ST - Sensata Technologies On The Edge Of Accelerating Electrification Demand

Summary

• Sensata's fourth quarter was a little better than expected, led by strong auto performance, and guidance for Q1'23 was better than feared, including margin leverage on minimal revenue growth.
• Electrification will drive more and more of Sensata's growth, as content wins, higher per-vehicle content, and EV ramps start to show up in the results more prominently.
• EV ramps should boost low-to-mid single-digit underlying auto volumes, though other markets are likely to see weaker trends in 2023.
• Long-term revenue growth of 5%+ and FCF growth of 8%+ can drive a worthwhile return from here.

Sometimes "it could have been worse" is enough for a stock to jump, and that would seem to be the case for Sensata Technologies ( ST ) coming out of the fourth quarter. While the company did post a small beat for fourth quarter results, I think it was guidance (a little light, but not as bad as feared) and management's declaration that significant M&A was off the table that really helped the shares pop.

I still like Sensata. This year (2023) is going to be more challenging for the commercial vehicle, industrial, and HVAC businesses, but I think auto (close to half of revenue) will not only continue to grow, but continue to outgrow the market as the company leverages content wins and growing EV production. I'm still looking for long-term growth of around 5% (revenue) to 8% (adjusted free cash flow), and I still believe that the shares offer upside from here.

Strong Auto Drives The Bus For Q4

Sensata came in with a quarter of better-than-expected results, led by especially strong results in the auto business.

Revenue rose almost 9% as reported and 10% in organic terms, beating by about 1%. Gross margin was down slightly from the year-ago level and up about a point sequentially (to 33.6%), which was a bit better than expected. Adjusted operating income rose 3%, with margin down 100bp year over year and up 70bp qoq, beating by 3%.

The Performance Sensing business grew almost 13% in organic terms, as strong auto revenue (up almost 19%) offset a modest decline in commercial vehicle (Heavy Vehicle and Off Road, or HVOR) revenue. Performance Sensing profits rose 6%, with margin down 110bp to 26%, and both revenue and segment profits were better than expected.

Sensing Solutions posted 3% revenue growth, also beating expectations, with a small overall decline in Industrial (driven by a double-digit decline in HVAC) offset by 24% growth in Aerospace. Segment profits missed expectations, falling a bit from the prior year, with margin down a point to 28.9%.

2023 Looks Challenging, But Auto Remains Healthy

Guidance for the first quarter wasn't exactly strong, but there were worries going into the quarter that it would be even worse given growing evidence of weakness in a variety of markets.

Management guided to revenue of $950M to $1B, with a midpoint flat year-over-year performance (and a 4% quarter-over-quarter decline) and a roughly 3% miss versus expectations. The midpoint of the operating margin range, though, works out to 19.5% - 30bp ahead of expectations and up 80bp year over year (again, on no expected net revenue growth).

Looking at Sensata's major markets, I'm generally bullish on autos. I think U.S. auto production will likely grow at a mid-single-digit rate, and I think most of the world ex-China will grow at a similar rate, but weaker production in China could pull global production down to almost flat.

While that suggests low single-digit end-market growth for Sensata (factoring in the respective geographic weightings), I'm also expecting close to 50% growth in EVs, and with Sensata having higher content here (as well as content growth opportunities across ICE and EV powertrains), I believe Sensata will once again show meaningful outgrowth over underlying production (in Q4'22, Sensata auto sales grew almost 19%, while global vehicle production grew around 2%).

I'm not as bullish on HVOR - I expect North American production to weaken as the year goes on, and China is a big wildcard here, and one that I'm not particularly bullish on. As for industrial and HVAC end-markets, I've written a lot about this, but I'm bearish for now - I think Sensata will see weaker demand for products for motors, et al into the fall, while HVAC will see meaningful destocking on weaker residential and non-residential activity.

The Outlook

Sensata logged about $1B in new wins in 2022, and those wins will translate into revenue over 2024-2027, including significant wins on new EV platforms that will meaningfully boost per-vehicle content in high-value areas like contactors, junction boxes, and battery management products (including disconnect). I'd also note that this is a volume-driven business (high variable costs), and as EV production ramps in the coming years, I expect a margin ramp as well.

Perhaps the best news for many investors coming out of the fourth quarter is that large-scale M&A is off the table. Management was clear - "we have all the pieces that we need" - and now it's a question of timing as the company ramps its electrification wins.

I remain bullish on Sensata's leverage to auto electrification, likewise with its Insights business (sensing paired with communications), and I think there could be opportunities down the road to repurpose many of these technologies to industrial electrification markets. I do expect 2023 to be a soft year relative to the longer-term trend, but I'm still expecting long-term revenue growth in excess of 5%, with long-term adjusted FCF growth more in the 8% range.

Sensata isn't hugely cheap on EV/revenue or EV/EBITDA, but with 2023 likely to be a more sluggish year, I'm not too surprised or bothered by that. I do still think the shares offer a reasonable return on discounted cash flow, with a near-term fair value around $55 to $60.

The Bottom Line

There has definitely been a "hurry up and wait" aspect to the Sensata story; management has positioned the company well (in my opinion, at least) for auto electrification (and potentially commercial vehicle electrification), but the quarter-to-quarter performance and share price moves haven't always reflected that. I do think the pieces are coming together, though, and I think these are shares worth owning.

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