Ladies and gentlemen, thank you for standing by, and welcome to the Eaton Third Quarter Earnings Conference Call. At this point, all
We just lost them.
Mr. Jin, can you hear me? Please go ahead.
Okay. Now I can hear you. Okay. Good morning, everyone. I'm Yanjun, Eaton's Senior Vice President of Investor Relations.
Thank you all for joining us for Eaton's 3rd quarter 2020 earning call. With me today are Craig Arnold, our Chairman and CEO and Rick Freon, Lead's Chairman and the Chief Financial And Planning Officer. Our agenda today includes our opening remarks by Craig highlighting the company's performance in the third quarter. As we have done our past comments. The press release and the presentation we'll go through today have been posted on our website at www.eton.com.
Please note that both the press release and the presentation, including reconciliations to non GAAP measures. A webcast of this call is accessible on our website it will be available for replay. I would like to remind you that our comments today will include statements related to the expected future results of the company and are there for forward looking statements. Our actual results may differ materially from our forecasted projection due to a wide range of risks and uncertainties that are described into our earning release and our presentation. They're also outlined in our related 8 K filing.
With that, I will turn it over to Craig.
Okay. Thanks, Ed. Let's start on page 3 with a highlight of our Q3 results. And I'd say, to begin by saying really pleased with how the entire Eaton team has continued to deliver and perform during this ongoing pandemic and economic downturn. Now, our results, while certainly below last year in absolute terms, they were much better than our guidance for the quarter.
Q3 earnings share at $1.11 on a GAAP basis and $1.18 on an adjusted basis, which naturally excludes the $0.05 of charges related to acquisitions and divestitures, and $0.02 related to a multi year restructuring program. Our Q3 revenues of $4,500,000,000, down 9% organically compared with last year, but up 16% versus Q2. Segment margins were 17.6%, these margins were 290 basis points above Q2 levels and our decremental margins of 25% were at the low end of our guidance range. Our organization, I just must say again, is doing an outstanding job of managing discretionary costs. We also generated strong Cash flow in the quarter.
Operating cash flow was $921,000,000, and our free cash flow was 832,000,000 As a result, we are reaffirming our 2020 guidance, for cash flows with a midpoint of $2,500,000,000 free cash flow and narrowing the range, to $2,400,000,000 to $2,600,000,000. And lastly, we repurchased 177,000,000 shares during the quarter, and, we're at 1,500,000,000 on a year to date basis. Turning to page 4, we summarized our Q3 results, and I'll just highlight a few items here. First, acquisitions increased sales by, 2%, but this was more than offset by the 8% impact of our divestitures. And this was primarily, as you'll recall, about the lighting business.
Second, our second margins at 17.6 percent were down versus last year, but still at very healthy levels, especially given the reduction in revenue. And lastly, I would just remind the group that we now record all charges related to acquisitions and divestitures and restructuring costs at corporate rather than at the segment level. And we hope that this makes it easier for you to model our results on a going forward basis. Next, on page 5, we show our results for the Electrical America segment, and we're very pleased that our largest operating segment returned to positive organic growth of 3% during the quarter. So it's better than the high end of our guidance range, which was up 2% and this was really driven by particular strength in residential and utility markets.
Revenues were naturally impacted by the sales of the lighting business, which reduced sales by 19% and negative currency impacted sales by 1%. Operating margins increased 280 basis points to 22.2%. And so our margins continue to be favorably impacted by the divestiture of lighting, as well as by ongoing cost containment actions. Our Americas business continued to show resiliency also when you look at our orders and backlog. Orders were down 1% on a rolling 12 month basis, excluding lighting, we saw, once again, particular strength in residential and also in data center markets.
Similar to what you've seen from others, Circular growth is being driven by really increased focus on the home in this work for home environment and our all of our growing dependence on digital connectivity. On a rolling 12 month basis, residential orders were up 14% and data center orders were up mid single digit. And sequentially, Q3 orders were up 16% from Q2. Lastly, our backlog was up 11% from last year driven by once again this noted strength in residential and data centers, but also by utility markets as utility markets are benefiting from the increased investment in smart grid and this energy transition that's taking place. On Page 6, we have a summary of our Electrical Global segment, Revenues were down 8%, with 10% decline in organic revenues, partially offset by 2% tailwind from currency.
Lower organic sales were driven principally by weakness in oil and gas and industrial markets. If you excluded oil and gas and industrial businesses, our European business was slightly negative and our Asia business was slightly positive. Operating margins declined 2 points to 2 16.6%, but were up 60 basis points on a sequential basis. Orders declined 6% on a rolling 12 month basis, but declines driven once again by oil and gas and industrial markets, partially offset by strength in residential data centers and utility markets. It's also worth noting here that data center orders were very strong in this segment, increasing some 40% on a rolling 12 month basis.
We also had solid sequential growth in orders, up 12% from Q2 And lastly, we continue to grow our backlog, which increased 7% versus last year. Moving to Page 7, we have the results of our Hydraulics segment. Revenues were down 15%, which was low organic but this was much better than the 25 percent organic decline at the midpoint of our Q3 guidance as end markets recovered faster than anticipated. Operating margins were 9.8%, flat with the last year. And encouragingly here, I'd say, we saw momentum in our Q3 orders which increased 8% with strength in both agricultural and construction equipment markets.
