have added it to the American Resilience portfolio to replace capital that had been connected with another position. We have reduced our allocation to that position based on its extremely strong share price performance and now fuller valuation.
Any reluctance we have previously had around ETN shares was purely based on valuation considerations. We are not alone in recognizing Eaton’s superior positioning across a wide range of durable demand trends. This has led to some meaningful multiple expansion over the past two years and significant share price outperformance. |
|  | Over the past 6 months, however, ETN’s share price performance has moderated (total return of approximately 13%, which is generally in line with the S&P 500), while the company has continued to deliver on growth.
While ETN does trade at an approximately 30% premium to industrial segment peers across various financial metrics, few if any of ETN’s peers benefit from the same kind of exposure to such reliably growing end markets. The valuation premium is warranted by the long-term growth potential and Eaton’s solid position within the most promising and dynamic segments of the industrial landscape.
The broader electrification picture
The global AI data center buildout is perhaps the most exciting growth driver within the electrification theme. We should point out, however, that there are broad sources of demand growth for electricity. This demand growth necessarily translates into demand growth for all the equipment that makes the generation, delivery, storage and consumption of electricity possible.
Advances in batteries, alternative sources of energy, and the injection of digital technology into nearly everything are driving investment in electrical systems across the economy. As AI is deployed, this will only intensify demand for such systems and the further extension of them.
As Sam Altman and many others have pointed out, innovation in energy will over time make energy more accessible and abundant. This sets up a virtuous cycle in which innovation in energy drives innovation in products and services that exploit the availability of energy.
Eaton sells a wide array of products—and continues to develop new ones—at almost every layer of the electrical energy supply chain. The technological revolution that began with Thomas Edison is actually accelerating, and Eaton sits right in the middle of it.
We encourage subscribers to consider ETN as a potential long-term investment that rides a steadily growing end market demand opportunity with no foreseeable upper limits. |
| | Having referenced Mark Twain, we would be remiss if we failed to point out Joseph Eaton’s personal connection to another great 19th century figure within American literature, Herman Melville. His father, Joseph Oriel Eaton, happened to be a noted artist who painted a famous portrait of Melville. |
|  | Eaton’s father’s famous painting |
| This portrait of Melville by Eaton’s father now hangs in the Edison and Newman Room at Harvard’s Houghton Library, a short walk from where Sam Altman recently presented. The room happens to be named after Theodore Edison, who was Thomas Edison’s son! |
| | | Eaton (ETN): Company Snapshot |
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