Good morning, everyone. We're gonna keep things rolling here with Craig Arnold, Chairman and CEO of Eaton. I see a nice full room, so, Craig, I think people have kind of sniffed out that things are going well.
Yeah, it's really? We hadn't noticed. No, absolutely, things are going well, and, you know, as I said, you can't pick a better time to be associated with our company and certainly with our industry in general, given all of the tailwinds that are at our back. So yeah, it's a great time to be here.
Excellent. Maybe just start us off with, what are you guys seeing? What are you focused on? I mean, a t some level, it's kind of an embarrassment of riches. There's a lot of different things going in the right direction, but how do you prioritize, and, you know, what's sort of catching your, the most of your attention these days?
Well, you can never have too many riches.
Fair
So w e're not embarrassed at all by them. But, you know, I think for us, you know, the real key becomes, you know, how do we execute against this opportunity that's in front of us? This is really, in many ways, kind of a once-in-a-lifetime opportunity when you have so many, you know, significant tailwinds, mega trends that are essentially, you know, pushing the company forward. And the real challenge for us, as we think about, you know, the messaging that we're delivering internally to our organization, is that we have to execute well in the face of this opportunity. We have to execute on our own facilities. We have to execute commercially. We have to execute with, you know, our extended supply chain.
So today, the messaging that we're really delivering and focused on as an organization is that make sure that we are prepared for the ramp. You know, as you notice in a number of our announcements, we're making some rather sizable investments to put capacity into places where we have bottlenecks, but it's much broader than what we're doing inside of our four walls. We have to really work with, you know, the broader industry and the value chain to make sure they're ready as well. So, you know, if you think about, you know, all these extended supply chains that we deal with and the labor challenges that we deal with in a market that's growing at the rate that ours are growing, you know, everybody has to execute well across the value chain, and that's the stuff that we're focused on.
Well, where do you see sort of the biggest leakage in that? I mean, certainly not price, but, you know, what, what would constitute sort of the biggest execution risk in your mind, you know, going through some of these larger projects?
Yeah, and to your point on price, I mean, you know, great environment. Obviously, when there's more demand than there is supply, it certainly gives you the ability to get price and hold price. And so the conversations with our customers are very different today than they've been historically. It is about, you know, supply and getting ready for the ramp and, you know, where's my order, where are my shipments, as opposed to, you know, contractual price negotiations. And so, you know, as I think about the things that we worry about, it's one, labor. I mean, if you need one example, for example, in just the capacity for some of these industries, take data center as an example.
You know, they're sitting today on about a $100 billion backlog of projects in the data center space, and if you look at it historically, that's about a six-year build to consume a $100 billion worth of data center construction projects. And obviously, the industry has got to ramp in order to do more than that going forward because, once again, the orders continue to come. Our orders, as we talked about in our Q2 earnings call, orders are up some 25% overall in data centers, and that's before you really have any of this impact of AI into the system. And so what we worry about, you know, beyond what's happening inside of our own four walls, is that the industry ready?
You know, where is the choke point gonna be in the industry around dealing with some of these growth trends? I think one of the big challenges will be labor. You know, skilled trades, you know, whether you're an electrician or, you know, a plumber, whether you're a, you know, any of these skilled trades, welders they are in tight supply today. And so the, you know, I think the gating item ultimately will be for some of these industries will be: Can you get the labor that you need to deal with the real demand that's in the marketplace?
Is that something that, in your mind, kind of forms a framework of we're volumetrically limited to grow, you know, 10% a year in any given year? I just think of all the different pieces from... You know, I think I've been in the Asheville facility. There's a lot of panel building, looks very, you know, manual, obviously, electric, you know, electrician trade labor is manual.
Sure.
Is there a ceiling that you think of as, regardless of the backlog, "Hey, we can only get X amount out the door any given year?
Yeah, you know, I think, you know, as we think about Eaton, I think we're gonna be able to solve our constraints. I think, you know, you're right, labor is tough to find. We're having to pay up for labor. I think we can solve the constraints inside of our own four walls. What we worry about more broadly is that, you know, you talk about in the building industry, it only takes, you know, one of these value chains to not be able to keep up, and that project won't be completed. And so I do think there's ultimately gonna be a gating item on growth in some of these industries because, you know, the weakest link is gonna be the limiting factor. I don't think it's gonna be Eaton. I think we're gonna get out in front of this.
We're making the investments that we need to make, but I do think ultimately, you know, that the constraining item will be labor and the ability to get the skilled trades that you need to get all of these projects done.