Lastly, we remain on track to close the Danfoss sale by the end of Q1 next year. Next, on Page 8, we have the financial summary of our Aerospace segment. Revenues declined 13% down 26% organically, partially offset by a 12% increase from the acquisition of Soria and a 1% positive currency impact. And as you would expect, organic revenue declines here were driven primarily by the continued downturn in commercial aviation which was partially offset by growth in military. On a sequential basis, organic revenues were up 15% from Q2 levels.
And while at healthy levels, operating margins declined to 18.5% due to lower sales volume and margins were certainly impacted by the impact of the Sorio acquisition. You know, I would note here that margins were up 3 70 basis points from Q2, and that the business is really doing an outstanding job of rightsizing and reducing discretionary costs. Orders were down 22% on a rolling 12 on the basis, and the backlog was down 11%. Turning to Page 9, we summarize our results for our Vehicle segment, Revenues were down 25%, including 20 percent organic decline. The divestiture of the Automotive fluid conveyance business impacted revenues by 4% and we had a 1% negative headwind from currency.
The 20% decline in organic revenues was once again much better than what we expected, we had 32% decline at the midpoint of our guidance and both light motor vehicles as well as truck markets have rebounded more quickly than we anticipated. In fact, organic revenues were up some 75% from Q2. The Louisville light vehicle market production in the quarter was down 4% and Class 8 OEM build was down some 34% in Q3. But given the strength that we now are seeing, we now project NAFTA class e truck production of some 200,000 units for the year, and this is up 14% from our prior forecast. Operating margins were 14% down 4.30 basis points on a year over year basis, but up 20 basis points, from Q2.
And we're also pleased to see the 31 percent decremental margin performance in this business given the magnitude of the revenue reductions, due to end markets. And we certainly would expect these trends to continue through the balance of the year. Moving to Page 10. We have the results of our e mobility segment. Revenues were flat with organic revenue declining 1%, offset by 1% positive currency impact.
Operating margins were a negative 2.5 percent, as we continue to really increase investment in R&D in this segment. Our focus in this segment continues to be on executing key program wins, as well as actively managing what we're looking at now as a multibillion dollar pipeline of opportunities. We continue to see the electrification market as a significant growth opportunity and we'd expect to see a sharp recovery as the market improves. In fact, I mean, some analysts are estimating a year over year increase of more than 30% in Q4 alone. Turning to Page 11.
We provide our Q4 outlook on organic revenues, versus the last year. For Electrical Americas, we expect organic revenues to be between flat and up 3% with continued strength in residential and utility, data centers, healthcare, warehousing, and also in water wastewater, offset by some weakness in industrial markets principally in office and lodging. For Electrical Global, we estimate organic revenues will decline between 7% 10% with strength in the Asia Pacific region, in data center markets, but being offset by weakness really in Europe and some declines in the oil and gas market. For Aerospace, we project organic revenues will be down with continued strength in military, but with continuing an ongoing weakness in commercial OEM and commercial aftermarket. For vehicle, we expect organic revenues will decline between 7% 10% with strong demand in China, and other markets really continuing to recover from the Q2 lows.
And for e mobility, we estimate organic revenues to be between flatten up 3%, with recovering global vehicle markets, and then with particular strength in electric vehicles as well. And lastly, for Hydraulics, we estimate a decline of between 6% 9%. And so overall, we're estimating organic revenues to be down between 5% 7% and this would be another quarter of sequential improvement as the global economy continues to improve. Moving to Page 12, we note our outlook for Q4 and for the full year. As I just noted, we expect organic revenue declines between 5% 7%, with modest sequential improvements versus Q3.
We also expect our Q4 decremental margins to be 20 percent, which is once again at the low end of our prior guidance range, which was between 25% 30%. Our Q4 tax rate on an adjusted earnings is expected to be 14% and then turning to the full year, we're reaffirming the $2,500,000,000 midpoint of our 2020 free cash flow guidance and narrowing the range, to be between $2,400,000,000 $2,600,000,000. Now, I'd say it's worth emphasizing once again the predictable nature of our free cash flow. We initiated guidance in the midst of, the downturn back in April, and we really expect to be right in line with this number. Free cash flow as a percentage of revenue continues to be very strong and for 2020, it's on track to exceed 2019 which was 13.4%.
I'd also note in our free cash flow to adjusted earnings ratio which is 142% on a year to date basis, and it's also well above the 120% levels achieved in 2019. An important element of our free cash flow has been our working capital management, where we've reduced net working capital by more than $350,000,000 year to date and this was driven principally by the reduction in the inventory. We plan to buy back $200,000,000 to $400,000,000 of our shares in Q4, And we're also reaffirming our full year guidance, which is between $1,700,000,000 $1,900,000,000. So I think you'll agree that our cash flow generation remains resilient, and it does really position us well for the upcoming economic recovery. Next, on page 13, we show our preliminary 2020 outlook, by end market within both the electrical and industrial sectors And once again, these numbers reflect if you look at these end markets, the percentage of the sector revenue that is accounted for by these various end markets.
