Eaton Corporation PLC

NYSE:ETN

Earnings Call Transcript 2023-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Eaton First Quarter 2023 Earnings Call. [Operator Instructions] And as a reminder, your conference is being recorded.

I would now like to turn the conference over to your host, Yan Jin. Please go ahead.

[Yan Jin, executive]

Good morning. Thank you all for joining us for Eaton's First Quarter 2023 Earnings Call. With me today are Craig Arnold, our Chairman and CEO; and Tom Okray, Executive Vice President and Chief Financial Officer. Our agenda today includes the opening remarks by Craig, then he will turn it over to Tom, who will highlight our company's performance in the fourth quarter. As we have done on our past calls, we'll be taking questions at the end of the Craig's closing commentary.

The press release and the presentation we'll go through today have been posted on our website. This presentation, including adjusted earnings per share, adjusted free cash flow and other non-GAAP measures. They are reconciled in the appendix. A webcast of this call is accessible on our website and will be available for replay. I would like to remind you that our commentary today will include statements related to the expected future results of the company and are therefore forward-looking statements. Our actual results may differ materially from our forecasted projections due to a wide range of risks and uncertainties that are described in our earnings release and the presentation.

With that, I will turn it over to Craig.

[Craig Arnold, executive]

Okay. Thanks, Yan. We'll start with some highlights of the quarter on Page 3.

And I'll lead off by noting that we've delivered another strong quarter. We generated adjusted EPS of $1.88 for the quarter, well above our guidance range, record for the quarter and up 16% from prior year. And we continue to post strong margins. Q1 record of 19.7%, up 90 basis points over prior year. Our sales were $5.5 billion, up 15% organically, our third quarter in a row of 15% organic growth.

We have particular strength in our Electrical Americas business, which was up more than 20% including very strong growth in commercial, institutional, utility and data center market. We also had exceptional growth in our Commercial Aerospace and eMobility businesses.

Our orders also came in ahead of expectations for the quarter. On a rolling 12-month basis, Electrical orders were up 13% and Aerospace orders increased by 21%, which led to another quarter of record backlogs, up 39% for Electrical and 27% for Aerospace. I think it's well understood at this point, but I'd note once again that reindustrialization, infrastructure spending along with secular growth trends of electrification, energy transition and digitalization have fundamentally changed the growth prospects for our company.

Lastly, free cash flow in the quarter was nearly $300 million, driven by higher net income and improved working capital. So I'd say a good start to the year that keeps us on track to deliver our free cash flow guidance despite higher revenue and receivable balances. So on balance, I'd say we're off to a very good start for the year.

Moving to Page 4. I'd like to once again highlight that Eaton is marking its 100th anniversary of our listing on the New York Stock Exchange. And as many of you saw, we celebrated by ringing the bell on in early March. Eaton is 1 of 32 companies who have reached this milestone. And I'd say our longevity on the exchange and our resiliency is really a function of our ability to adapt to a changing world. But what has remained constant over that time is the spirit of innovation that guides us and our commitment to all of our stakeholders, our employees, our customers, our shareholders, communities and all of society.

Now as Eaton stands at the forefront of perhaps the most significant growth trends that we'll see in our lifetime, we're convinced that our best days are still ahead of us. And we've been busy planning for this moment. As we look at Eaton today, we position ourselves as our customers' trusted partner across power management spectrum. And Slide 5 provides a good example of how we're playing across the electrical value chain from power generation to power distribution, to how it's consumed in various applications. We're building a business that supports our customers with a full range of end-to-end solutions beginning with deep domain expertise in specific applications and the ability to specify electrical solutions. We're now providing intelligent electrical products, offering Data as a Service, providing software solutions, doing installation commissioning and providing aftermarket services. Our role has changed from simply selling components to helping owners fulfill their changing energy needs.

We're also proving that we can leverage our technology and create scale solutions that serve all of our end markets. For those of you who are with us at our March meeting in New York, you saw an example of this and a new product we call Breaktor. Breaktor is a combination of a breaker and a contactor, we developed the technology in our Electrical business and have successfully sold it in our eMobility and Aerospace businesses. And as the electrification of everything continues, the need for Eaton's technology and solutions will certainly continue to grow.

And the primary source of this growth is coming from the mega trends that we've discussed. In addition to electrification, we're benefiting from energy transition from digitalization and the reindustrialization of the U.S. and European market, and we're seeing record capital spending levels. And as you know, this capital is being supported by an unprecedented level of infrastructure spending by governments around the world. And while early, we're tracking a large number of infrastructure-related projects.

For example, in our Electrical Americas business, we've already seen over $1 billion of projects and have won roughly $250 million of orders. And as this chart reflects, we're also at the beginning of a strong aerospace growth cycle and seeing rapid adoption of electric vehicles. Collectively, these trends have positioned the company for strong growth for the foreseeable future.

Next, on Page 7 of the presentation, we provide an example of how reindustrialization is creating a record number of mega projects, and we define a mega project as a project with more than $1 billion of capital. Since 2021, announced nonresidential mega projects have a cumulative value of almost $600 billion, at least 3x the historical run rate for nonresidential projects. And this is North America only. $600 billion announced over the last 9 quarters, $400 billion more than historical run rate. These projects are certainly in various phases of design, planning or construction. But as you can see, these secular trends are translating into specific projects, and they haven't slowed down. There's billions more in the planning stages, which will certainly sustain our growth for years to come.

On Slide 8, we take you from the $400 billion of announced mega projects and what it means for the electrical industry. We estimate that the electrical content on these projects is in a range of 3% to 5% of the total project value. This suggests $12 billion to $20 billion of incremental electrical revenue. Keep in mind, there's certainly a wide range of electrical content on various projects, and our exposure is tied more closely to building infrastructure. But assuming these projects get planned, designed and built over the next 5 to 7 years, they will expand the electrical market by some $2 billion to $4 billion a year. And that's just from what's been already announced in mega projects. We naturally expect more large and small projects to come.