And then I want to turn it over to backlog, if we could. You guys have been in sort of the enviable position of you built a lot of backlog during sort of the supply chain crunch, and then as that has normalized, you haven't seen the reversion. If anything, you know, a lot of these trends have strengthened since then. You report on kind of that funnel from the starts activity of mega projects. How do we think of the time to convert from those starts into your order book? Some of that stuff's tied to things like IRA, but is that something that's happening on a linear basis, or are we gonna have a period where maybe the private stuff or, you know, the normal non-megaproject business plateaus before we get kind of this next leg?
You know, now that's kind of the $64,000 question, Josh, in many ways. If you think about, you know, this megaproject kind of trend that we've been seeing going back to 2021, as we reported in our Q2 earnings call, we were around, you know, $686 billion of projects through, let's say, the end of, you know, last month. That number is now $800 billion, and so megaprojects continue to grow. There was, in, in the month of August alone, $41 billion of megaprojects, 14 projects that accounted for some $41 billion of opportunity, you know, in these industries that we participate in. And the question becomes, is that gonna crowd out, to your point, some of these other projects, because there's other constraints around labor and other factors? And I'd say that TBD.
The growth is there, and a lot of it, as you know, is in fact subsidized by a lot of the stimulus spending that's taking place today in the U.S. and around the world. You have, you know, the Inflation Reduction Act, you have the infrastructure bill. And what I would tell you, once again, most of what we're seeing today in these project announcements , you know, in our order book, today doesn't really represent the impact of most of these projects. If you think about this number of $800 billion, about 21% of that today has started. The other 80% or so hasn't even started. We're seeing some of that in our negotiations, as we reported in the last earnings call.
We've actually, you know, we've seen about $2 billion worth of projects, of which we bid on $1 billion. We've won $500 million. So we're just in the early innings of really participating in some of this infrastructure build-out related to reshoring, related to energy transition, and so that really is largely a future. Once again, we are concerned about, you know, the ability for the industries to keep up with these projects. And as you know, if you think about the Inflation Reduction Act, the IRA, it's time-limited. You know, these projects have to be built, you know, the dollars have to be deployed in order to get the credits, and so there is a kind of a mad dash, if you will, to, you know, grab for the dollars.
And so we'll have to see how that all plays out in terms of the ability to get it all done and whether or not it will crowd out the ability to do some of the more, you know, smaller flow projects.
Is that something you see on the stimulus front really starting to ramp up into 2024?
Yeah, absolutely. We're starting to see it now, and certainly we're gonna get as we go, you know, throughout 2024 and into 2025 and 2026, you know, this is gonna have a very, you know, kind of extended tail to it. I think probably what's gonna happen is that, if you think about, you know, this expansionary phase that we're in, because there are gonna be constraints, I just think the cycle goes on for a much longer period of time than you would traditionally imagine that it would. These projects just will be extended out. They'll get done, but I just think they'll get done perhaps over a more extended period of time.
How do you think about that in terms of your own strategy with backlog? I mean, obviously, visibility is good. I guess you can never have too much, but having something booked for three years from now probably doesn't feel too comforting, just given that it's so far away. Is there sort of an ideal length of time that you would like to keep backlog to, and how do you think about, you know, gating factors like price or something else to make sure that you're not going out too far for its own sake?
Yeah, no, and certainly, having lived through this inflationary period of time, you know, we had to essentially really rethink our pricing strategy. And as many of you know, in the room, we actually went out and had to reprice a lot of these long-term projects to deal with the inflationary environment that we're in. And so it's not something that we like to do, but you know, clearly, we took the steps that were needed, given this inflationary environment. So, I would say that today, you know, backlog is at a very high level for sure. You know, we don't think that the backlog will continue to grow at the rate certainly, you know, given where we've been.
The backlog today is up 3x of where it's been running historically, and so it's really at a level today where I would not expect the backlog to continue to grow. I wouldn't expect that, you know, the orders to continue to grow, given this high level of that we're at today, and we just don't have the ability to take more, and ultimately speaking, unless you can deliver stuff, it doesn't make sense for customers to give you more orders when you're still backlogged on a lot of the orders that they've given you already. So I do think there'll be a natural reversion to the mean with respect to the order intake, and I do think that the backlog, though, will stay essentially.