Within our electrical sector, data centers, utility, residential, institutional infrastructure end markets make up some 50 percent of our revenue and each of these markets is holding up well and expected to continue to grow. Industrial end markets, which represent some 30% where the outlook is more mixed, with some areas of strength, like in machinery and industrial facilities, but also some areas of weakness and particularly in oil and gas. We understand that there's been some concern raised about the near term growth of commercial construction, but I think it's important to note here that commercial construction only represents 20 strength, bike and warehousing, that can, you know, partially offset areas of potential weakness that we would see certainly in the office and lodging segment. It's also worth noting, I'd say here, that retail is only 2% of total commercial construction markets, whereas the warehouse segment accounts for about 5% of the market. So there's clearly some puts and takes in this market.
And lastly, within the industrial sector, our primary outlook for 2020 includes growth within all of the end markets with particular strength and truck and electric vehicles. And finally, while we continue to manage through the short term challenges of the pandemic, We also remain focused on our broader strategic and financial goals, which we summarize on Page 14. Now, I begin by first saying that, We continue to move the company in the direction of becoming an intelligent power management company that's really taking advantage of these important secular growth trends that we talked about in the past, electrification, energy transition, IoT connectivity, digitalization, And our recent announcement of the Bright lair Digitalization Initiative is a prime example of how this transformation continues. In simple terms, bright layer for us is really where we extract data from our intelligent devices. It's where we use data science and machine learning to create new insights and software, and it's where we partner with customers to develop value added solutions.
But I'd also say that the overriding goals of the company remain the same, and that's to create a company that has better secular growth that has higher margins and better earnings consistency. And with the added benefit of strong free cash flow, we'll continue to be smart in how we deploy investing in organic growth, paying a top quartile dividend, buying back shares and actively managing our portfolio, while being a disciplined acquirer. And while perhaps delayed by a year or so, our long term financial goals remain unchanged. They include 2% to 3% organic growth 20% segment margins, 8% to 9 percent EPS growth, and $3,000,000,000 a year in free cash flow. And so with that, I'll stop and I'll turn it back over to Jan, and we'll open up Q And A.
Before we begin the Q And A section of the quarter then, given the time constraint only for an hour, I appreciate if you can limit your Judy, just one question and a follow-up. Thanks, you know, and once for your cooperation. With that, I will turn it over to the operator, give you guys the instruction.
Thank you. First, we'll go to the line of Jeff Sprague with Vertical Research. Please go ahead.
Thank you. Good morning everyone. Couple of things. First, just on, on cash flow, Craig, the numbers, have been very robust Thanks for kind of reiterating your longer term target. I am wondering now as we think about this 2021 you've laid out with, kind of a return to growth if those greens and yellows are correct.
Do you see the ability to actually grow free cash flow in dollars next year? Or does kind of the natural working capital swing and maybe other things kind of coming back into play, mute the ability to grow cash flow. I would assume the conversion would still be pretty good, but really talking about, absolute dollars.
Jeff, Jeff, maybe I'll take that. Yes, the conversion will remain strong, but as you know, we have a lot of amortization that lowers the net income. And of course, that's noncash. We continue to believe that we have further progress on things like days on end inventory. I mean, we have improved markedly, but if as we talked over $300,000,000 generated so far this year, but we believe we probably can take another couple $100,000,000 out of that over time.
And so that'll be just an efficiency improvement that, will help us. And of course, we'll have to put a little bit back into receivables, simply to reflect sales growth But absent hydraulics coming out, and you got to remember, if assuming hydraulics closes at the end of March, you will lose the free cash flow from Hydraulics, and that'll of course reduce free cash flow. But apart from that, we think that the puts and takes are likely to allow us to maintain the free cash
And as we've shared in the past, I mean, our free cash flow is remarkably consistent through periods of economic expansion and contraction as higher net income that we generate tends to be the offset for the increased consumption or use of working capital. So we do think that next year will be a very good year as well as free cash flow.
And maybe on the topic of hydraulics, I don't know if there's else to say about the closing timeline, but what is your thinking in terms of lack of a better term kind of replacing those earnings, whether it's, kind of more of a running start on share repurchase in the early part of 2021 or perhaps the M and A pipeline is active. Just, no, you're probably not working to precisely manage the ins and outs, but it'd still be interesting to hear how you see that playing out in 2021.
I appreciate the question, Jeff, and certainly as we think about, you know, our strategy around, what we'd like to do with the company, in the near term and in the longer term, it's really to take funds and reinvest in growth. And we've said from a priority standpoint, our priorities are largely around the electrical business. And certainly, as we think about aerospace, if we can pick up an asset that's got relatively speaking, higher defense exposure and valuations coming to line, we felt like the aerospace market as well. But I would say that, you know, from where we sit today, what we've committed is that we won't let cash just build up on the balance sheet. We don't feel like we have line of sight to, you know, meaningful M and A, you know, that will continue to buy back shares as a way of returning, you know, cash to shareholders.
But I would say in terms of, as you think about, you know, the way 2021 will likely unfold is that we're not going to take roughly $2,900,000,000 of proceeds and then soon as we receive those proceeds, go back and buy back a bunch of shares. And so we'll try to be, as we've done in the past, more opportunistic in terms of our share buyback program and buying at the right times into the market.
Great. I'll leave it there. Thank you.
Thank you.
