TEL - TE Connectivity: A High Quality High Returns Anchor To Your Portfolio

2023-11-22 06:09:25 ET

Summary

• TE Connectivity is a high-quality investment-grade company that continuously outperforms.
• The company supplies electrification and connectivity components with a focus on EVs.
• TEL has a strong balance sheet, is a consistent value creation, and scores well using our Cash Flow Returns On Investments-based tools.

We have analyzed TE Connectivity (TEL) from a Cash Flow Returns On Investments lens and it stands out as a high-quality investment grade company. It is a stable value compound outpacing the S&P 500. They cater to a large list of clients supplying electrification and connectivity components with increasing importance on EVs.

The Company

TEL is a global manufacturer of industrial technology connectivity solutions. They supply terminals and connector systems and components, sensors solutions, relays, antennas, application tooling, interventional medical components, heat shrink tubing, and wire and cable. These components are supplied across three reportable segments, Transportation, Industrial and Communications. Transportation accounts for 60% of revenues, including automotive, and commercial transport. Industrials account for 28% of revenues and factory and warehouse automation and control, aerospace, energy and medical. Finally, communications account for 12% of total revenues and consist of networking, data center and wireless infrastructure, and home appliance components.

Financials

TEL recently reported its full-year results for the year ending Sep 2023. Q4 EPS was up 2% from $1.75 to $1.78, and revenues were slightly down from $4,053m to $4,035m. Full-year revenues for 2023 came in 1.5% below last year, at $16.0bn and adjusted EPS saw a decline of 8% from last year's $7.37 to $6.78. 2023 has been a tough year for TEL, revenues have been subdued after a post-Covid bounce and higher inflation has been eaten into margins. If we compare 2023 revenues to 2019, they are up 19% or a CAGR of 4.5%. Similarly, EPS is up 21.5% or 5% CAGR. Growth seems to be coming from its transportation segment, where it saw revenue growth of 4%, with the other sectors seeing some decline.

Q1 Guidance is provided by the company sees revenues to be flat and strong margin expansion and EPS increasing to $1.7, up 10%. Consensus sees FY24 EPS up 9.8% and increasing further to early double-digit numbers going forward. Revenues are expected to grow by 1.7% for FY24 and to be high single-digit going forward. A record fall in Inflation to 4.7% in October 2023 will help TEL with its margin expansion, as both wage inflation and cost of goods sold will moderate.

TEL is highly cash-generative and is also growing modestly. It has returned excess cash to its shareholders. As much as $8bn has been paid out as dividends and share repurchases over the past 5 years and $16.6bn over 10 years. Shares outstanding have gone down from 418m in 2013 to the current 311m, down 25%. With modest growth and share buybacks, revenue per share has increased steadily at 5% CAGR over 10 years and EPS at 7.6%. This has been achieved while improving efficiency, where asset turnover improved from 0.5 to 0.6. Asset turnover is the amount of assets (investment) required to generate revenues. So far we have seen modest growth, improving margins, and better asset turnover, all pointing to improving returns.

The improving Returns On Cash Generating Assets (ROCGA), a methodology based on Cash Flow Returns On Investments is a measure of economic performance. To add value, you need these returns to be higher than the cost of capital and investments that generate revenues to grow.

More information on how ROCGA is calculated including gross assets, gross cash, and Cash Flow Returns on Investments can be found in Bartley Madden's paper " The CFROI Life Cycle ". Bartley Madden has been a significant contributor to the Cash Flow Returns on Investment methodology.

TEL is in the process of acquiring Schaffner Holding for approximately $350m. Schaffner is an electromagnetic solutions company based in Switzerland and will help TEL expand its product offerings and increase its geographical reach.

TEL has a strong balance sheet with a net debt of only $3bn and a net debt to EBITDA of 1.3x. Interest cover is 33.5x and a dividend cover of 2.9x, with a dividend yield of about 2%.

Risks

Uncertainty and risks faced by the company are mainly macroeconomic. We see inflation receding, but an uptick would in turn put pressure on costs of goods sold and wage inflation. A macroeconomic slowdown, especially in the transportation segment would severely impact top-line growth. TEL faces foreign exchange risk, but we think this can only be transitory, can go both ways, and will not affect the long-term prospects.

Cash Flow Returns On Investments Valuation

This a high-quality investment-grade company and it will not offer itself up too cheaply. It is currently trading at a Sep 2024 PE of 17.7x, a touch below its 5-year average PE of 18.1x, and significantly below its sector average of 22.6x.

TEL is a consistent value creator and has outperformed the S&P 500 over the 5-year and 10-year period.

To value a company, we use our affiliate ROCGA Research's quantitative and systematic Cash Flow Returns On Investments based DCF valuation and modeling tools. The first step involves modeling the company, back-testing the valuation for correlation with the historical share prices, and using that same model to forecast forward.

Value is a function of returns and growth in cash-generating assets. The total value of the company takes into account the present value of existing assets and the present value of growth.

The blue band above represents the share price highs and lows for the year and the orange line is the DCF model-driven historic valuation. The green line is the forecast warranted value derived using the same model along with consensus earnings and default self-sustainable organic growth. Self-sustainable organic growth is a ratio of investable free cash as a ratio of invested capital. The valuation model above has worked well in the past and we use the same model to project forward with consensus EPS.

As mentioned earlier, TEL is a consistent value creator and DCF warranted value per share has increased from $57.5 to 118.1 from 2013 to 2023, a CAGR of 7.5%, along with an approximately 2% dividend yield.

Conclusion

As can be seen in our default valuation chart above, share prices and valuation have consistently increased year after year and will continue to do so going forward. TEL does offer itself as a deep-value stock, but it is an investment-grade stable company to add as an anchor to your portfolio. We initiate with a BUY rating.

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