How Surging AI Demand Could Drive This Dividend Stock Higher

As more companies are adopting artificial intelligence (AI), cloud computing, and big data, the AI boom is causing a huge increase in energy and power demand - and the number of data centers being built to keep up. 

These data centers need a lot of electricity. The Electric Power Research Institute (EPRI) predicts that by 2030, data centers might use up to 9.1% of all electricity in the U.S., mostly because AI uses so much power. Morgan Stanley even predicts a 70% annual increase in power needs for generative AI for most of this decade.

As companies build more data centers for AI and cloud computing, Eaton (ETN), a company that manages power systems, is in a great spot to benefit. Wall Street has noticed this too. In a Sept. 16 note, Citi rated Eaton's stock a “Buy,” telling investors it could rise up to $348 per share. The firm believes Eaton will outperform as more data centers need power solutions.

Eaton isn't just about AI growth potential, of course. It's also well-known for paying regular dividends, not to mention having increased them for 15 years in a row. Supported by growth in AI and data centers, this reliable dividend pick looks set to keep growing its earnings base in the coming years.

Let's take a closer look at how Eaton fits into the AI picture and why it might be a smart passive income pick now.

A Closer Look at Eaton's Performance

Eaton Corporation plc (ETN), a diversified power management company, operates through various segments, including Electrical Americas, Electrical Global, Aerospace, Vehicle, and eMobility. The company's portfolio is divided into its industrial sector, which serves markets like commercial vehicles and general aviation, and its electrical sector, which caters to data centers, utilities, and residential markets.

ETN stock has exhibited impressive strength over the past 52 weeks, gaining 52.2% to outpace the broader S&P 500 Index ($SPX). The year-to-date performance has been particularly noteworthy, with ETN posting a solid return of 36.6%, and trading not far from May's all-time highs around $345. The company boasts a market capitalization of $125.8 billion. 

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Currently valued at a forward price-to-earnings (P/E) ratio of 29.33, investors are willing to pay a premium for Eaton's future earnings potential relative to its industrial sector peers.

The company's commitment to dividend growth is another attractive feature for investors. Eaton has consistently raised its dividends for over a decade, with a current annual yield of 1.19%, based on the current quarterly payout of $0.94 per share. With a five-year dividend growth rate of 5.69%, and a payout ratio of around 40%, Eaton's dividends are well-covered by earnings.

ETN Beats on Q2 Earnings

Eaton's recent earnings report further solidifies its strong position. For the second quarter of 2024, Eaton reported record earnings per share of $2.48, up 33% year over year, and record adjusted earnings per share of $2.73, which beat expectations. The company also achieved record segment margins of 23.7%, 210 basis points above the second quarter of 2023, and experienced 9% organic sales growth - above the high end of guidance, with strong backlog growth of 27% in Electrical and 14% in Aerospace.

The company's raised guidance for the full year 2024 also paints a promising picture for investors. Eaton now expects organic growth of 8-9%, up from the previous range of 7-9%. They also predict better profit margins, between 23.3% and 23.7%. Eaton raised its earnings per share (EPS) forecast to $9.38-$9.48, up 18%, with adjusted EPS expected between $10.65 and $10.75, a 17% increase. 

Behind Eaton's Strategic Drivers

Eaton's strategic drivers are propelling the company towards a promising future. Their recent collaboration with Tesla (TSLA) means that by early 2025, Tesla's Powerwall will seamlessly integrate with Eaton's AbleEdge smart breakers, optimizing energy use and extending backup power during outages. This partnership aligns perfectly with Eaton's "Home as a Grid" strategy, focusing on flexible power systems that intelligently manage home energy consumption.

Moreover, Eaton's innovative AbleEdge home energy management system is a game-changer. It simplifies the safe energy transition for homeowners and installers, offering a comprehensive, quickly installed, and fully integrated solution. The system's interoperability with leading energy storage and solar providers, coupled with its next-generation smart breakers and microgrid interconnect device, positions Eaton at the forefront of the residential energy market. These strategic moves could significantly boost Eaton's stock performance. 

Wall Street's Bullish Stance on Eaton

Wall Street analysts are optimistic about Eaton. Out of 17 in coverage, 13 say it's a “Buy” or better, while 4 suggest a “Hold.” 

On average, the forecast calls for ETN to reach $343.56, which is about 4.5% higher than Thursday's close. The Street-high price target of $385 suggests expected upside potential of 17%.

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Notably, Citi recently initiated coverage on the company with a “Buy” rating and a price target of $348, highlighting Eaton's potential for multi-year mid-single to high-single digit organic growth. Analyst Andrew Kaplowitz believes that "data center power demand will continue to experience strong growth in the mid- to long term," and that "Eaton can benefit as a top player in the space from its varied power management portfolio and services."

Conclusion

Eaton Corporation stands at the intersection of two powerful trends: the explosive growth of AI, and the increasing demand for efficient power management in data centers. The company's strong financial performance, consistent dividend growth, and positive analyst sentiment all point towards a bright future. 

As Eaton continues to innovate and capitalize on the surging AI market, it stands poised to deliver both growth and income to shareholders. For those seeking exposure to the AI revolution through a well-established company with a history of dividend growth, Eaton could be a compelling choice for reliable income.

On the date of publication, Ebube Jones did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.