We're running today around $9 billion of backlog, and I think that backlog will be at that level for some time to come. I don't expect that we'll be able to materially eat into the backlog. I don't think we'll be able to materially get back to historical levels, but I do think this backlog will be kind of at a high level for an extended period of time. But I do think the orders, and we've certainly seen it already, orders will certainly begin to moderate. We're anniversarying some really big numbers, you know, 25%-30% order growth in the second half of last year.
But it sounds like even, you know, with sort of a reversion to the mean on orders and sort of the tyranny of the math on comps, that, like, still high confidence that you can grow this business, you know, on the better side and maybe even double digits the next few years?
Yeah, I mean , you know, double digits the next few years is a tall number, and it's one that I'd say today, you know, we're in the midst today of thinking through, you know, what our guidance is going to be for 2024 and beyond. I would say that today we obviously have a lot of confidence in what's happening in Electrical Americas, given the, you know, the sheer size of the backlog in that business. I think what's going on today, most of you are aware that, you know, the picture in Europe is a little different. The picture in China is a little different. And so I'd say that very high confidence in double-digit growth in businesses like Aerospace and Electrical Americas, some of our bigger businesses.
I think the story in Europe and the story in China today is a little bit of a TBD. Most of the economic data coming out of Europe has been weak. Fortunately, the electrical space has performed better than the overall market, but still, on a relative basis, you know, Europe has been a bit of a disappointment for sure, and China has been a bit of a disappointment. You know, we're still seeing growth, for example, in China, but we're not seeing the growth maybe that everybody anticipated as, you know, the government came back from COVID. So I would say that to the specific question around, you know, can we grow the company double digits over the next few years? I would say that's a very tall order.
What we provided in the form of guidance is, we said, you know, our original guidance was some 5%-8%. We talked about being, you know, an expected rate of growth this year. That's more like 7% or 8%, which we thought was kind of more a good starting point for the way to think about 2024.
Excellent. Yeah, to be clear, I meant more of the marquee businesses like Americas and EMEA, where there's a lot of visibility.
Yeah.
I think that all makes sense. I guess on the flip side, there's a few sort of related talking points here that I think, maybe an older version of Eaton would have experienced differently, namely, what's going on in parts of non-res, like commercial real estate and the weakness there, that you're clearly able to shrug off. And the same notion in electrical distribution, where you're seeing some destocking, and I don't think that's really played into your business either. Maybe just spend a few minutes, if you wouldn't mind, talking about how your exposure to those phenomena have changed.
Yeah. I mean, when you say, you know, commercial real estate, you know, everybody defines that category a little bit differently. Sometimes people use the term non-res, and which means it's everything other than residential, which is basically most of our business. I mean, residential for Eaton maybe accounts for, I don't know, what's the number? Less than 10% of our total business. And so, it's been residential that's been relatively weak. You know, overall, you see the data as well as I do in terms of what's happening in single-family housing as interest rates have risen. So that's a very small piece of our total business, and we have seen some weakness there.
But even in that market, as we talked about in the last, you know, future earnings call, we said we think that market's going to be relatively flat this year, despite everything that's going on in the housing market and rising interest rates, largely because in that market as well, the electrical intensity continues to increase. Codes are changing, the adoption of EV, the IRA, all of these things are driving more electrical content, even into the weaker parts of our businesses. But most of the business is non-residential. So you know, you think about the utility markets growing dramatically. Double-digit growth last year, double-digit growth this year, double-digit growth probably for the foreseeable future. We talked about in our Q2 earnings call, that that market, we think, grows at about an 11% rate between 2022 and 2025.
You think about today, what's happening in perhaps the one segment that's going to see the greatest growth is really in what we're calling, you know, kind of institutional industrial. All of the reshoring that's taking place, all of the investment that's going into manufacturing, new EV plants, new battery plants, new LNG, liquefied natural gas facilities, renewables. I mean, there's just massive investments that are coming into, you know, this particular piece of the industrial side of our business that will drive significant growth into the future. And then obviously, you have, you know, data centers, which continues to be very strong, robust growth. And so I'd say that, you know, once again, that's largely a North America story.
You know, the story around the world, I'd say Europe is seeing a lot of the same trends that we're seeing here in the U.S. with respect to renewables, with respect to energy transition, electrification. But there are some real weakness on the manufacturing side that's biting today in Europe, that's offsetting some of this real strength that we have in energy transition. And in Asia, you know, very much similar. Still growth. We're seeing growth today, certainly in our Asia business, but perhaps not nearly as robust as it is here in the Americas. And so, you know, by and large, Josh, I'd say that you know, a good set of problems to deal with, some real challenges today, and certainly the ability to keep up as the industry, but we're optimistic.
