Is TE Connectivity Stock A Buy?

TE Connectivity’s growth in recent times could be attributed to its strong market positioning in sectors witnessing an increased demand for technological advancement. These trends are expected to continue, thus driving the company’s earnings and stock price higher.

TE Connectivity Ltd., together with its subsidiaries, engages in the design, manufacture and sale of connectivity and sensors solutions across a number of different markets, including automotive, commercial transportation, industrial, aerospace, medical technology, IT, energy and data communication.

The company operates through three segments:

• Transportation,
• Industrial, and
• Communications Solutions. 

TE designs and builds a number of high-tech components, including connectors, connector components, relays, sensors, antennas, switches, wires, cables, and cable assemblies, for automotive, industrial, and connectivity-driven applications.

The company focuses on bringing connectivity and sensor solutions to market for environments that are the most demanding (harsh environment).

TE Connectivity serves customers in more than 140 countries in Asia–Pacific, Europe/Middle East/Africa (“EMEA”), and the Americas.

The company was formerly known as Tyco Electronics Ltd. and changed its name to TE Connectivity Ltd. in March 2011. TE Connectivity was founded in 2000 and is headquartered in Schaffhausen, Switzerland.

Auto Is A Huge Growth Driver For TE Connectivity

TE was founded a few decades ago, but the technology company has really started to find traction in the last ten years or so.  The reason for it is that the company’s offerings are in line with those industries that are currently undergoing massive restructuring for enhanced electrification and automation, such as the automotive industry.

It is no coincidence that the automotive industry represents more than a third of its total annual sales of more than $13 billion.

To put it in perspective, Transportation Solutions contributes around 60% of its total sales, Industrial Solutions around 27%, and Communications Solutions makes up the remaining 13% of its total revenue.

TE Connectivity’s growth over the past couple of years has been driven by the company’s ability to build a number of high-tech components that are used in a variety of growing industries. These trends are only expected to gain further momentum, which could translate into higher revenues and profit for the company in the foreseeable future.

TE’s largest growth market, by far, is the automotive segment. This is the real growth area for the company, as its connectivity-based solutions span a wide range of applications, including sensors, infotainment, safety systems, and power-train technology.

It is expected that, in the next five to six years, the number of components in the average vehicle will witness a CAGR of 6%, which means the automotive business will continue to be the dominant revenue generator for TE Connectivity.

The growth is likely to be driven by increasing demand for EV (electric vehicle) expansion in Europe and China, as the growing environmental concerns push governments to bring in new laws to discourage purchase of carbon-based vehicles.

For example, TEL is an investor in the much-hyped Nikola Corp. [NKLA], a nascent, but promising player in the hydrogen-powered trucks market.

Its DEUTSCH connectors have a plethora of applications in the Nikola One hydrogen-powered engine. It is to be noted that Nikola Corp is yet to contribute any revenue to TE, simply because the company is yet to launch its innovative truck in the market.

In fact, all of its valuation is based on expectations of how fruitful the collaboration is likely to prove for TEL in the next couple of years. Simply put, TE’s Transportation segment revenues are going to get a real boost if Nikola manages to make good its promise of delivering hydrogen fuel cell Class 8 trucks to market in 2022. 

TEL Sales Growth Has Bounced Back Sharply

The company’s sales fell precipitously earlier in the year, as it battled significant unfavorable impacts from the COVID-19 pandemic.  Its essential end-markets were shattered by the cataclysm, which significantly impacted its liquidity and financial conditions.

However, as the economy opens up and industrial productions gain momentum, the company managed to deliver a better-than-expected result for the fiscal first quarter ending Dec. 25, 2020. It quickly erased all the 2020 losses, delivering an almost 25% price return YTD.

Net sales increased $354 million, or 11.2%, to $3.5 billion, in the first quarter of fiscal 2021 as compared to the first quarter of fiscal 2020.

The connectivity and sensor component manufacturer reported $1.47 earnings per share for the quarter, topping analysts’ consensus estimates of $1.29 by $0.18.

