2023-10-13 10:59:43 ET
Summary
- Amphenol operates in a saturated and competitive Electrical Components Subindustry, with China dominating the market.
- The company has a successful diversification strategy, with a wide product portfolio and presence in various end markets.
- Amphenol's acquisition strategy has been effective in leading industry consolidation, with inorganic revenue growth contributing significantly to overall growth.
Amphenol Corporation ( APH ) operates in the Electrical Components Subindustry. According to GICS , companies in this Subindustry manufacture “electronic components, connection devices, electron tubes, electronic capacitors and resistors, electronic coil, printed circuit board, transformer and other inductors, signal processing technology/components”. To determine the competitiveness of Amphenol, we sought to understand the Subindustry dynamics and determine if Amphenol’s business model is best suited to compete in this Subindustry.
Saturated and Competitive Market
We looked through various sources to identify various companies operating within the Electrical Components Subindustry and calculated each of their market shares based on their respective revenues. We identified 38 companies, and we were careful to only include their revenue related to electrical components and excluded revenue from other segments.
Company Data, Industry Research Biz, Khaveen Investments
Looking at the chart, the first thing we notice is how saturated the market is. The largest player is BOE which holds only 5.96%, followed closely by many other competitors. 15 companies make up the top 47% of the market. The others consist of various smaller companies spread throughout the globe. We estimate the Subindustry size to be $402.7 bln in 2022 based on Industry Research Biz ’s CAGR of 3.08%.
The saturated market is not surprising considering that electrical components are required in basically every technological device and infrastructure. However, unlike semiconductors, software, or even hardware (PCs, smartphones, Smartwatches), electrical components are much simpler and require less specialization which reduces the barriers to entry creating a much more competitive Subindustry.
Company Data, Industry Research Biz, Khaveen Investments
Looking into the breakdown by region, we see that China makes up the bulk of the share (28.42%), followed by the US. This is also not surprising, as mentioned that these products are relatively simple, with the focus coming down to manufacturing on large scales. In this aspect, China is known as the global manufacturing hub. We actually find it surprising that the share of the US and other developed countries here is this high. This could be due to our geographic share chart using the 38 companies we identified to represent the geographical breakdown not giving an accurate picture, as many of the smaller companies could be operating in countries with low manufacturing costs. The Primary Cost Index by KPMG below illustrates our belief.
KPMG
KPMG’s Primary Cost Index measures costs associated with doing business in a particular country, such as wages, utilities, real estate costs, and taxes. China ranks first, along with other low-cost manufacturing countries. This also explains how Malaysia holds a 1.17% share despite being such a small economy (0.38% of 2022 global GDP), as it scores the highest in the Primary Cost Index.
It was also interesting to note, that among the top 20 companies, 3 of them had Electronics Manufacturing Services (‘EMS’) segments, which is not surprising as EMS companies would be the main companies utilizing the electrical components to assemble electronic devices. One of these 3 companies includes Foxconn, the world’s largest EMS company.
Overall, we note that Amphenol operates in a very saturated Subindustry with competitors across the globe. We believe countries with lower manufacturing costs provide a huge advantage, and also note several EMS companies also compete in the Subindustry.
Diversification Strategy Enables Widest Reach
Given the simplicity of products manufactured in the Subindustry, we believe companies operating should undertake a broad diversification strategy to cater to as many markets within the Subindustry as possible. To this end, we found that the company is indeed following this strategy based on the excerpt below from its annual report .
The company has highlighted its broad portfolio of products such as connectors, antennas, sensors, flex, PCB and cables from its investor presentation .
The company’s breakdown by end-markets is also broadly diversified as seen below.
To confirm if the company has indeed built a broad enough product portfolio, we analyze the company’s three main reporting segments below.
We note that each segment comprises an overlap of different key products from their portfolio, for example, connectors and cable assemblies & harnesses appear in all three segments. Additionally, we note that the end markets also overlap across the different reporting segments, with almost all end markets appearing across three. We believe this exemplifies the diversification that the company is undertaking.
