UBS downgraded Eaton (ETN.US) to “neutral”: high-quality but expensive, there is limited room for short-term profit improvement

The Zhitong Finance App learned that UBS published a research report downgrading the Eaton (ETN.US) rating from “buy” to “neutral.” The bank pointed out that although the power management company still has an advantageous position in the rapidly growing artificial intelligence (AI) and data center supply chain, there appears to be limited room for profit growth over the next year.

UBS analyst Stephen Fisher said that Eaton's current stock price is in the premium valuation range, and the pressure of production capacity expansion on profit margins and the market's general expectations for 2026 results are making its stock price increasingly sensitive to downward pressure on profit forecasts.

Fisher wrote in the report: “We acknowledge Eaton's strong position in the AI supply chain and the company's ability to execute solid results over the years. “But in the short term, the chances of an increase in earnings forecasts are very limited — this is critical for overvalued stocks.”

UBS currently predicts that Eaton's initial performance guidance for 2026 will fall short of market expectations because continued expansion of production capacity will limit the increase in profit margins of its American electrical division. The bank expects the American electrical sector's operating margin to be 29.5% in 2026, down 20 basis points from the previous year, falling short of the moderate improvement generally expected by the market.

Although Eaton continues to benefit from strong demand for data centers, UBS warned that the scale of profits that can be achieved by this business growth will fall short of investors' expectations. Relying on solid data center order reserves and on-hand orders exceeding $18 billion, the bank expects the organic growth rate of the American electric sector to reach 11% in 2026; however, as new production capacity is gradually put into operation, the incremental profit margin of the business is expected to be only 28%.

Affected by these factors, UBS estimates that Eaton's earnings per share in 2026 and 2027 will be 3% to 4% lower than the market's general expectations. For a stock that has long relied on upward mobility in profit expectations to support valuation, this dynamic could trigger a negative correction.

UBS also pointed out that investors are beginning to more clearly differentiate between the advantages and disadvantages of industrial companies involved in the AI field based on their share of service business. In this context, Eaton is relatively less popular than its peers with higher recurring service revenues — including Vertiv (VRT.US), GE Vernova (GEV.US), and commercial HVAC equipment suppliers such as Trane Technology (TT.US) and Johnson Controls (JCI.US).

The bank believes that at least until the second half of 2026, when Eaton's current round of production capacity investment is basically completed, and the year-on-year cost comparison enters a more favorable range, the upward trend in profit expectations is expected to reappear.

However, UBS emphasized that despite the downgrade, Eaton is still a high-quality company with the ability to achieve high-single-digit organic sales growth and double-digit earnings per share growth over a long period of time. Fisher said that this rating adjustment was based on valuation rationality considerations rather than concerns about the company's long-term growth logic.

UBS lowered Eaton's 12-month target price from 440 US dollars to 360 US dollars, corresponding to a valuation of 24 times the 2027 earnings per share forecast. It is basically the same as the average valuation level of the entire industrial sector, and is lower than the premium valuation multiplier previously used.

Fisher concluded, “Eaton's organic sales and earnings per share growth potential are still at a high level, but we believe the downward pressure on earnings forecasts should reduce its valuation multiples.”