And our next question from Scott Davis with Melius Research. Please go ahead.
Craig, you mentioned in your remarks, around aerospace, around restructuring and rightsizing, or maybe more specifically, I think you're use the word rightsizing. What does that mean? What is the new normal? How do you kind of plan for, I noticed, obviously, Aerospace is green in your chart on Slide 13. But is there a specific target of 20% down or 15% down or something that you're rightsizing to, or are your factories going to flexible enough to moderate down, or moderate backup, I should say, because the decremental margins are pretty tough in the quarter in that business.
Yes. No, I'd say, obviously, if you think about all of our end markets, the aerospace market probably is the one that is certainly most challenged and probably where you have, the least certainty around what the future looks like in terms of the rate of improvement in that market. We do believe coming off of a, you know, positively horrific year this year that we do see some modest growth in the commercial aerospace market next year. But once again, coming off of a very, very low base, which is why we, that market will be green for us. And the military market will continue to, be performed this line.
But I'd say we, we have done already based upon the actions that we've already taken in the business, we have already sized the business for the level of economic activity that we're experiencing today inside of Aerospace. And so we have very quickly moved, going all the way back to Q2 to really, you know, what I call rightsize the business for the level of, economic activity that we are experiencing. And to the extent that the world recovers faster than what we're currently envisioned. And I think what we've said in the past is we don't think that this market really returns to 2019 levels until probably sometime in, you know, late 'twenty 3, 'twenty 4. And so we really are prepared for a long term kind of downturn in that business.
And we've structured the business in a way that allows us to deliver attractive margins, I mean, even at 18.5%, and I'd call those very attractive margins for the Aerospace business in the context of this environment. And so we are we've done the work that we need to do to prepare the business to really continue to deliver attractive margins in this environment.
Okay. Thanks, Craig. And just moving on to the grid and kind of what does smart grid really mean for you guys? And as it relates to an add on to historic growth rates, I know utilities never been all that fantastic of a growth rate historically for you guys, probably more like 2% to 3%. Does smart grid add meaningfully to that historic growth rate so we can expect something higher or is there just a mix shift of spend that gets taken from one side into the other and that the overall growth rate in utility is the same?
We do think that this energy transition that we're going through, which includes, you know, smart grid does add meaningful growth to the historical utility business. And so I'd say that if you think about, you know, today the amount of investments that's going into renewables, if you think about today in the context of, you know, everybody today is both a consumer and a seller of electricity of electrons, as we think about everything as a grid that we, you know, that Udi Yada spent some time sharing with the group, during our, investor meeting, we do think that the investments that will be required to, 1st of all, harden the grid, build more resilience into the grid And then to think about how do you manage this environment where electrons are moving, in many different directions, you have to manage that power very differently. If you think about all of the growth vehicles that are coming online and the additional load that that's going to put on the grid, the grid is going to have to get smarter in the way it manages all of these various loads, and that's going to mean more opportunities for our electrical equipment and gear and software and the solutions that we bring to market.
And so while the utility market maybe historically has been, you know, let's say, a relatively slow growth, market, we do think, you know, the future for the utility market for at least, at least the near term and into the midterm is going to be very attractive.
Okay. Good luck, Craig. Thanks guys. Thank you. Thanks.
Our next question is from Ann Duignan with JP Morgan. Please go ahead.
Yes, hi, good morning. Actually, Craig, maybe along similar lines, but at different regions, You mentioned in your comments that, electrical Global Europe was still very weak. Are you seeing any signs of life in that region in terms of the huge investments they're considering making in things like hydrogen and all the infrastructure that would have to be built out to support that. And also more recently, they announced their intention to retrofit all owned buildings. I'm just curious whether all of those investments that they're talking about in Europe are going to be years out and require private funding or whether you're here any signs of life over there on the back of any of these humongous secular changes that they're talking about?
Thanks.
Yes, I appreciate the question, Ann, and I'd say maybe addressing the specific one around hydrogen. I think it's a little early, for us to really understand the role that hydrogen is going to play kind of in the overall energy equation although there's massive amounts of investments that are going in. I would say to you, to your broader point around building electrification, it's obviously a very significant opportunity for eating both in Europe as well as in the U. S, you know, as I'm sure you're aware, you know, buildings say account for directly or indirectly, some 1 third of energy consumption and nearly 40% of the direct and indirect CO2 emissions. And so as we highlighting that's a part of our energy transition, you know, growth discussion at the investor day, you know, we think energy transition and the changing electrical power value chain is creating this, what we call, everything as a grid environment.
And with it, it's going to come to we think very large opportunities for us. So with customers, once again, producing, selling, consuming, electrons, you know, you're really into an environment that is so much more complex that's going to require our type of equipment and our type of solutions. Specifically, the EU, the legislation that you mentioned, a large emphasis on climate friendly investments, building innovation. And obviously, you know, Eaton is very well positioned to capitalize on this market growth. The EU Green New Deal you know, they committed about 1,000,000,000 to be spent on climate friendly investments.
A lot of that going into building renovation you know, doubling of spending in things like energy storage and digital solutions. And so all of those things are just really beneficial to our company. And I think we're very well positioned to take advantage of it.
And so you do think you have the portfolio well enough positions to take advantage of those opportunities when they arise?
