TEL - TE Connectivity: Leveraging EV And AI Trends Amid Market Challenges

2023-11-28 21:00:39 ET

Summary

• TE Connectivity's Q4 2023 earnings call reveals mixed results, with strong automotive sales and robust cash flow, but flat sales and a decline in Commercial Transportation business.
• The company is well-positioned to capitalize on the growth of electric vehicles and artificial intelligence but faces challenges such as market weaknesses and rising input costs.
• Financially, TE Connectivity has shown resilience and potential for long-term growth, with steady revenue growth and expanding profit margins. The stock is undervalued compared to peers, offering potential for price appreciation.

Across the globe, the shift towards electric vehicles (EV) and artificial intelligence is reshaping industries. Among the firms grappling with these changes, TE Connectivity ( TEL ) stands out. Its Q4 2023 earnings call unveils a blend of wins and setbacks. While the surge in automotive sales and robust cash flow promise growth, flat sales and a dip in Commercial Transportation business pose concerns. Balancing these contrasting trends, this article delves into the company's recent performance, fundamental strengths, and financial standings, aiming to offer a comprehensive understanding of its future prospects.

Analysis Recent Business Trends

In our view, TE Connectivity Ltd.'s Q4 2023 earnings call on Nov 1, 2023, presents a mixed bag of positives and negatives.

Starting with the positives, we are heartened by the strong sales growth in the automotive business, up 5% YoY. Our analysis suggests that the rise of electric vehicles (EVs) and the ongoing trend of vehicular electrification are significant drivers of this growth. In our opinion, TE Connectivity is in a strong position to capitalize on these trends, given its global footprint and leading position in EV connectivity solutions. Moreover, the company's expectation that it will continue to outperform the market by 4-6 points due to its increasing content per vehicle is a bullish sign.

The company's confidence in its cash flow is another positive, in our view. We concur with TE Connectivity's assessment that its strong cash generation model, coupled with a robust balance sheet, positions it well to continue returning capital to shareholders while pursuing bolt-on acquisitions.

However, our analysis also reveals some negatives. The company's sales were flat YoY, and it experienced a 7% sales decline in the Commercial Transportation business due to market weakness in North America and China. We believe these weaknesses could weigh on the company's growth prospects in the near term. Inflation in the environment for many items that the company needs to buy is another concern. Although the company has taken pricing actions to offset inflation, we believe that rising input costs could pressure margins going forward.

The company's expectation of flat YoY sales growth in Q1 2024, with organic growth in Transportation and Industrial segments, suggests a cautious outlook. We believe it reflects the challenges posed by the ongoing inventory destocking in the Industrial Equipment business and cyclical weakness in the Communications segment.

On balance, we believe that TE Connectivity is in a better position heading into 2024 than it was a year ago, especially regarding its cost structure. The company's commitment to improving margins, coupled with its strong execution in the second half of 2023, is a positive sign. We are also encouraged by the company's ongoing restructuring efforts, which are expected to result in significantly lower restructuring charges in fiscal '24.

However, we caution that the company's growth prospects could be tempered by ongoing market challenges, including inventory destocking and cyclical weakness in certain segments. Furthermore, the strengthening of the dollar could pose a headwind to sales in fiscal '24.

In terms of the company's AI opportunity, we believe that TE Connectivity is well-positioned to capitalize on the increasing demand for AI applications. The company's increasing AI-related sales and pipeline of AI programs suggest strong growth potential in this area. However, we note that the AI business could be subject to lumpiness and potential cannibalization of other businesses.

In conclusion, while we see several positive aspects of TE Connectivity's performance and outlook, we also recognize some challenges that could temper the company's growth prospects. We believe that the company's ability to navigate these challenges and capitalize on growth opportunities, particularly in the EV and AI spaces, will be key to its performance in 2024.

Fundamental Analysis

In our analysis of TE Connectivity, we find that this company has established a commendable position within the industry, bolstered by a multitude of strengths that contribute to its competitive advantage. In our opinion, TEL's dominant standing in the global connector market, particularly in the automotive sector, is one of its most significant competitive advantages. The firm's ability to consistently maintain a leading share of this market over the past decade only underscores the robustness of its business model.

A critical aspect of TEL's success, in our view, can be attributed to its competitive advantages, characterized by the company's unique intangible assets and high switching costs. Its advantages can be seen as a protective barrier that shields the company's economic profits from potential rivals. The company's products are designed for mission-critical applications in harsh environments. This specificity creates sticky customer relationships, where the high costs associated with switching to another component supplier are prohibitive.

However, it's also crucial to consider the potential disadvantages that TEL faces. Our analysis suggests that the company's revenue concentration in the automotive and commercial transportation markets exposes it to potential downturns in production, as was evident in 2020. Furthermore, the company's reliance on elevated R&D spending to maintain an innovation advantage could pose a risk if there's a slowdown on its part or acceleration on the part of competitors.