So just trying to highlight the difference between, you know, say, U.S. and Europe and Asia. Obviously, your portfolio and your own categories there differ a little bit. If I were to transplant the North America portfolio into those other parts of the world, would that drive an uptick just because you're exposed to some of these, you know, higher-performing areas? I guess, how much of this is macro versus where Eaton plays in some of these markets?
Yeah, and I'd say that there is a little bit of both. So clearly, if you think about today, you know, the legacy part of our business is obviously, you know, we grew up as a U.S. company, and we have higher shares in North America, and quite frankly, the strongest market in the world for our kinds of businesses is the U.S. market, and it is the strongest market in the world, and we have the best market share. So we are certainly advantaged because of those two factors. And then there are some segment-specific where we have great. Let's take the utility market, for example. We're a major player in the utility market in North America, the broadest player in the industry.
We don't have the same portfolio, let's say, in Europe, and so there's an opportunity to do some things differently in and around Europe to build a better position, let's say, in the utility market. We have a great position, for example, in the utility market in China, and so we're doing well there because once again, our portfolio is strategically advantaged in terms of where we have a presence. And so I think it's a combination of both. It's a combination of, you know, where we have a unique portfolio advantage a nd a different mix of our businesses. A nd it is, in fact, the macro around, quite frankly, the U.S. market right now is just that much stronger than the rest of the world.
Got it. So I promised myself I wouldn't lead off with this too early because I know it's a suspenseful topic for people, but I hear this AI thing is sort of important.
Sure.
Data centers, in particular, have obviously been strong for Eaton. Can you maybe give us just some context, as you've seen the market evolve here, what that high-performance data center or, you know, kind of GPU-based data center looks like in terms of an opportunity, perhaps relative t o what this business has been at other points in time?
Yeah, and I know that's the question that's on everybody's mind. It's, it's certainly one that we spent a lot of time as an organization working with our hyperscale customers, trying to figure out exactly, you know, what this new AI world is gonna look like, and how do you configure a data center for GPUs versus CPUs. There'll be a combination of both. And I will tell you that today, a lot of that, you know, sorting out is yet to be done. We know that, you know, it's gonna drive more demand. We know that it's gonna drive an increased requirement for power. We know it's gonna likely drive an increased requirement for backing up data in, in our UPS business.
But how it's all gonna play out exactly, and how it's gonna fit within the broader context of a market that's already very hot, as I talked about, $100 billion, you know, backlog already, six years of construction projects. You have this now layered in on top of it, and so I think it's still early to really sort through what the impact is gonna be. It's gonna be helpful. How helpful? I think once again, because of these other constraints, I think what it will ultimately do is it will extend these cycles. We're gonna see strong growth in data centers, you know, what they talk about, you know, 20%-25% growth, kind of that we've been experiencing. Can that number be significantly greater than that?
I think once again, the industry's got to sort through a lot of bottlenecks in order for that reality to take place. So I think the most likely way it plays out, from my perspective, becomes a cycle that just gets extended to an even longer period of time than we originally anticipated. And we were already saying, you know, at least a 10-year cycle. I mean, this is, t he world will continue to generate, consume, process, and store increasing amounts of data, and that's gonna mean you have more data centers, and that was the premise long before ChatGPT and AI, you know, really, you know, took hold.
Now, I know these things are notoriously power hungry. I would assume that your content sort of scales up with the amount of power they consume. Anyway, just even in kind of a bigger than a breadbox kind of analogy, to say these things are consuming, you know, 2x the power, 5x the power, or anything to dimensionalize would probably just be, you know, helpful to level set.
Yeah, I'd say that there's countervailing forces. You know, GPUs, you know, typically are more efficient. So in the one sense, you know, I need less power because they run more efficiently. On the other hand, you know, they consume a lot more, you know, and do a lot more processing, so they need more power. So there's puts and takes on this, and I'd say that today, what we'd be comfortable doing, and we're obviously working today on a number of projects, and quite frankly, we're working with, you know, our big data center customers today with much longer lead time and much better visibility into the future.
Once we get one configured and one we'll share with this group exactly, "Okay, here's a real example of, you know, a new data center that's been configured, you know, for this GPU world, and here's the real implications of it in terms of what the math looks like." We're just not at that point today where we have enough of these variables defined that we can really put our finger on exactly what it's gonna be. So we're not gonna get out there, you know, making promises and statements that we really can't back up with hard examples of where, you know, we've actually worked through the math with our customers.