Yes. And we do. And I'd say there's certainly some work that we need to do around some of these things that we're making those investments things like energy storage and software solutions to be able to manage the power But I'd say by and large, we are well positioned to participate and take advantage of it.
Okay. I'll leave it there in the interest of time. Thank you. Appreciate
it. Thank you.
And next we'll go to Nicole DeBlane, with Deutsche Bank. Please go ahead.
Yeah, thanks. Good morning, guys.
Good morning.
Hi. Can we maybe start with Electrical Americas? I was pretty impressed by the margin performance there during margins that you're currently seeing there into the fourth quarter and into 2021, particularly given that some of these temporary cost cuts start to come back?
Yes, no, I appreciate the question. And we did, like so many other companies put in place on, you know, quite a few that's cost measures as we dealt with the pandemic. And I'd say there was a few of those cost measures that were in place in Q3 than they were in Q2 and it'll be Q1 for Q4 than it will in Q3. But for the most part, our base assumption is that most of those costs largely come back during the course of, during the course of 2021. But having said that, the margin story in range for this business, I'd say into the foreseeable future.
A lot of what we're doing is around improving our execution As you know, we've also, once a company run and taken a number of restructuring programs that we would expect that would deliver benefits to offset some of the one time cost measures, although some of those could be more back end loaded. But no, I would think that the margins that you're seeing today in the Americas business is very much in line with the way we expect that business to perform.
Got it. Thanks, Craig. That's really helpful. And then for my follow-up, just thinking about channel inventory and I guess Did you guys start to see any early signs of restocking in the channel, particularly in the electrical business in the quarter or maybe you could characterize just overall inventory levels as well?
Yes, we did. In fact, I mean, we certainly saw in Q2 of pretty large inventory drawdown specifically in the electrical, Americas business and certainly during the course of Q3, we did see some restocking that took place with most of our distributors. And so, as we come into Q4, I would say that in distributor inventories today are pretty much well in line with where they've been historically. When you go back to the number of days on hand that would be sitting in a distributor inventory right now in the fourth quarter versus where we were, let's say, in Q1, those days on hands are about the same. And so we think inventories today are very well aligned for the level of economic activity that we're forecasting into Q4 and into next year.
So we don't think there's another inventory build in front of us, but nor do we think that there's an inventory drawdown either. So we think it's pretty well balanced
And Nicole, I might make just one addition to that. The only area where inventories, I'm not yet really been rebuilt, are in auto dealer lots. I mean, auto inventories are about 50 days, normally they're mid-60s. And, because sales have been so strong, the auto OEMs have had difficulty, building enough cars to get the lots restock. So they're probably in Q4 and maybe into Q1, you'll see some benefit from that.
Thank you.
And next, we'll go to Nigel Coe with Wolfe Research. Please go ahead.
Thanks. Good morning.
I wanted to go back
to the
2021 framework, if that's the right word. And obviously Industrial is one of the Amber end markets. And obviously, that's not a monolithic end market. There's lots of different parts of that. Is the caution just tied to oil and gas and maybe heavy industrial markets.
So would machine to OEM be sort of a flash number as well? I mean, any kind of color you can give us on the different end markets there would be great.
Yes, I mean, I think you hit it in your commentary there, Nigel, I'd say that certainly everybody's all understand what's going on right now in the oil and gas markets and some of the industrial markets, but MoEM, segment of the market, the manufacturing segment of the market, we do think that those markets are become positive, during the course of 2021. And that's a little bit of the offset. And why we think in aggregate, that market still grows. And then obviously, we think about markets like data centers, right, in the context of what's going on. And data center markets, I talked those orders being up some 40% in the quarter.
So data center markets continue to be very robust.
Right. Yes. I mean, I just would have put industrial, the green, but I just was curious what drove it down to be an amber. And then
Yes, I mean largely, largely it's oil and gas. It's largely oil and gas and petrochemical. And on balance, if you put it netted altogether, Nigel, it's probably going to be down, but not dramatically down.
My follow on question is sticking with 2021, the outlook for aerospace and military. There are some question marks around military with DOD budget constraints. I'm just wondering kind of how good is your visibility into sort of the next year for military? And there are there any constraints on commercial error recovery? I mean, there's a lot of, again, concerns around park planes and, town by park from pop planes.
Do you think that's a risk for 'twenty one?
Yes, maybe dealing with the first part of your question around the military side, I'd say, we do tip have fairly good visibility. Those orders tend to be longer lead time. We do sell obviously into some of the depots depos, that service to military market, which tends to be, let's say, more short term. But by and large, we have fairly good visibility. And if you take a look at the defense budget and defense spending, we don't anticipate that those things are going to be dramatically changed as we look out into the future.
And so we do think that that market holds up fairly well and, you know, not let's say runaway growth, but solid growth, nonetheless. In commercial aerospace, there's no question I think what you're seeing today in the market is that there are, in fact, a lot of park planes. What has happened in the industry historically is that a lot of these park planes never come back into service. They end up being parted out, which then has an impact on the aftermarket. I can tell you from where we sit today, given the level of, let's say, revenue passenger miles, revenue passenger kilometers, activity levels have been so low that we've not seen, a bunch of cannibalization of park aircraft, but we do anticipate as that market improves and some of these older aircraft are not brought into the market, we do anticipate that that will happen again at this point in the economic recovery.