I'd say these projects are a good example of how mega trends are playing out in creating a very different growth outlook for the electrical industry and one we think will run for a decade or more.

Another helpful proof point is represented on Slide 9, where you can see how our negotiation pipeline has grown. As you can see, our negotiation pipeline has doubled from what we've seen historically. In 2022, we saw nearly $5 billion of projects in our negotiation pipeline in Electrical Americas alone. And similar to mega projects, we're seeing broad strength in manufacturing and data center, industrial and utility market. This large step-up in negotiation is further supported our expectations -- further supports our expectations for strong markets and faster organic growth as we go forward.

And just one additional proof point is noted on Page 10. Here, we show a few examples of how these projects are translating into specific orders. As we reported, our electrical orders have been at record levels for 2 years now. So what we're demonstrating here is how these mega projects are translating directly into large wins for our Electrical business. For example, we've won $180 million of orders to provide power management solutions for 2 new EV plants in North America. Specifically, we're providing power distribution equipment and Brightlayer industrial remote monitoring software.

Another example is a $100 million order for a new U.S. semiconductor plant, and we're already working on Phase 2 of this project, which could be even larger. So overall, we're seeing record project announcements, record negotiations, a record set of orders that has led to record backlog. And keep in mind, the revenue impact is mostly in front of us.

Moving to Page 11. We're also benefiting from mega trends in Aerospace and Vehicle. We're at the beginning of an Aerospace growth cycle in both commercial and defense market. Specifically, Commercial OEM build rates are expected to grow in the mid-teens over the next several years. And our commercial aftermarket should also grow by double digits as global revenue passenger kilometers continue to recover to pre-pandemic levels and beyond.

We've also noted the significant step-up in defense orders and expect to see a significant lift in defense revenues beginning in 2024. As a point of reference, our defense orders have more than doubled from 2019 levels. And in recent years, we've run increased content on both Commercial and Defense platforms.

In Vehicle, electrification continues to accelerate, and we now expect global EV penetration rates to exceed 50% of global auto sales by 2030, up from our prior estimate of 40%. While we're not providing any new revenue updates today, we once again are relooking our forecast for our eMobility segment.

And on Page 12, we highlighted a few key wins in our Aerospace and eMobility businesses beginning with a $500 million win for cryogenic coolers and controllers for the CityAirbus Urban Air Mobility program. The CityAirbus win is a good example of how digitalization, software and electrification are beginning to benefit our Aerospace business. And as Tom will report shortly, we're seeing more than 30% growth in our defense and commercial aftermarket orders. And in eMobility, we continue to realize significant wins.

The most significant of which are coming from our power distribution product line within our eMobility business. You'll recall this is where we're able to leverage our broader electrical business and our unique breakthrough technology. Our latest set of wins comes from a leading European automotive OEM and will generate $100 million a year of mature year revenues.

So like Electrical, our industrial businesses are delivering significant wins tied to long-term mega trends that will support faster growth. When you combine the businesses, we're confident that our market should grow at more than 2x their historical rates. And as we've stated, we're in the early innings. These trends are expected to deliver outside growth for years to come.

With that, I'll turn it over to Tom to walk us through Q1 financial results and updated guidance.

[Thomas Okray, executive]

Thanks, Craig.

On Page 13, I'll start by providing a summary of our strong Q1 results. For the third consecutive quarter, we generated organic growth of 15%. Revenue was up 13%, with the organic growth reduced by 2 percentage points of unfavorable foreign exchange. Operating profit, a first quarter record, grew 19% and margins expanded 90 basis points to 19.7%, also a Q1 record. Adjusted EPS increased by 16% over the prior year to $1.88. All in, the strong organic growth and margins enabled us to report a first quarter record adjusted EPS.

Our higher growth not only demonstrates the mega trends, but also the importance of prioritizing our customers by carrying higher levels of inventory when supply chains were challenged. Lastly, our free cash flow of $209 million was nearly $300 million above prior year and exceeded our expectations. You will recall from our Q4 call, we expected free cash flow to be relatively flat year-over-year.

Moving on to the next chart. Our Electrical Americas business had another very strong quarter. We have set Q1 record for sales, operating profit and margin. Organic sales growth was 22%. Electrical Americas has generated double-digit organic growth for 5 consecutive quarters, including back-to-back quarters of at least 20% growth.

On a 2-year stack, organic growth is up 32%. In the quarter, there was broad-based growth in all end markets, with especially robust growth in commercial and institutional, utility and data center market. Specifically, we posted 25% organic growth in our data center revenues in Q1. So we continue to see very strong growth in this important market.

Utility and Commercial and Institutional were up more than 30%. It's also worth noting that we posted strong revenue growth of 17% in our residential business. The 2-year stack is over 40% growth. We're seeing strength in multifamily homes, completion of single-family homes in process and increased electrical content per home, which are more than offsetting weakness in new single-family start.

Operating margin of 22.9%, was up 380 basis points versus prior year, benefiting from higher volumes. Incremental margins were very strong at more than 40%. We continue to manage price effectively to more than offset inflationary pressures.

Orders and backlog show continued strength. On a rolling 12-month basis, orders were up 18%, which remains at a high level with particular strength in data center, distributed IT, utility and industrial market. On a quarter-over-quarter sequential basis, orders grew 19%. We're also continuing to build backlog. Backlog was up 51% versus prior year and up 9% sequentially. In addition to the robust trends in orders and backlog, our major project negotiations pipeline in Q1 was up more than 20% versus prior year and nearly 20% sequentially from especially strong growth in data center, water, wastewater and transportation market. Overall, Electrical Americas had a very strong quarter to start the year.