Understood. Makes sense. Maybe turning the same logic over to utility, where there's a little less ambiguity. But I do know there's sort of different constituent groups and different product categories that maybe have some different phenomenon going on. I think everyone talks about transformers, and now they're sold out for, you know, years on end- at this point. But I guess, where are you seeing the growth relative to something like, you know, transformer or substation versus more the pole-mounted, kind of traditional transmission? Are there pockets that are more or less interesting to you, and do you participate in the pockets that you think are the most interesting?
Yeah, I'd say that we participate really across the full spectrum. As I talked about in our Q2 earnings call, we're, you know, the industry's kind of broadest supplier into the utility market. Everything from, to your point, yes, you know, we've got very broad supplier of transformers and voltage regulators, and electrical switchgear, obviously, and software and services. And so we are a really broad player in that industry. And, and as a result of that, if something's happening in the utility market, we are benefiting from that. And so I'd say today, you know, if you think about that industry and, you know, I talked about 11% growth between 2022 and 2025.
It's another industry, as you mentioned, that is, there are capacity constraints, and you've heard us make a number of announcements around new investments that we're putting in to deal with some of these capacity constraints. We talked about a $500 million investment capacity. You'll see more from us as well, other investments that we're making to build capacity. And I can tell you the other thing we're doing today is we're working with these customers with also long-term commitments, to make sure that as we make these investments in capacity, that we have customers there committed, to make sure that these facilities are full. But, so I'd say good problem to have.
Utility market is, historically, as you know, has not been the most exciting end market that we participated in, but we're in a very different world today with respect to, you know, climate change, energy transition. You've all seen, experiencing some of these global events, whether it's fires or floods. So grid hardening, grid resiliency, there's a lot of dollars today that are being put into the distribution side of the utility market, which is where we play. We're not on the power generation side, for the most part. We're on the distribution side, which is where most of the capital dollars are going. And we're seeing the same thing, by the way, in other regions of the world. We're seeing that in Europe, we're seeing that in China as well.
Got it. Maybe pivoting over to the Aero side of the portfolio. Obviously, a good story there as well, both growth and margin. But you do have a mixed phenomenon that's gonna be more acute here over the next several years. How do you think about that relative to where we are on margins today? Is that something that's a headwind, or can we sort of stabilize here, even with that higher OE growth?
Yeah, the, you know, the quick answer is we'll absolutely continue to expand margins in our Aerospace business. But you're right, I mean, we're, we're in the midst and the very early stages of a fairly significant ramp on the OE side. You saw from the announcements from Airbus, they're gonna be going from, you know, 45 A320 to 75. Volumes moving from 30 a month on the 737 to 50. You see the same thing, even bigger growth in things like the 787 and the A350, where these numbers are growing quite significantly over the next three or four years. And so we are gonna see a big ramp on the OE side, but we're also seeing a big ramp as well in aftermarket.
You know, if anybody's gotten on a commercial plane lately, you know that these seats are full, and so the aftermarket side of the business is also growing. In addition to that, on aftermarket, we're also doing some things in the area of modifications, upgrades, and retrofits. That also is driving the aftermarket business. And so as we think about our Aerospace business, you should assume that the margins will continue to expand. We talk about as a company, you know, of kind of a 30% incremental. We think that's still a good number for planning purposes, and so you should expect that as the Aerospace business improves, that those margins will improve as well.
The other big self-help opportunity we have, not just in Aerospace, but really across the entire company, are the things that we can do to improve our own operating efficiency. As I said before in one of the earnings calls that, you know, we had a very strong year in 2022. Record financial results, but at the same time, it was one of our worst years ever in terms of our operating efficiencies internally. Massive inefficiencies driven by supply chain and other challenges that we had in our own operations. And so we have a huge self-help opportunity in our Aerospace business, in our company, to deal with some of these inefficiencies that we've been driven by some of the supply chain challenges that we had.
Understood. Sounds like we're gonna need to revisit some of the segment margin targets here before too long.
I think we, you know, we'll give you some new targets to think about, as we give you guidance for 2024. But I do think to the broader question, that yes, you should expect Aerospace margins to continue to expand.
Excellent. Well, I see we're out of time. Craig Arnold, appreciate the time.
Sure.
Great to have you here, and thanks for showing up.
Sure, no. Thank all of you.