ST - Sensata Technologies: Struggling But Promising Sensor Business

2024-01-16 15:22:01 ET

Summary

• Sensata Technologies has been struggling despite its positioning in the sensor market.
• The company misses its guidance quite often, and earnings are quite adjusted.
• A low multiple and leverage being under control should provide for some comfort here.

Sensata Technologies ( ST ) has been a struggling stock, despite the promise of its positioning. In the spring of 2022, I believed it was time to put the sensors on, even as the company started 2022 on a softer note.

In the end, Sensata missed the original outlook for 2022 by a wide margin, but despite the shortfall, there is some appeal as leverage is down a little bit, but the same applies to its shares.

Despite the promise, Sensata continues to underperform versus its positioning, and while adjusted earnings multiples look very compelling, realistic earnings are a different story.

On Sensata

Sensata has a long history which goes back to the 1930s, when the company patented its first motor protector. The company was acquired by Texas Instruments in 1959, after which Bain acquired the business in 2006, bringing the company public again in 2010.

Sensata is all about sensors and has large operations to provide its clients with such solutions. In fact, over a billion sensors are shipped every year from its global operations, which employ over 20,000 workers, with nearly 50,000 individual products coming from over 500 manufacturing lines.

A constant need and focus on safe and efficient operations, electrification and insights drive the usage of sensors in various applications. This is of course a long term trend which has started to pick up momentum.

To shed some perspective, we go back to pre-pandemic times, as the pandemic and the mess in the supply chains in the aftermath, create very difficult comparables. In the year 2019, Sensata generated $3.5 billion in sales on which it posted adjusted operating profit of $800 million, equal to $3.50 per share (although the gap with GAAP earnings was substantial).

A $50 stock looked fairly valued based on adjusted earnings power, as net debt of $2.5 billion was relatively high, with EBITDA reported at $900 million. Moreover, high exposure to the automotive sector created a discount, given the cyclicality and lesser of a growth profile versus other types of sensors.

Tough Times

With the pandemic disrupting automotive markets in particular, 2020 sales fell 12% to $3.05 billion, with adjusted earnings down 38% to $2.21 per share. A recovery in 2021 actually gave management the confidence to make a $400 million deal for Xirgo Technologies. This deal, an organic revenue recovery and pricing efforts helped 2021 revenues rise some 25% to $3.82 billion, with adjusted earnings reported at $3.50 per share.

2022 revenues were projected around $4.2 billion, with earnings seen around $4 per share, as this looked rather interesting given that shares traded at just $45 per share in May 2022. This came after first quarter sales rose just 3% to $975 million, with organic sales down in a minimal fashion, and operating margin pressure was observed. While the company maintained the full year guidance, it was clear that risks were on the increase here, as a $2.6 billion net debt load worked down to a 2.8 times leverage ratio based on trailing adjusted EBITDA.

This leverage ratio would furthermore shoot up as the company announced a $580 million deal for Dynapower, a provider of energy storage and power conversion systems. Products to think of include inverters, converters and other related energy products, used in industrial and defense applications.

With a mere $100 million revenue contribution, the deal was more expensive at nearly 6x sales, roughly double the sales multiple of the own business. This was to be justified by 30% organic revenue growth of the business, as well as solid margins, although that net debt of $3.2 billion would result in a pro forma leverage ratio of 3.4 times.

It was this leverage situation which made me cautious, although an 11-12x multiple looked enticing as well, as I allocated a small position at the time.

Disappointing

A $45 stock in the spring of 2022 hit the $40 mark over the summer of that year, recovered to the lower $50s early in 2023, but fell below the $40 mark again in the fall of 2023. After trading as low as $30 in recent months, shares now still trade at just $34 per share.

Forwarding to January 2023, Sensata posted its 2022 results. Revenues were up 5.5% to $4.03 billion, but fell way short of the original $4.2 billion guidance. This shortfall was seen on the earnings front as well, with adjusted earnings down to $3.40 per share, missing the original outlook by fifteen percent. Full year EBITDA fell a bit to $903 million, working down to a 3.4 times leverage ratio as net debt fell to $3.05 billion.

The company started relatively strong in 2023, with first quarter sales up 2% to $998 million and adjusted earnings being reported at $0.94 per share. Second quarter sales rose by 4% to $1.06 billion, with adjusted earnings improving further to $0.97 per share. These positive trends, although achieved in an inflationary environment, were offset in the third quarter.

On the final day of October, Sensata reported a near 2% decline in third quarter sales to $1.00 billion, with adjusted earnings reported at $0.91 per share. The largest performance sensing business grew sales some 2% and makes up over three quarters of sales. This was offset by double-digit revenue declines at the smaller, but lucrative sensing solutions business, with that business hurt by inventory de-stocking in many industrial applications.

That is expected to have a continued near term impact, with fourth quarter sales seen down further to $950 million towards a billion, as the company furthermore lost its CFO. A small positive sign is that restructuring efforts are set to cut costs by $40-$50 million next year.

While full year earnings are seen around $3.65 per share this year, and this results in a modest 10x multiple (or even less) there is a caveat to that. Again, GAAP profits are much lower, reported at $1.30 per share for the first nine months of 2023. These came in at just half the adjusted earnings reported for the period, at $2.80 per share.

This comes as the business typically sees aggressive adjustments and continued charges related to restructuring, financing, and step-up depreciation and amortization charges, some of which are structural and involve cash.

And Now?

It is hard to see what the realistic profits of Sensata are, but it's fair to say that current earnings realistically come in between a non-GAAP guidance of $3.65 per share and a GAAP number close to half that number. Pegging realistic earnings somewhat in the middle of these numbers, a roughly $2.70 per share earnings number works down to 13-14 times earnings.

Fortunately the modest growth in 2023 and modest deleveraging which reduced leverage ratios to 3.1 times, as net debt fell slightly to $2.94 billion, with EBITDA improving to $933 million. A lower interest rate environment (as seen in the fourth quarter of 2023) should provide support to the bottom line in the coming years and to valuation multiples at large.

The problem is that continued electrification in automotive and AV act as long term drivers for the business, but it still feels as if the company is underperforming compared to its positioning. Furthermore, a somewhat related peer Mobileye ( MBLY ) , which operates in not similar, but adjacent markets, has issued a massive profit warning as well recently. In fact, due to inventory de-stocking at clients, it sees big revenue declines.

Nonetheless, the company expects a current electrification revenue base of $380 million to triple to $1.2 billion in 2026, of which a lot has been booked already, as this should drive long term growth, but investors apparently have some reservations.

Given all of this, I am performing a balancing act, but with leverage under control and interest rates being low, we can wait for the business to deliver on its promises, although some greater (outside) pressure on the business and management might be welcomed.

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