On Page 15, you'll find the results of our Electrical Global segment, which posted all-time record sales of $1.5 billion. Organic growth was up 8%, which was partially offset by headwinds from foreign exchange and a divestiture. Organic growth was driven by strength in utility, data center and distributed IT market. Our data center revenues for Electrical Global increased 32% in the quarter, utility was up 25% and distributed IT up 20%. Operating margin of 18.3% was down compared to prior year, primarily from manufacturing inefficiencies and investment in growth, partially offset by higher sales volume and inflationary price recovery. Orders were up 4% on a rolling 12-month basis with strength in data center, commercial and institutional and utility market. Sequentially, orders grew 12%. Backlog increased 3% year-over-year and 6% sequentially.

I'm also pleased to highlight that last month, we closed the acquisition of a 49% stake in Jiangsu Ryan Electrical Company. This is a Chinese-based business with approximately $100 million of revenue which manufactures power distribution and subtransmission transformers and will accelerate Eaton's growth in renewable energy, data center, utility and industrial market. This is Eaton's fourth JV in China in the last 2 years, allowing us to expand our market presence, serving high-growth markets inside and outside of China.

Before moving to our Industrial businesses, I'd like to briefly recap the combined Electrical segment. For Q1, we posted organic growth of 16%, incremental margin of 34% and operating margin of 21%, which was 180 basis points of year-over-year margin improvement. Orders grew 13% on a rolling 12-month basis, with sequential growth in the quarter of nearly 20% compared roughly -- compared to roughly flat sequential order growth in the 6 years prior to the pandemic. Backlog grew 39% in the quarter and 8% sequentially.

On a rolling 12-month basis, our book-to-bill for our electrical sector remains very strong at above 1.2. It was also above 1.2 for Q1. We remain confident in our positioning for continued growth with strong margins in our overall Electrical business.

The next page recaps our Aerospace segment. We posted Q1 record for sales and operating profit. Organic growth was 13%, with a 1 percentage point headwind from foreign exchange. Growth was primarily driven by strength in Commercial aftermarket, up more than 30% and commercial OEM up more than 25%. Operating margin was 22.5% which was 40 basis points over last year, driven by volume growth and inflationary price recovery. Order growth in backlog trends also remain encouraging. On a rolling 12-month basis, orders were up 21% organically with strength across all end markets, including continued outgrowth in defense OEM orders.

Similar to the second half of the year, we continue to see -- a second half of last year, we continue to see strong growth in our defense orders in the quarter with OEM up 55% and aftermarket up more than 40%. On a rolling 12-month basis, our book-to-bill for our Aerospace segment remains very strong at more than 1.2 including more than 1.25 for Q1. Year-over-year backlog growth increased 27% in Q1, an acceleration from up 21% in Q4.

Moving on to our Vehicle segment on Page 17. In Q1, revenue was up 10%, with 11% organic growth and 1 percentage point of unfavorable FX. We saw particular strong growth in both the Americas and EMEA market. Operating margins came in at 14.5%, with unfavorability to prior year, primarily due to manufacturing inefficiencies, partially offset by higher sales volume and price cost. We continue to make progress towards securing more sustainable technology wins, which most recently includes multiple new programs for our e-Powertrain solution.

On Page 18, we show results for our eMobility business. We generated strong growth in the quarter. Revenue was up 17%, including 18% from organic growth. Margin was down 30 basis points versus prior year, driven by higher manufacturing start-up costs associated with new electric vehicle programs. We remain very encouraged by the growth prospects of the eMobility segment. We continue to leverage our capabilities across our entire portfolio, including core technology in both electrical and industrial businesses.

Since 2018, we have won $1.4 billion of mature year revenues in this business with many of these programs ramping up in 2023 and 2024. This strong momentum includes additional recent wins with Breaktor, including next-generation battery platforms with a large European OEM.

Next, on Page 19, we show historical backlog charts for the Electrical sector and Aerospace segments. We think it's important to illustrate how backlog has grown over time. Our record backlog was roughly $12 billion to end Q1. This is up nearly 3x the ending 2019 level. These metrics provide us with great confidence in the outlook for the full year and going forward.

On the next page, we show our fiscal year organic growth and operating margin guidance. We are raising our organic growth guidance for 2023. We continue to have a robust negotiations pipeline and build backlog with particular strength in Electrical Americas and Aerospace. We now expect organic growth in Electrical Americas of 11% to 13%, up 300 basis points from our prior 8% to 10% guide. We're also raising Electrical Global 200 basis points to 6% to 8% from 4% to 6%. And we're increasing Aerospace 200 basis points to 10% to 12% from 8% to 10%. In total, we're increasing our 2023 organic outlook by 200 basis points from an 8% midpoint to a 10% midpoint. Our strong end market growth forecast combined with building backlog provides tremendous visibility and confidence in this 2023 outlook.

For segment margins, we're raising our guidance range for Electrical Americas by 20 basis points to a revised range of 23.3% to 23.7%, which reflects the continued strong momentum that we have in this business.

Overall, we are reaffirming our total Eaton margin guidance range of 20.7% to 21.1%. As a reminder, this is a 70 basis point increase at the midpoint from our 2022 all-time record margin. For eMobility, we are adjusting both the organic growth and margin ranges. This is primarily due to delayed OEM launch plans and higher start-up costs related to large new program wins. In summary, we continue to be well positioned to deliver another strong year of financial performance.

On Page 21, we have the balance of our guidance for 2023 and Q2. Following our strong Q1 performance and improved organic growth expectations for the year, we are raising our full year EPS range to $8.30 to $8.50. At the midpoint of $8.40, we have raised guidance by $0.16. This represents 11% growth in adjusted EPS in 2023. We're also raising our CapEx guidance from $630 million to approximately $700 million to fund additional investments for growth including in our utility business, where we continue to experience strong increases.