And so we have a relatively muted view frankly, what the aerospace market is going to look like next year. Some, like I said, some modest growth coming off of a pretty horrific downturn this year, but, but we've already factored in those numbers into our outlook for the year. That's great. Great cost. Thanks.
And next we'll go to John Inch with Gordon Haskett. Please go ahead.
Thank you. Good morning, everyone. So Craig and Rick, a lot of temporary costs, if not most of them coming back next year, what kind of incrementals are you planning for? And I ask in the context that your incrementals or your decrementals have been beating. And given all the cost takeout you've done and you've got some pretty leverageable operationally businesses such as vehicle and the portfolio, you'd be looking at some pretty big incremental despite some of these temporary costs coming back next year, what sort of framework should we be thinking about?
Hey, John. Appreciate the question. And it's obviously one of the things that we're trying to work through right now as we work on our internal plans, which have not quite finished for next year, but I do think it is important to, to once again, note the fact that we have taken out very sizable, let's say one time costs this year, much of which have been temporary costs and much of that cost will come back next year. And that return of costs will have a muting impact on the incremental margins out in the, fiscal, in our calendar year 21 year. Having said that, we also have some offsets and some of the offsets being the fact that we've announced and launched this restructuring program, which is going to obviously add, to be additive to the incremental margins year over year.
But I, but I would say as we think about, you know, for planning purposes, we'll certainly provide you some more guidance as we come out of our Q4, earnings call But, but at this point, I would say that you could, you know, you probably should be planning on incrementals that are lower than what you would typically see because we will in fact see costs come back next year that, that were one time costs that we're dealing with this year.
That makes sense, Greg. Can I just, as a supplement to my question, are you managing toward incrementals at this point? I say this because Fortive has this framework that they say, well, it's just going to be 35 percent incrementals and if it's higher, we'll spend the money away. I think that's kind of their implication. Is that Is that how you're thinking about it?
In other words, let's just say because of vehicle, another operational gearing, and we had a better than expected recovery had big incrementals. Were you just going to let those flow through or would you be predisposed to try and take that money and apply it to kind of keep the incrementals in check or in a range?
Yes, I mean, if I understand the question, I mean, every one of our businesses has a normal incremental rate, you know, a percentage of fixed versus variable costs. And so every business is expected to essentially manage their business in a very proactive way to manage margins on the way up and the way down, flexing our variable costs. And so I think that, that expectation is absolutely built into every one of our businesses. And then to the extent that we do better than that because we go beyond, we were more effective or more efficient. You know, those benefits tend to flow through, and which is why we're delivering better than normal decremental margins this year.
But the results are the results. They flow through as they come, we don't, I mean, we don't really have much latitude around managing them other than that.
That makes sense. And then maybe just as a follow-up, this might be for Rick. If Biden and the Democrats win, their platform is to jack up corporate tax rates. I think they're trying to go after the guilty tax. It's something that you guys as an Irish company are far better position than other companies, that are U.
S. Based or domiciled. Rick, do you have any preliminary thoughts about how you, respectively, might manage this to try and keep your tax rate down, which has obviously been very value additive to shareholders over the past several years.
Well, no, you're exactly right, John, to point out that as an Iris domiciled company, we don't really have issues with things like guilty you know, our non U. S. Earnings are essentially not taxed at U. S. Rates or by U.
S. Provisions. And so the only real impact of what has been suggested by Biden that the corporate rate comes up is that our income in the United States would face a higher tax rate, but our our income outside the U. S. Would really not be affected at all.
And that's very different than a typical U. S. Domicile company that would see both its U. S. Income and its non U.
S. Income affected by the biden proposals.
Yes, makes sense. Thanks very much.
I think we can say confidently that we have an advantage today and that vantage at least maintains if not improves in the event of a It should improve,
right, by several points for us compared to a a typical U. S. Multi industrial.
Our next question is from David Raso with Evercore ISI. Please go ahead.
Hi, good morning. More near term, I was curious why the Electrical Americas organic sales growth rate in the 4th quarter is a little slower than the 3rd quarter. I mean, it feels in the channel, residential is accelerating seem like utility maybe is as well. And I'm just trying to understand why the slower growth rate is data center starting to come off a bit? Or is industrial not even showing a second derivative improvement?
Just trying to understand in case I'm missing something there.
Yes, appreciate the question, David. And I'd say, and obviously, there's uncertainty in terms of whether we're going to ultimately end up, but the biggest delta in terms of Q2 versus Q3 really is this inventory rebuild that we talked about that we saw, in the distribution channel, largely in the And so we did in fact see some restocking that took place, in the Electrical America's business And that's what's having, you know, when we think about a quarter over quarter, quarter over quarter basis, a little bit of a muting impact on what the growth trajectory looks like But I'd say no, we've not seen any slowdown in the key markets that are strong, whether that be residential or data centers or utility. Those markets are continuing to perform just fine. And as we think about the growth rates that we've laid out for quarter, it's very much in line with, you know, what we saw at the end of September and into October.