Amphenol Segment Revenue ($ mln) | 2018 | 2019 | 2020 | 2021 | 2022 | H1 2023 | Average |
Harsh Environment Solutions | 2,055 | 2,249 | 2,286 | 2,752 | 3,107 | 1,743 | |
Growth % | 9.4% | 1.6% | 20.4% | 12.9% | 14.8% | 11.8% | |
Communications Solution | 3,949 | 3,679 | 4,056 | 4,832 | 5,652 | 2,288 | |
Growth % | -6.8% | 10.3% | 19.1% | 17.0% | -15.2% | 9.9% | |
Interconnect and Sensor Systems | 2,198 | 2,298 | 2,257 | 3,292 | 3,863 | 1,997 | |
Growth % | 4.5% | -1.8% | 45.9% | 17.4% | 6.7% | 16.5% | |
Total | 8,202 | 8,225 | 8,599 | 10,876 | 12,623 | 6,028 | |
Growth % | 0.3% | 4.5% | 26.5% | 16.1% | -1.0% | 11.8% |
Source: Company Data, Khaveen Investments
Looking at the table above, we believe that the diversification strategy is effective. In 2019, the Communications Solution segment posted negative growth, but the overall growth was still positive. The following year saw the Interconnect and Sensor Systems segment post negative growth, but overall revenue growth was still positive.
Amphenol Geographic Revenue Breakdown ($ mln) | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | Average |
United States | 1,674 | 1,696 | 1,741 | 1,978 | 2,241 | 2,525 | 2,494 | 3,155 | 4,155 | |
Growth % | 17.0% | 1.4% | 2.6% | 13.7% | 13.3% | 12.6% | -1.2% | 26.5% | 31.7% | 13.1% |
China | 1,441 | 1,676 | 1,866 | 2,067 | 2,594 | 2,306 | 2,598 | 3,044 | 3,265 | |
Growth % | 15.8% | 16.3% | 11.3% | 10.8% | 25.5% | -11.1% | 12.6% | 17.2% | 7.2% | 11.8% |
Other foreign location | 2,231 | 2,197 | 2,680 | 2,966 | 3,367 | 3,394 | 3,507 | 4,676 | 5,203 | |
Growth % | 15.0% | -1.5% | 22.0% | 10.7% | 13.5% | 0.8% | 3.3% | 33.3% | 11.3% | 12.0% |
Total | 5,346 | 5,569 | 6,286 | 7,011 | 8,202 | 8,225 | 8,599 | 10,875 | 12,623 | |
Growth % | 15.8% | 4.2% | 12.9% | 11.5% | 17.0% | 0.3% | 4.5% | 26.5% | 16.1% | 12.1% |
Source: Company Data, Khaveen Investments
The same thing can be seen when examining its revenue breakdown by region. The company breaks it down into three regions, the US and China (representing the two largest economies in the world), and all other regions. In 2015, 2019, and 2020, overall revenue was still positive despite one of the segments posting negative growth.
Aside from revenue stability, we believe customer concentration risks can also be mitigated through this strategy and the company has confirmed this in its annual report.
Overall, we believe that Amphenol’s diverse product and end-market mix are capable of creating consistent overall revenue growth for the company, with the company amazingly achieving positive revenue growth in each of the past 10 years. However, for 2023, we prorated its H1 2023 and Q3 guidance to estimate a growth rate of -3% for the company. Based on its latest earnings briefing , this is amid a weak market environment “as operators moderate their spending following several quarters of strong demand and investments”. However, based on our understanding of the company’s business model and historical performance of the company, we believe there is a high chance that the final year's growth would end up positive, implying stellar H2 growth.
Acquisition Strategy Leading the Industry Consolidation
The other Subindustry dynamic that was identified in the Electrical Components Subindustry was the saturation of players. We identified that Amphenol has an acquisition strategy that has been carried out for more than a decade, with the company mentioning around 50 companies had been acquired over the past 10 years.
We identified through Tech Bullion that there is a wave of consolidation in the Electrical Components Subindustry, that allows these companies to "enhance their product portfolios, geographic reach, and technical expertise. Because of this pattern, distributors can use economies of scale to offer a wider selection of goods and services". We believe that Amphenol is well-positioned having already been on top of this situation for years now.