Free cash flow guidance remains unchanged. For Q2, we are guiding organic growth of 10% to 12%. Segment margins of between 20.5% and 20.9%, representing 60 basis points growth at the midpoint versus prior year, and adjusted EPS in the range of $2.04 to $2.14, a 12% increase versus prior year at the midpoint.

Now I'll hand it back to Craig to wrap up the presentation.

[Craig Arnold, executive]

Thanks, Tom. Now turning to Page 22.

As we continue to track our end markets, we want to provide a slightly revised look and our assumptions for the year. Once again, we do expect a mild recession in 2023, and we've built that into our base case assumptions. But with healthy demand and strong secular growth trends, we continue to expect growth in almost all of our end markets, and we raised our growth assumption for the utility market from solid growth to strong double-digit growth. Here, energy transition and electrification continue to gain momentum. And we've increased our residential market from declining to flat. So while we recognize the slowdown in U.S. single-family housing market, the combination of resilient renovation market, pricing momentum and strong backlog now supports an upward revision. And as Tom noted, we posted a 17% organic growth in Residential and Electrical Americas in Q1.

The balance of the forecast remains unchanged, but I want to emphasize once again that despite market concerns about nonresidential construction market, we have a robust negotiation pipeline, a growing backlog and strong orders. Data centers, utility, industrial, commercial institutions continued to perform extremely well. And I know that most of you have drawn reference to the declining PMI data, but I'd point out that our market and revenue growth are much more aligned with capital spending where we continue to see strong momentum. As a result, we do not expect any of our end markets to decline in 2023, and most are expected to see healthy levels of growth.

Let me close on Page 23 with just a few summary comments. Once again, we delivered a strong quarter and set a handful of Q1 record. We delivered 15% organic growth and have record backlog. While electric orders are experiencing some expected normalization, our supply chains continue to improve. The secular growth trends and strong execution on our backlog support another strong year of growth. Having exceeded our Q1 forecast and continued secular tailwinds, we're raising our guidance for the year. Despite macro uncertainty in markets -- despite macro uncertainties, our markets are performing well, and we're improving our internal execution.

And as I highlighted, we're seeing more evidence that mega trends are accelerating. And we now think our end markets will grow at more than 2x historical growth rate. These market forces are just beginning to show up in revenue and will position the company for strong growth for the decade to come.

I'll stop here and open it up for any questions you may have.

[Yan Jin, executive]

Thanks, Craig. For the Q&A today, please limit your opportunity to just one question and a follow-up. Thanks, everyone, for your cooperation.

With that, I will turn it over to the operator to give you guys the instruction.

[Operator]

[Operator Instructions] Our first question is from the line of Joe Ritchie from Goldman Sachs.

[Joseph Ritchie, analyst]

Great start to the year. Let me just kind of start on the Electrical Americas' margins. Clearly, a standout this quarter. I think your highest quarter -- highest first quarter ever. As you think about kind of like the incremental margins going forward, it looks like you posted about a 40% incremental in the first quarter. How should we be thinking about the rest of the year? Are there any items that potentially reverse as you progress? Or do you expect incrementals to be as strong throughout the year?

[Craig Arnold, executive]

We appreciate the recognition, Joe. And our team in the Americas is just doing an outstanding job of executing. And as we talked about last year, we had a fairly sizable inefficiencies in our manufacturing operations as we were dealing with a number of supply chain related disruptions. And so those got clearly better into the first quarter. And we would expect that as we go forward, while the incrementals for the company, we're still calling the company in and around 30%. We do expect our Americas business to perform better than that as we continue to see improvements in supply chain.

[Thomas Okray, executive]

Yes. And the only thing I would throw on top of that, Joe, is, to your specific question, there were no unusual items in the first quarter driving the Americas margin.

[Joseph Ritchie, analyst]

Got it. That's super helpful. And look, Craig, you outlined a lot of reasons to be excited about the growth dynamics for the companies going forward. I saw you took up the utilities expectation for the year. I'm curious, are you starting to see some of the money loosen from the Jobs Act, particularly on the grid side? Or what's kind of driving your increased expectations on utilities growth for the year?

[Craig Arnold, executive]

Yes. I mean this is something that had been long anticipated, quite frankly, Joe, by us is as you think about all of these mega trends of whether it's electrification of the economy or energy transition, we knew at some point that the utility market would have to start to make the kinds of investments that are going to be needed to support the electrification of the economy.

As I mentioned, I think, on the last earnings call, one of the longest lead time pieces of equipment that you could order today in the electrical industry is a transformer. And in many cases, lead times there are 12 months or beyond. And so we continue to see the utilities making investments in their distribution infrastructure to really support this energy transition that's taking place, the electrification of the economy. And so yes, we think the utility market is going to be a really strong growth market for some years to come as they deal with needed investments.

And so no question, as we began the year, we were a little bit conservative in terms of what the expectation is, but it's coming through, as you heard from Tom and since some of the orders growth, orders growth are quite significant now, and we think that's going to go on once again for some years to come.

[Operator]

The next question is from Josh Pokrzywinski from Morgan Stanley.

[Joshua Pokrzywinski, analyst]

So good to see that supply chain looks like it's starting to unlock there in Electrical. I guess, even though it's not as bad today, maybe labor with the -- either in your plans or maybe on the installer side or somewhere else in some of these bigger projects might still be a limiting factor. Craig, I guess if you just sort of take a step back notwithstanding the current backlog, demand is really good, all those sorts of things. Is there sort of a cap on how fast the industry can grow thinking about kind of the totality of the supply chain, including that labor pool at the contractor level?

[Craig Arnold, executive]

No, I appreciate the question, Josh. And that's certainly one of the things that we're spending a lot of time trying to sort through right now. I mean clearly, as I mentioned, supply chain on the material side from our suppliers has improved. We're not out of the woods by any means. Especially when you think about electronic and semiconductor-related components, they still are constrained constraining our growth.