And just to clarify the comment about the margins electrical Americas from this 22% level we just saw. When you said we should expect that type of level, I mean, do you feel this is a business all else equal, even include any seasonality around the first quarter that there should be a 2 handle on the operating margin? Or is the mix is maybe the restock data center strength something that is providing a positive enough mix we should have maybe take that comment, maybe quite as literal as you meant it. I just want to make sure I understood your comment.
No, I mean, if you think about, you know, one of the, you say, think about what is it that's driving these margins to the levels that we are seeing now, and one of the big, things is we've fact we've sold the lighting business. And so the fact that we divested this dilutive lighting business has certainly helped margins quite a bit in electrical business, and our teams are doing a very effective job of running the business, executing and taking out discretionary costs. And so I say, we're not prepared to make a call on a given quarter, but if you think about the business on a 12 month basis, we think that level of profitability is very much in line with where this business should perform
And next we'll go to Joe Ritchie with Goldman Sachs. Please go ahead.
Maybe just following up on John's question from earlier, obviously a big day here in the U. S. And I know his question was kind of limited to the implications. But I'm curious, Craig, just to hear your views on election outcomes and what that could potentially mean for your business over the 12 to 24 months?
Yes, and I mean, and at this point, I mean, it is clearly speculation because we're not exactly sure of what the proposals would be from either one of the administrations. But I would say that by and large, I think infrastructure spending is certainly an agenda item for both administrations. And I think that, we're hopeful and would expect, you know, probably an infrastructure bill of some sort, you know, coming from either one of the candidates think a lot of the things that we've talked about that are really secular trends that are impacting our industry, we talk about electrification, digitization, energy transition. These things, I think, are much bigger than what's going on in the U. S.
And in the U. S. Administration. I can tell you, despite the fact that the current administration perhaps has not been as focused on green, we continue to see increasing investments around the world in essentially energy transition and the greening of the economy. So I think there are the secular growth trends that we're experiencing inside of the global economy that are essentially bigger than any administration in the U.
S. And I think are going to be positive for us independent of who's in the White House.
Got it. That's helpful, Craig. And then maybe just my one follow on, I know we've talked a little bit about incrementals and decrementals, but just maybe honing in on the electrical global business, which saw decrementals tick up in 4Q. Maybe just a little bit more color what's happening there and whether we should see just kind of improved performance on the on the decrementals going forward?
Yes, I mean, I'd say that we talk about the company. We've given you 25% decrementals is what we expect for all of Eaton and in any given quarter, depending upon what's going on in the business and what went on last year, you can have some parts and pieces moving around in our individual segments. And so I would say there's nothing specifically that you should worry about with respect to the electrical global business. That business is doing well. They're executing, you know, incrementals could move around slightly higher, slightly lower than the rest of the company, depending upon what quarter.
But by and large, we're very comfortable with the guidance that we provided and delivering the 25 percent decrementals in Q4.
Our next question is from Julian Mitchell with Barclays. Please go ahead.
Maybe, Craig circling back to your comments around, slightly lower than normal incrementals next year. So is the way to think about that, but your gross margin is around 30%. And so a slightly lower than normal increment, it is something in the sort of low mid-20s. Is that a reasonable sort of placeholder for now?
Yes, I'd say Julian would be higher than that. I mean, you know, we our typical incrementals would, you know, would say it would be probably more number that you started with. And so it would be certainly higher than that number. And then once again, we, we were not done with our plans for next year, and we would hope to be in a position, when we do our Q4ings to give you a more definitive number, but I'd certainly higher than the number that you just quoted.
Thank you. And then just holding in perhaps on, the Aerospace segment and the margins there. Understood they were down a fair amount year on year, but I suppose what I found most interesting was very high sequential incremental margin in aerospace, 40% plus, So I just wondered, you're at that high teens margin run rate in the 3rd quarter. Is that a good sort of baseline now when you look out to your end market prognosis and the cost that I imagine a fair proportion of those are in the Aerospace division. And also related to that longer term, you talked about the aero market top line getting back to the old peak maybe in 3 to 4 years' time.
Should we assume Aero can get back to prior peak margins perhaps before that, and what do you think the peak margin entitlement is for that business?
I would say that if you think about, you know, the margin expectations for the business, you know, as we go forward and we're dealing at these levels of economic activity, I think it's reasonable to assume that, you know, the most recent quarter is probably a good predictor of where that business is expected to perform at at this level of economic activity and this level of revenues. To the question around the longer term, without a doubt, we would certainly expect this business to get back to prior peak margins that the business posted, which were close to 25% as the market recovers, whether or not we can get back there earlier or not. I think it's really going to be a function of, in many ways, what happens with the underlying mix of the business and what happens principally with aftermarket. As I think everybody understands in aerospace, you know, world, most of the margins are made in aftermarket, which means revenue passenger miles, which means consumers have to get on planes, starting. And so I think it really will be a function of to what extent does the aftermarket business return and our consumers and businesses comfortable putting people on planes and and flying again.
And so too early to call at this juncture in terms of when it returns, we certainly know that it will return, but but at this juncture, just too early to ascertain when.
Our next question is from Andrew Obin with Bank of America Merrill Lynch. Please go ahead.