Organic and Inorganic Revenue Breakdown ($ mln) | 2014 | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | Average |
Organic Revenue | 4,983.9 | 5,505.9 | 5,680.1 | 6,789.3 | 7,992.9 | 7,955.9 | 8,389.6 | 10,146.7 | 12,506.7 | |
Growth Contribution % | 8.0% | 3.0% | 2.0% | 8.0% | 14.0% | -3.0% | 2.0% | 18.0% | 15.0% | 7.4% |
Inorganic Revenue | 361.6 | 62.8 | 606.3 | 222.0 | 209.1 | 269.2 | 209.3 | 728.7 | 116.3 | |
Growth Contribution % | 7.8% | 1.2% | 10.9% | 3.5% | 3.0% | 3.3% | 2.5% | 8.5% | 1.1% | 4.6% |
Total | 5,345.5 | 5,568.7 | 6,286.4 | 7,011.3 | 8,202.0 | 8,225.1 | 8,598.9 | 10,875.4 | 12,623.0 | |
Growth % | 15.8% | 4.2% | 12.9% | 11.5% | 17.0% | 0.3% | 4.5% | 26.5% | 16.1% | 12.1% |
Source: Company Data, Khaveen Investments
In the table above, we compiled its growth based on inorganic and organic revenue growth based on disclosures by management in its annual reports. As seen, the average company growth over the past 10 years has been 12.1%, and inorganic revenue growth due to acquisitions has contributed on average to 38.1% of that. In 2019, the entire growth was contributed by inorganic revenue which even managed to offset the negative growth of the company.
We believe the company’s acquisition strategy is not only a good fit for the Subindustry but also executed extremely effectively as we mentioned above. We now examine the company’s debt levels and cash flow generation abilities to determine if it can continue pursuing acquisitions.
Company Data, Khaveen Investments
Looking at the company’s debt and cash levels, we find its cash-to-debt ratio has steadily declined over the years, likely due to the acquisitions. It has become stable though and actually slightly increased over the past 2 years. Additionally, debt levels were the highest in 2020, and the company has been working to reduce levels over the past couple of years.
Company Data, Khaveen Investments
In terms of cash flow, the company has generally positive free cash flow, with occasional negative margins due to large acquisitions. For example, in 2016 the company acquired FCI Asia Pte Ltd ($1.28 bln), in 2019 it acquired Esterline Technologies ($4 bln), and in 2021 it acquired MTS Systems ($750 mln).
The average free cash flow margin of 13.55% does indicate to us the capability of the company to continue to fund acquisitions, and with its cash-to-debt ratio improving, we believe debt funding could also be utilized going forward.
Risk: Low-Cost Alternatives
The risk we identified relating to the Subindustry is that certain regions that have lower-cost manufacturing would provide an advantage to the companies operating there, especially against American companies such as Amphenol. However, globalization has made it possible for companies to diversify their operations. Amphenol states that 90% of its workforce is located outside the US. Additionally, 83.3% of its properties (in square feet) are located outside the US.
Company Data, Khaveen Investments
Finally, only 25.8% of its Long-lived assets (which includes land, buildings, furniture and fixtures, machinery and equipment, and vehicles) are situated in the United States with 31.5% situated in low-cost China. Hence, while we believe this could be a risk to the company, Amphenol seems to be mitigating it pretty well.
Verdict
In summary, Amphenol operates in a highly competitive subindustry with lower manufacturing costs in certain countries providing a significant advantage. We identified the company as having a broad diversification strategy to tap into various markets with its wide-ranging product portfolio, including connectors, antennas, sensors, flex, PCB, and cables. Overall, we believe Amphenol's diverse product mix and presence in various end-markets position it well for the Electronic Components sub-industry, which has less specialized products. Furthermore, we believe Amphenol’s established acquisition strategy is well suited for the industry given rampant consolidation to increase scale. We believe their healthy average free cash flow margin of 13.55% allows them to continue funding acquisitions. Additionally, with an improving cash-to-debt ratio, we believe the company may explore debt funding for future endeavors.
We believe the Free Cash Flow of Amphenol accurately reflects its cash flow generating abilities accounting for the capex required to sustain its acquisitions. The company’s current P/FCF ratio of 26.98x is around 8% below its 5-year average P/FCF ratio of 29.08x. This is roughly in line with analysts’ consensus price target ($94.11) of the company's upside of 11%. Hence, we rate Amphenol as a Buy.
For further details see:
Amphenol: Excellent Strategic Prowess In A Saturated Market