But to your point, labor is also a fairly significant constraint today. And so one of the reasons why I think you've seen this big gap between orders and revenue is because, once again, our extended supply chain and labor availability have been constraints on the industry. I don't really have an answer to your direct question in terms of -- from an industry perspective, what's the limiter because as you know, in these very complicated supply chains, it only takes one supplier, one player in the market to become the constraining factor. So it's a great question and one that we're trying to spend some time thinking through, but not one today that we have a really clear answer to today in terms of what is the real upper boundary of the industry's ability to deliver given labor, given our extended supply chains and some of these material constraints.

I can tell you that today, things are getting better across the board. And we're feeling much better about the growth outlook for our company and for the industry and just tons of positives that we talked about in our opening commentary, where we're seeing just significant broad-based strength and it's showing up in our backlog, it's showing up on our order books. And we would hope that we continue to post very strong revenue growth tied to these secular trends.

[Joshua Pokrzywinski, analyst]

Got it. That's helpful. And I understand it's not an easy question to answer just yet.

Maybe shifting over to the pipeline for my follow-up. Anything you can share in terms of the book out rate and maybe any churn that you see in that pipeline with things like financing, supply chain, all these stimulus projects, some of which I would imagine are kind of mutually exclusive. Is there -- has there been any underlying volatility in that? And how should we think about the lead time between when something enters the pipeline and then maybe transmits into backlog?

[Craig Arnold, executive]

Yes. No, I appreciate the question. And it's -- I mean there's a lot in the question that you asked very specific in terms of whether or not we're seeing a lot of churn. I'd say that overall economic activity whether it's negotiations or orders or revenue, everything is kind of doing significantly better than it has historically and certainly better than even, quite frankly, we anticipated when we put our plan together for the year.

So in general, things are positive. And we continue to -- with more negotiations, with more orders than we anticipated, obviously translating into more revenue. So I'd say that stimulus specifically, we talked about that a little bit in some of the opening commentary. We are starting to see stimulus have an impact. We are in the very early innings. If you think about that $600 billion of projects, mega projects that we talked about, we think some 25% of that has already broken ground and started many of that, whether it's semiconductors or EV factories and battery factors are obviously being busters by some of the early Infrastructure Spending Act.

The Inflation Reduction Act, we really have not seen any impact from that yet. We're certainly seeing some impact from the Semiconductor Act. So yes, a little bit of a mixed bag there, but I'd say most of the impact there continues to be out in front of us and lead times today on these projects, I would say, we have better visibility today. As these projects are bigger, they tend to run them over a multiyear period. And so we're feeling great about our visibility into the future because of these very large projects that will be delivered over multiple years. But I'd say...

[Thomas Okray, executive]

Yes. The only part that I would amplify on that is going back to our speaker remarks, our negotiation pipeline in the U.S. quarter-over-quarter is up almost 25%, year-over-year up almost 25%. And some of the big segments are up well over 30% growth. So we're seeing very robust pipeline here.

[Operator]

The next question is from Scott Davis from Melius Research.

[Scott Davis, analyst]

Craig and Tom. Look, how I want to just fixate on these big projects because this is so new, at least since I've been covering this space. Maybe a couple of different angles to go out here. One is just the competitive dynamic. Does it change when you get to this size? Meaning there's just a lot less people that can really at least be trusted suppliers for the customer when you're talking about orders and $10-plus million up to $100 million kind of total bid stuff?

[Craig Arnold, executive]

Yes. I mean, first of all, we will acknowledge what you just said, Scott. These -- we've always had mega projects, but historically speaking, they've been relatively few and far between. But I think it's really -- if you go back to this broader theme that we talked about around reindustrialization of manufacturing in the U.S. for sure, to a certain extent also in Europe, this is resulting in a really, let's say, a big surge of investing in the manufacturing sector in the U.S.

And to the point that you raised, the bigger the project, the more complex the project, the fewer companies who are able to essentially provide the services that our customers need. And so we think the competitive dynamic in this environment certainly favors companies like Eaton because of our large capable organization. And quite frankly, in general, when you think about the more complex projects in general, they're also more electric intensive. If you think about a typical office building versus a typical semiconductor plant or an EV factory, the electrical intensity or a data center, the electrical intensity of these applications is much greater than a typical strip mall or office building, which also helps support the underlying growth of the industry and companies like Eaton.

So we think it's certainly -- it's an important trend that's going to drive growth for the industry, but should also allow our companies to grow at a faster rate.

[Thomas Okray, executive]

And I think it really gives another lens in terms of what these big projects focused not so much on the PMIs, which we've all read historically. And to Craig's point, this reindustrialization, which is driven by these higher levels of CapEx, which we just don't see slowing down.

[Scott Davis, analyst]

Yes. Helpful. And then just to back up a little bit, when you talk about selling less traditional products and let's just say, like software/remote monitoring, et cetera. Is that a separate sales process into facilities like this? Is it the same? I mean I'm kind of picturing a EPC firm putting out a bid, but this is a little bit of a different animal. So how is the sales process really changing and evolve with this type of unique product?

[Craig Arnold, executive]

Yes, we've spent some time with you over the years talking about the way we think about the sale of software to state of data and insights to that. For us, we really do think it's linked to the equipment. And so for us, for the most part, we're selling products that are digitally enabled. They're digitally native. These products all have the ability to stream data. From that data, we create algorithms and that allow us to provide insights, from the data coming off of our products, and we can either monetize that either in the form of Data as a Service or software.

So for us, and it's not the same for every company in this space, we do link the sale of hardware, the places where we have deep domain knowledge and expertise to the sale of data and software and these services that we bundle together. So for us in the way we go to market, we do go together through the same channel through the same decision point. But that's not the same for every company in the space.

[Operator]

The next question is from Nicole DeBlase from Deutsche Bank.