Just a question on E Mobility. You guys sort of, I think, made some intriguing statements about potential ramp in revenues into the fourth quarter. Just taking a longer term view, how much of a ramp should we expect over the next couple of years? And you keep talking about, I guess, the investment cycle How long is the investment cycle until this business really starts contributing a material until this business starts moving the needle? On profitability for Eaton.
Yes, and it's and as I'm sure you appreciate, Andrew, with the automotive industry, I mean, these product development life cycles are quite long. I mean, they can be, you know, 5 years or so, especially when you think about launching a new technology And so what we've said before is that really you're talking about something around from start to finish, probably a 10 year cycle by the time it really starts to contribute meaningfully to the profitability of the company, But the ramp will largely depend upon, the rate at which the automotive OEMs start launching new vehicles into the marketplace. But if you think from a standing start to when does it really start delivering meaningful margin contributions to the company, I think something in the order of magnitude of 5 to 10 years would be a reasonable expectation.
Got you. And sustainability of the revenue ramp term?
You said the sustainability of the revenue
ramp? Yes, and, Andrew, one way to think about it is probably the easiest way to think about it, about 2 thirds of the revenues now an e mobility go into internal combustion cars. So this is electrical equipment going into that. And a third goes into the battery, electric, and hybrid cars. And so you're going to have different growth rates in those 2, but right now, we're in a big recovery period from the sharp down of Q2.
And so you're going to see pretty good growth in both of those two categories. Over the next several quarters.
Got you. And just a follow-up question on capital allocation and M and A. I know you guys said electrical and aerospace are a focus. But there were a couple of deals in the industry as both OSI companies that went at a very, very high multiples. How does Eton think, participating in these kinds of deals And how do you think about just M and A in the software and IoT space?
Is that an option given where the multiples are? Thank you.
No, I mean, I appreciate your reference to the M and A. And one of the things that we've prided ourselves on over many, many years is the fact that we try to be a very disciplined acquirer and recognizing for sure that software companies grow faster. They trade at higher multiples, in the two deals that you referenced and understanding those business and seeing the multiples that they went for, we just think that there are much better ways of deploying capital and creating shareholder value than the kind of multiple that those 2 transactions went at. I mean, they just went into extraordinary multiples and we just think we have better, more attractive alternatives than that that will deliver a better return for our shareholders. But we will say, our capital allocation strategy continues to be focused on electrical.
And we are, in fact, looking at a number of opportunities there. There's nothing obviously that zeminent, but we have, in fact, seen the deal pipeline pick up a bit. We continue to look at things in and around aerospace. And once again, as I mentioned, valuations would have to come in line and be reflective of the current reality and uncertainty in that market. Before we would do anything, but, we're obviously having some conversations and discussions in that space as well.
But, and we always have the option of buying back stock. I mean, it's not the first choice. We would love to grow the company. But, you know, once again, if we're not able to deploy capital in a shareholder friendly way towards an acquisition, we don't have to do a deal. We're very comfortable with our ability to invest in the company organically, grow the company organically, and acquisitions are a way of accelerating a strategy, of augmenting a strategy, but the prime path for us will continue to be things that we're doing to focus on growing the company organically.
Our final question will be from Jeff Hammond with KeyBanc. Please go ahead.
Just on data center, the order rates have been really strong. And I know this is a good secular market, but there tends to be these lulls from time to time. Any anything you can speak to in the quoting activity that would point to continued strength or any kind of low end of 'twenty one?
Not really, Jeff. In fact, we had a very strong quarter. If you take a look at our global data center orders for the quarter, we were up some 9%. And what we really saw over the last number of months is a really return of hyperscale. And as we've talked about on these calls and prior earnings call, hyperscale tends to be lumpy.
These orders come, you know, when they go and they come, when they come in large increments. And so, I mean, there's really nothing that seen in data centers that would suggest that the market is in any way pulling back. And if you think about it, it makes a lot of sense, you know, especially in the context of the environment that we're living in today, where everybody's working remotely, everybody's, you know, zooming and webexing and teeming, you know, all of these technologies that we're all using to conduct business remotely just add more kind of accelerate to a market that is already growing quite rapidly. And as the world continues to digitize connectivity and where you're living in a 5G environment in the not too distant future, all of these things will continue to add to the momentum that we're seeing in the data center market. So we think that becomes, continues to be a very attractive market for the foreseeable future.
Okay. And then, truck cycle seems to be inflecting here. Just give us a sense on how that your truck business within vehicle acts the same or different given the JV structure?
Yes, I'd say that if one of the things that we try to do by putting the joint venture together is really to kind of dampen some of these big cyclical swings in the outside impact that the truck business in North America had on the overall company. And so I would, you know, what you ought to expect is that to see, you know, in the bottom of a downturn to see a much smaller impact on the company and in the event of an big upswing, you're probably going to see a more muted impact on that side as well. But keep in mind that, you know, the JV today is basically in North America Class 8, you know, automated transmissions. I mean, everything else globally, clutch business, aftermarket business, all the other elements of that business we still owned. And so we do expect to see, you know, attractive, growth in our vehicle business as this market returns the growth into 2021 and into the fourth quarter.
Okay. Thanks a lot, Kurt.
Okay. Good. Thank you all. I think we reached the end of our Paul, and we do appreciate everybody's question. As always, Chip and I will be available to address your follow-up questions.
Thank you for joining us today, and have a great day.
Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.