In terms of innovation and technology, we see TEL's focus on increasing its dollar content in end applications as a strategic move that should continue to pay dividends. The firm's products drive greater electrification and connectivity in vehicles, planes, and factories, which allows it to occupy a larger portion of these end products' electrical architectures. This strategy, in our opinion, positions TEL favorably amidst the ongoing shift towards electric and autonomous vehicles, which present lucrative opportunities for the firm.

Moreover, we are particularly impressed by TEL's ability to leverage artificial intelligence-related sales, which reflects its commitment to staying at the forefront of technological advancements. The company's growing exposure to AI, although currently small, is a promising sign of its ability to adapt and innovate in line with market trends.

Despite the company's strengths, it's important to note that TEL operates in a competitive and rapidly evolving industry. This dynamic environment necessitates constant innovation and adaptation. In our analysis, we see TE's ongoing footprint consolidation as a positive step that should help expand its midcycle operating margins and improve cash flow. We also believe that TE will remain a serial acquirer, further expanding its geographic and technological reach through strategic acquisitions.

Our analysis leads us to view TE Connectivity Ltd as a strong player in its industry, with a well-defined competitive advantage and a strong focus on innovation and technology. However, like any company, TEL faces challenges and potential disadvantages that need to be skillfully managed to ensure its continued success. As always, we recommend investors conduct their own thorough research before making investment decisions.

Financial & Valuation

Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.

Our analysis of TEL's latest earnings reveals a mixed bag of results that investors should carefully weigh. The firm delivered FY Q4 earnings on November 1, 2023, leading to a 4.3% increase in its stock trading. Despite a 7.4% year-over-year decline in revenue to $4,035 million, which aligned with consensus estimates, TEL managed to maintain operating margins at 17.3%, only slightly down from 17.4% a year ago. The EPS for the quarter was $1.78, down 5% year-over-year, but still outperforming consensus by 1.3%.

TEL's financial trends indicate resilience and potential for long-term growth. We're seeing a robust and steady growth in revenue, with a CAGR of 9.6% over the past three fiscal years. The sell-side consensus forecasts a revenue growth of 1.8% this fiscal year, reaching $16.3 billion, and a more robust 6.7% growth the following fiscal year, hitting $17.4 billion. The company's EBIT margin has also expanded by 2.4% points in the past three fiscal years, from 14.2% to 16.7%, and is forecasted to further expand to 18.5% by the next fiscal year, underscoring a positive trend in profitability.

We cannot overlook the capital allocation moves by the management. They spent 0.7% of revenue on share-based compensation over the past three years and coupled this with a 6.4% decrease in outstanding common shares. This suggests a strategic use of share repurchases to offset shareholder dilution, which we commend as a shareholder-friendly move.

The company's EPS growth, at a CAGR of 16.5% over the past three fiscal years, is particularly impressive as it outpaces its revenue growth. Consensus forecasts suggest this trend will continue with EPS forecasted to rise by 12.7% to $8.36 next fiscal year.

Turning to free cash flow ((FCF)), consensus estimates project $2,160 million for this fiscal year, implying a 13.2% FCF margin. This is an improvement compared to four fiscal years ago when the company posted a 12.3% FCF margin with $1,495 million. The average FCF margin over the past four years stands at 13.3%, indicating a stable cash generation capability. The capital expenditure of 4.8% of revenue signals moderate capital intensity.

TEL's return on invested capital is strong at 12.8%, and the stock's current dividend yield of 1.8% is 37 basis points above the dividend yield for the S&P 500, suggesting a higher income potential for investors.

However, TEL underperformed over the past year, returning 10% less than the S&P 500, or 5.7% in absolute return. The stock is trading 2.0% above its 200-day moving average but is 11% below its 52-week high and 17% above its 52-week low. This indicates some volatility and suggests investors tread with caution. The low short interest of 0.7% signals that there are fewer bets against the stock, which is a positive sign.

In terms of valuation, TEL is trading at a forward 12-month P/E of 17.4, almost exactly at its 5-year mean of 17.5. This is within its standard deviation range of 12.3 to 22.7, indicating a medium valuation relative to its historical range. Compared to its peer APH, which is trading at a forward 12-month P/E of 28.3, TEL is relatively undervalued. This suggests that there may be room for upside potential in the stock price, making TEL an attractive investment opportunity for value investors.

Conclusion

In summary, TE Connectivity's recent performance and future prospects present a complex portrait of opportunities and challenges. Its compelling strengths in the automotive sector, robust cash generation model, and promising prospects in the EV and AI spaces underscore its potential for growth. However, market weaknesses, rising input costs, and potential cannibalization of businesses cannot be ignored.

Moreover, the company's financial trends reveal resilience and offer hope for long-term growth, with commendable EPS growth and stable cash generation capability. Yet, the stock's recent underperformance and volatility urge caution. In terms of valuation, TEL seems undervalued when compared to its peers, suggesting potential for price appreciation. Therefore, while TE Connectivity is a strong player in its industry, investors are advised to tread with caution, weighing the opportunities against the challenges.

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