[Nicole DeBlase, analyst]

Just maybe starting with the second quarter outlook for organic growth, embedding a bit of a deceleration from the 15% in the first quarter. Just can you talk a little bit about what's driving that deceleration from a segment perspective?

[Craig Arnold, executive]

Yes. I'd say that there's always a bit of uncertainty, Nicole, as you can imagine, when you look forward in terms of where you think the market is going to land. But one of the things that I'd say is clearly, if you look at the balance between price and volume as you move forward for the balance of the year, you get relatively smaller contributions from year-over-year price increase, and you get, obviously, a pretty significant contribution from volume. And so you clearly have that dynamic that's taken place in the business throughout the year and -- inclusive of the second quarter. So we'll see. I mean, at this point, we're early days into Q2. We're off to a good start here. And so if we're able to convert and we continue to have some of the supply chain issues resolved, certainly, we have a range of possibilities for the quarter. It could be better.

But at this point, I'd say we're taking a prudent view based upon the fact that we're not out of the woods completely from a supply chain standpoint. And once again, I mentioned less price on a relative year-over-year basis than we certainly had in Q1.

[Nicole DeBlase, analyst]

Got it. That makes sense. And then second question, just update on what you're seeing with respect to channel inventory in Electrical? Still pretty low relative to history or any movement there in the past quarter?

[Craig Arnold, executive]

Yes. We think today, channel inventories are actually in relatively good shape, obviously, with some spots where they would like more and I think when you look at channel inventory, I think probably the most important message that I can leave with the group is that you really got to look at those inventories in the context of the size of the backlog, in the context of the orders. If you're looking backwards, you're going to draw one conclusion with respect to inventories. If you're looking forward, you're going to draw a very different conclusion. And it's one of the things that we tried to express for our own company in our Q1 earnings call, where Tom laid out some of the ratios between inventory and backlog, inventory and orders to say that. They're actually below where they've been historically based upon a forward view of our industry and our markets.

And so today, I'd just say inventories in general are, generally speaking, in good shape. Our distributors today, where I'm having phone calls and discussions with distributors, it's -- 90% of the time, it's about I need more. Can you help me solve a particular issue I have today with a customer because I don't have enough inventory. But in general, I'd say they're in fairly good shape. We did see a little bit of an issue in the fourth quarter in Europe, where there was a little bit of destocking in Europe in the fourth quarter. That -- since that time, turned around. And as Europe has performed better than even we anticipated, so on balance, inventories are in good shape.

[Operator]

And the next question is from the line of Steve Volkmann from Jefferies.

[Stephen Volkmann, analyst]

Craig, sort of a big picture question based on sort of what you were just saying. Do you think these backlog levels are the new Eaton and we should think about Eaton operating with these types of backlog numbers going forward? Or do you think as the world sort of normalizes from supply chain or whatever that backlog will come back down again?

[Craig Arnold, executive]

It's a great question, and it's not one, once again, but I could tell you that I have clarified well thought through answer to specifically. We certainly, as we think about for 2023, we don't anticipate reducing backlogs. We think we'll carry the same level of backlog throughout much of 2023. A lot of that will have to do with obviously lead times and whether or not we can actually get out in front of some of these ramps that are taking place in the industries and the markets that we serve.

And can we get capacity online quick enough to reduce lead times so that we can go back to perhaps where we've been historically in terms of stated lead times to our customers. And so we're not there today. And I do think a lot of it will be a function of how the markets unfold not just in terms of demand level because demand level, I think we know is going to be strong, but how quickly can we and others put capacity in to support this higher level of growth.

[Thomas Okray, executive]

Steve, where I would chime in on that, I think it's connected. Your question was backlog, but I think the new Eaton is definitely a higher growth Eaton and as Craig said in his prepared remarks, we see the markets doubling over where they have been historically. And that's a big thing when you say doubling and that doesn't include our outgrowth that we think we can put on top of that.

And just some perspective, if you look also at order growth that we've got going back to the first quarter of '19, there's such strong numbers. Electrical Americas growing about 50% in terms of their quarterly orders. Electrical Global up over 25% and aero up over 40%. So just a volume of quarterly orders that we're seeing coming in and the continued building of the backlog, I think the new Eaton is a much higher growth Eaton.

[Stephen Volkmann, analyst]

Great. And then switching gears to Aerospace. We haven't talked about that one too much. But just kind of reading from the commentary on this call and others that I've heard you guys talk about it. It feels like '24 may be like a real stair step for your Aerospace business. I think you mentioned, Craig, that you have a bunch of military business that sort of ramps up. I'm just curious if we should be thinking that there's kind of a bigger increase in revenue and margin in '24 than might normally kind of be the year-to-year case?

[Craig Arnold, executive]

I think it's certainly early for us to be putting out guidance for 2024. We'll have an opportunity to do that obviously later in the year. But I -- but your thesis is not off the mark. We do believe that certainly on the commercial side, that industry continues to ramp. Both Airbus and Boeing have already put out numbers in terms of increases in line rates for [indiscernible] is improving.

Consumers are getting on planes. Revenue passenger miles and kilometers continue to grow up, I think, some 60%, I think, in Q1, still not back to 2019 levels. So there's a long way to go just to get back to 2019 on revenue passenger miles, which, as you know, drives the aftermarket for us.

And then on the military side, huge growth in orders this year that will begin to be delivered most of them into 2024. So I think the setup for our Aerospace business is certainly quite favorable right now, and we'll certainly be in a position later in the year to give you an indication of how good we think it's going to be.

[Operator]

And the next question is from Nigel Coe from Wolfe.

[Nigel Coe, analyst]

I do want to come back to this -- these mega projects. But before we get into that quickly, just global margins, you went through the investments. Maybe just peel back going in on Global, what we're seeing in some of the major markets and what gets better from a margin perspective to get to that 19.7% full year?

