Eaton Corporation (tkr: ETN) is a power management company that provides efficient solutions to help its customers manage electrical, hydraulic and mechanical power. Eaton operates in five primary segments: electrical products, electrical systems and services, hydraulics, aerospace, and vehicle. The two electrical segments make up the largest portion of Eaton’s revenues (about 60%), and include lighting and wiring products in addition to distribution and control services. In 2012, Eaton acquired Irish company Cooper Industries for $11.8 billion. This acquisition allowed Eaton to establish its new headquarters in Dublin, Ireland, garnering a lower effective tax rate. It also expanded Eaton’s exposure in the electrical utilities market. Eaton’s electrical segments offer architects and building designers a one-stop shop solution that includes everything from power transmission to light units. Eaton should benefit from retrofits to older buildings, a trend driven by the adoption of energy-efficient standards.

Approximately half of Eaton’s sales come from outside the US, which has caused foreign exchange headwinds due to a strong US dollar in recent years. Furthermore, Eaton’s end markets, particularly the hydraulics segment, have been hurt by low oil prices since mid-2014. However, we think the dollar’s strength and oil’s fall have plateaued for now. In response to these challenges, Eaton has undertaken a three-year restructuring program to drive down costs, which has included plant closings, workforce reductions and re-engineering production processes. Eaton has already realized higher cash flow and higher operating margins in some segments. As Eaton continues to restructure, the company should see a leaner cost structure and better operating leverage.

With a host of potentially volatile events on the horizon, including the US presidential election, the uncertainty in the wake of Britain’s decision to exit the European Union, and a possible rate rise by the Federal Reserve, we wanted to add a stable stock to our industrial sector. As an established diversified industrial company with a solid management team, Eaton fits this description. We also wanted a stock with a low price-to-earnings (P/E) ratio and a high dividend yield to act as an anchor in these volatile times. We believe Eaton is undervalued with a P/E ratio of 16x, lower than that of its peers and below its historical average P/E ratio of 18x. Eaton also carries a substantial dividend yield of 3.5% which adds yield to our portfolio in addition to any capital appreciation.

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