TEL - TE Connectivity: Seeing A Connection

2023-09-06 09:20:11 ET

Summary

• TE Connectivity has seen solid growth in the long haul, combining modest sales growth, margin expansion, and consistent share buybacks.
• While absolute growth is not too convincing, growth on a per-share basis is rock-solid.
• TE Connectivity recently announced a deal to acquire Schaffner Holding AG to add EMC filter products to its solutions, but the deal is not expected to significantly impact sales or earnings.

Back in 2014, I believed that TE Connectivity ( TEL ) , once part of the iconic Tyco conglomerate, made a smart deal when it acquired Measurement Specialties in a substantial $1.7 billion deal, gaining a stronger foothold in sensor markets.

The deal was set to increase TE's offerings with regard to connectivity and sensor solutions, adding to a somewhat mixed track record of the business. Fast forwarding to today, TE Connectivity has seen solid growth on the back of a cocktail of modest topline sales growth, margin expansion and consistent share buybacks, as current valuation looks quite reasonable given the positioning of the firm.

A Quick Recap

With a $1.7 billion deal for Measurement Specialties, TE Connectivity was adding over half a billion in very profitable sales to its own business, which was generating about $14 billion in annual sales back in 2014, all while net debt would essentially double to $3.3 billion.

The company was posting earnings close to $4 per share as shares of the company were trading around the $62 mark, resulting in a reasonable 16-17 times earnings multiple.

After shares were spun off from Tyco in 2007 at levels around the $40 mark, shares fell to just $10 during the pandemic in 2009, having recovered to $60 in 2014 upon the announcement of the Measurement Specialties deal.

While that deal looked good, I believed that shares had seen a decent run to $62 already, and while the 16-17 times multiple was quite modest, I believed that quite some good news was priced in, as the underlying operational performance was quite frankly not too impressive in the years before.

Steady Performer

Since 2014 shares have seen gradual advancements as they touched upon the $100 mark in 2018, to trade at similar levels pre-pandemic. Following a whipsaw move amidst the outbreak of the pandemic, shares rose to a high in the $160s in November 2021. Over the past year, shares have largely traded in a $110-$140 range, currently exchanging hands at $133 per share.

Forwarding between 2014 and November of last year, when the company posted its 2022 results, the revenue developments have been rather lackluster. A pro forma $14 billion business in 2014 had seen sales advance to $16.3 billion in 2022, all while operating margins have improved a bit, with operating profits reported at $2.7 billion.

This translates into earnings of $2.4 billion (GAAP earnings) with earnings reported at $7.47 per share, while adjusted earnings came in at similar levels. Notably, these earnings advancements on a per-share basis have been impressive, as the share count was reduced by a fifth over the past 8–9 years.

In terms of the sales composition, the business relies heavily on a $9.2 billion transportation solutions business, which posts margins in line with the company-wide average. This is complemented by a $4.5 billion industrial solutions business, although it posted lower margins. The $2.5 billion communication solutions business was the smallest, but showed the strongest growth and highest margins, at least in 2022.

So far in 2023, after reporting results for the third quarter in July, the company has seen flattish revenue trends with revenues up a percent to $12.0 billion for the first nine months of the year, although that sales actually fell a bit in the third quarter year-over-year, with quite severe declines in communication solutions sales holding back the reported results.

Amidst some restructuring charges being taken and the flattish overall revenue results, diluted earnings of $4.27 per share, which were down a dollar compared to the same period last year, although that adjusted earnings of $4.95 per share were down a bit less, down by about a tenth.

Net debt is reported at $3.1 billion, and that is ahead of a more than $700 million pension liability. With EBITDA pegged around $3.4 billion a year here, leverage ratios remain very modest. The 317 million shares now trade at $133, granting equity of the business a valuation of just over $42 billion, and the enterprise at $45 billion, equal to around 3 times sales. With realistic earnings trending close to $6.50-$7.00 per share, the company trades at a reasonable 19–20 times earnings multiple.

Adding Some Growth

Trying to ignite some growth again, TE Connectivity announced a deal to acquire Swiss-based Schaffner Holding AG in a deal valued at CHF 505 francs per share. The deal terms call for a huge 79% premium being offered, in order to get its hands on EMC (electromagnetic compatibility) filter products, to be added to the line-up of TE's solutions.

Despite the big premium offered, this is just a bolt-on deal as the purchase price is equal to EUR 335 million, far less than a percent of TE Connectivity's own enterprise valuation. Given this number, the deal is not going to move the needle in terms of sales or earnings contribution, or even the leverage position of the firm.

Concluding Remark

Given the developments seen in the business in recent years, I think that TE Connectivity offers a reasonable combination of shareholder growth through a balanced capital allocation approach, making a fine balance between share buybacks, M&A activity and organic growth.

With the core business benefiting from a solid positioning, with TE Connectivity at large benefiting from generally greater connectivity in various applications, shares look like a decent play trading at a market multiple here, amidst a still relatively conservatively financed balance sheet. While the current valuations are largely fair, and certainly not dirt cheap, a sound quality business (on the back of the positioning and sound capital allocation moves) is in a good position to continue to deliver value.

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