[Craig Arnold, executive]

Yes, I'd say the big thing that gets better to get to the higher margins is, one, you're getting to higher volumes, and you're obviously delivering an incremental, but I'd say the single biggest one is, as we talked about last year, we had fairly significant manufacturing inefficiencies in the business last year. Given the supply chain challenges, lots of people standing around in factories waiting for components that didn't show up on time and lots of expedited freight and logistics costs and so we -- despite the fact that we had a record year of profitability in 2022, we had a year of record inefficiencies as well.

And so if I had to put it on one thing that's going to get better and it is getting better, it's really the elimination of many of these manufacturing inefficiencies that we've experienced over the last 12 to 18 months or so.

[Nigel Coe, analyst]

Okay. Volumes are on the more positive way, that makes sense. And then at the risk of beating a dead horse going back to the $600 billion of mega projects, in a very general sense, roughly what percentage of those have been bid on and awarded at this point? You said the majority haven't. So just wondering how that looks. And then what's your win rate? Your market share in the U.S., North America is about 3%, how does your win rate compared to that bogey?

[Craig Arnold, executive]

Yes. As I said, on these mega projects, these are all announced projects. And as I said, we said 25% of them are actually broken ground and are under construction. And I'd say that our underlying win rate on these mega projects is essentially pretty much at or above the underlying market share for the company overall. So we've been very pleased with our success rate. As we talked about earlier, the bigger the project, the more complex the project, the higher the likelihood that we would be selected. And so the underlying win rate on these projects -- and keep in mind, these products will be delivered over the next, let's say, 3 to 7 years. And so it's got -- they have a fairly long tail on them. So I wouldn't necessarily expect to see big movements in the near term based upon these projects. But the underlying win rate is good, and the underlying profitability is also good.

[Thomas Okray, executive]

The only thing I would amplify that for the given quarter, we were actually materially above our share win rate. So yes, we're doing well in terms of closing the deal.

[Operator]

The next question is from Julian Mitchell from Barclays.

[Julian Mitchell, analyst]

Maybe just my first question would be around a lot of electrical equipment manufacturers and sort of broader multi-industry ones have had very disproportionate price tailwinds to revenue in Q1 and a very, very substantive price cost margin tailwind as well in Q1. So I just wondered sort of on those 2 points, how do you see the pace of normalization of those 2 tailwinds over the next 12 months?

[Craig Arnold, executive]

Yes. I'd say -- if we look at our own business, Julian, I'd say that price versus cost, I mean, while commodity costs are certainly down versus where they were a year ago, commodity costs, in many cases, are actually up versus where they were in the fourth quarter. Take a look at steel, for example, a major commodity for us is steel. It's actually down about 25% from a year ago, but it's actually up 25% from where it was in the fourth quarter. So you have a mixed bag there.

And then also on the labor side, as you can imagine, we're seeing more labor inflation in the business today. And so in our own company, the price versus volume piece maybe is not as significant as it is for others. But I would say that as we look forward and embedded in our guidance is mostly, it's around volume at normal incrementals and the elimination of a lot of the inefficiencies that are in the business that's going to ultimately drive the growth in earnings and the growth in our margins more than it is this relationship between price and cost.

As we said, from a strategic standpoint, we don't think price is either additive or subtractive from the underlying margin rates of the business, and that's the way we manage the company.

[Thomas Okray, executive]

Yes. What I would add, Julian, is we don't see ourselves losing business because of our price cost either. We're not getting feedback from our sales organization that we've got too much price. We just think we're managing effectively.

[Julian Mitchell, analyst]

That's helpful. And then just my quick follow-up. Craig, you mentioned those inefficiencies just now, and those are most apparent in the first quarter margins at Electrical Global and I think Vehicle. As we go through the year, we should see those margins kind of start to expand year-on-year. Just wondered when does that happen for the 2 segments? Is it as soon as the second quarter or it's more kind of the second half is when the margins expand in EG and Vehicle?

[Craig Arnold, executive]

We would expect to see progress, Julian, in each quarter. I mean, without a doubt, those are the 2 places where we had some challenges specifically in inefficiencies, and we would expect then in each of the subsequent quarters to see our businesses get sequentially better.

[Thomas Okray, executive]

For sure. And not to get too much into the accounting, but what we're seeing from last year rolled through the P&L in the first quarter and muted the margins somewhat because it was coming off of the balance sheet. So it should be a tailwind going forward.

[Operator]

The next question is from Chris Snyder from UBS.

[Christopher Snyder, analyst]

Craig, you mentioned a few times that the secular drivers coming through are pushing market growth 2x above historical levels. Is this a 2023, 2024 comment? Or do you believe that the 2x market growth rate is not the long-term view? And with that, can you just kind of quantify what the 2x uplift means for market growth from here?

[Craig Arnold, executive]

Yes. There's no question. It is the long-term view. As you think about most of the secular trends that we're talking about, whether it's energy transition, the move to renewables, the electrification of the economy, whether it's cars or cooking appliances or equipment in your factories, the growth in digital and data and connectivity, reindustrialization, you think about all the investment that needs to go into the U.S. market as an example to basically reinvest in manufacturing that had moved offshore and the stimulus dollars that are all supporting that. So this is clearly our long-term view that we think our markets would grow at least 2x -- not 2x, but at least 2x the historical growth rates. And so we think those growth rates for the markets are in the mid-single-digit range.

[Christopher Snyder, analyst]

I appreciate that. And then if I want to -- just my follow-up on the U.S. mega projects and just broader domestic investment. There's been a focus of the administration to drive higher domestic content on projects or infrastructure where the government is providing incentives. Does this have a material benefit for Eaton as a U.S. manufacturer and could it allow the company to take higher share or even maybe just protect margins or support margins on these mega projects relative to prior cycles?

[Craig Arnold, executive]

Yes. What I would tell you is that where we get the most direct benefit is the fact that we tend to have higher market shares in the U.S. Most of the global electrical companies that we compete with around the world, they also have fairly much localized much of what they do. But our U.S. market shares just tend to be higher. And so we'll get an unfair share of projects as this reindustrialization and manufacturing takes place in the U.S. market.

[Operator]

The next question is from David Raso from Evercore ISI.

[David Raso, analyst]

So the growth rate exiting '23. Just for the framework of how you're laying out your organic sales growth. Is it right to assume it's 15% first quarter, you're saying 11% for the second quarter and then the back half of the year is about 7%. So let's call it 8% in the third and 6% in the fourth. Is that just a decent general framework of how we're exiting '23 that kind of 6% growth rate is the framework?

[Craig Arnold, executive]

Yes. And I'd say that at this point -- and we missed the front end of your question, but I think I get the gist of what you're asking that based upon the implied numbers in our guidance, order of magnitude, 7% growth rate would be the exit rate for the year, and there's a lot of assumptions that we need to work through to really understand what's the guidance is going to be for next year, what happens with supply chain, how the year unfolds. But I don't -- given where we sit today, if you had to pick a number, that would not be a bad starting point if you're looking to make an assumption for what 2024 looks like. It wouldn't be a bad starting point.

But keep in mind, as we talked about, there are certain of our markets that we think are going to really inflect very positively next year, Aerospace is one. And so early days, but if you had to put an anchor down today as a starting point, it wouldn't be a bad place to start.

[David Raso, analyst]

Yes. I'm just trying to think through how much negativity you already have baked into Vehicle to end the year, particularly the truck part would probably be viewed positively. So I guess within Vehicle, do we have truck down by the fourth quarter. Aerospace is 150% the size of trucks. So if Aero is up big in '24, no problem. If trucks down even significantly? But I'm just trying to get a level...

[Craig Arnold, executive]

We do have -- by the time we get to the fourth quarter of this year, we think North America Class 8 truck will be negative, and that is baked into our assumptions.

[Operator]

The next question is from Phil Buller from Berenberg.

[Philip Buller, analyst]

A question for Craig in relation to the portfolio. Obviously, this has come along quite a lot on your watch, and you framed things with this, I guess, grow the head and shrink or fix the tail analogy, which has now aligned the group very nicely to these mega trends. But I'm wondering if there's much of a tail at this point? I don't get that sense from the prepared remarks. I get that there's always room for some incremental self-help here and there, and you touched on some of the efficiencies. But what, if anything, would you be deprioritizing from here in terms of organic or inorganic investment? And I guess I'm asking in relation to the Vehicle segment or trucks or potentially there's something else that you'd call out?

[Craig Arnold, executive]

Yes. No, I'd say that I appreciate the acknowledgment. We have done a lot of work to position the portfolio to be where we are at this moment in time to really participate in the secular tailwinds, and that's certainly paying off.

And to your point as well, we think we're never done with the portfolio. I mean, clearly, every year, we go through a fairly comprehensive process with our Board of Directors, looking at every business in the portfolio and understanding whether we like it today, we're going to like it 5 years from now. And so that is a very well in green process inside of our company as we look at the portfolio. And so we will continue to do that. We'll continue to evaluate every piece of the portfolio, not only the Vehicle businesses, but we're going to evaluate everything.

Today, we like where we are. We think there's a real synergistic element of what we do today across Aerospace, across Vehicle as the whole world and the Mobility space specifically continues to electrify. We're getting real benefit today by -- as we launch this new eMobility segment by being a legacy provider to all of the automotive OEMs around the world. And so today, it works. We can't say that it's going to always work into the future. Every business has got to earn the right to stay a part of the portfolio. And that message is one that we deliver to everything, to every part of the company, not just to the Vehicle team.

[Thomas Okray, executive]

Yes. A tangible example of that is if you go back to the prepared remarks in Electrical Global, we actually had a divestiture, which impacted the results in the quarter. It would be nonstrategic by our [indiscernible] fee line, and it's a great example of how we're fixing the tail. Craig is constantly challenging the organization for that.

[Philip Buller, analyst]

That's great. And just one very quick follow-up, if I may. In terms of the defense business, obviously, it's a good spot to be in terms of the growth outlook, but there's a lot of investors where defense exposure is a bit of a hurdle, particularly so for some European investors. So I'm wondering how you're thinking about defense M&A from here and whether or not that's a high or a low priority for you going forward?

[Craig Arnold, executive]

Yes, I'd say strategically, the way we think about the Aerospace business is you're either in or out. And if you're going to be in Aerospace, you need to be in defense. It's an important part of national security for sure. So there's a -- we understand the ESG-related concerns. And we understand that many investors have this 5% threshold. Today, defense is close to that number for Eaton. It's maybe 5% to 6% of our business overall. But I'd say that for us, we're really focusing on good businesses that make strategic sense for the company.

And Aerospace is a platform within the company that we'd like to continue to grow. It's a good business. It's got all the right characteristics in businesses that we like. It's high margin. It's a highly differentiated based upon technology. You've got great position on platforms with a huge aftermarket that runs for decades. And so it has all the right set of characteristics for businesses that we like.

So we will continue to prioritize first and foremost, Electrical, as we've said in the past, for a lot of reasons including these secular tailwinds. But Aerospace, from a priority standpoint, is second only behind Electrical.

[Operator]

Thank you and at this time, there are no further questions in queue. Please continue.

[Yan Jin, executive]

Okay, guys. Thanks. As always, [ Chip ] and I will be available for answering any follow-up questions. Have a good day, guys.

[Craig Arnold, executive]

Thank you.

[Thomas Okray, executive]

Thank you.

[Operator]

Thank you. And ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T teleconference service. You may now disconnect.