“Our strong first quarter performance reflects our global team’s ability to adapt to ongoing dynamic market conditions to deliver double-digit sales and EPS growth that exceeded our expectations,” said TE Connectivity CEO Terrence Curtin. 

Free Cash Flow Conversion Bodes Well For TEL

Additionally, TE Connectivity boasts exceptional FCF conversion. FCF is the ratio of free cash flow to net income. It demonstrates the quality of a company’s earnings and its business.  To TE’s credit, it boasted 100% conversion even during the pandemic. Another advantage of the company is its capital efficiency as well as its healthy balance sheet.

The company was optimistic with its forward guidance as well.  In the second quarter of fiscal 2021, the company expects net sales of approximately $3.5 billion, reflecting an approximate 10% increase, with EPS of approximately $1.47, up 14% year over year.

To sum it up, TE Connectivity stands to gain a lot from the forces that are currently shaping the world’s economy, generating healthy demand for automotive, industrial and personal electronics markets. Increasing automation and expansion of Internet of Things (IoT), where more and more devices will be connected to the internet; the EV revolution and greater emphasis on renewables; and the evolution of healthcare will inevitably bolster demand for TEL’s essential products – connectors and sensors of all kinds, thus highlighting multiple advantages of investing in TE Connectivity.

TEL Vulnerability Lies In Its Biggest Revenue Segment

The Transportation solutions segment, which services the automotive industry, is the largest revenue generator for TE Connectivity.

The automotive industry, no doubt, is an exciting growth catalyst, but then this is also where the company’s vulnerability lies.

It is important to note here that the company’s businesses are well-diversified, except for its exposure to automotive, which represents more than a third of total sales.

And herein lies the maximum risk for the company, as heavy reliance on automotive could prove to be calamitous for the company, in case there’s even the slightest of disruptions in car production and sales. 

The good thing is that many of the components used in highly technical vehicle systems are, to an extent, insulated from a sudden disruption, but the company’s heavy exposure, nevertheless, could be a cause for concern for some investors.

Additionally, there are anxieties regarding high valuation of the company despite renewed growth in recent years, presence of long-term growth drivers, and favorable trends in growth industries.

In fact, analysts believe the high valuation is the fly in the ointment, while some going as far as to claim it as a consequence of reckless exuberance that can evaporate in a second and trigger a valuation reset.

The company is also facing a host of legal proceedings and claims, including patent infringement claims, product liability matters, employment disputes, disputes on agreements, other commercial disputes, environmental matters, antitrust claims, and tax matters, to name a few.

Unfavorable outcomes can disrupt the company’s operations, financial position, or cash flows, though TE claims that none of these is likely to have any material impact on its revenue and profitability. 

Do TE Connectivity Competitors Pose A Threat?

TE Connectivity’s top competitors include Amphenol Corporation, Molex and Honeywell International Inc.

Amphenol Corporation [NYSE: APH], together with its subsidiaries, primarily designs, manufactures, and markets electrical, electronic, fiber optic connectors, and interconnect systems.

China, by far, is Amphenol’s largest market, responsible for almost 35% of its total revenue. Trump administration’s hard stance on doing business with China weighed on its performance.

But under the new administration, there is a possibility that the tension between the two of the world’s largest economies may ease, which, in turn, is likely to lift its business’ outlook.

Apart from good news on the trade front, Amphenol is also expected to be a prime beneficiary of expected high growth that the industrial sensors market is likely to witness in coming years.

Reports suggest that the market for gas industry sensors is expected to grow at a CAGR of 6%, whereas the global temperature sensor industry is likely to expand at a CAGR of 7% till 2026.

The company recently had to undertake several cost-cutting initiatives as the pandemic led to a demand slowdown in the communications, industrial, and automotive markets. APH closed the fourth quarter with sales of $2.151 billion (down 3%) and EPS of $1.03. 

However, APH, like TE Connectivity, is expected to benefit from demand rebound in the market it serves, which is likely to push revenues higher in the coming years.

The company also recently acquired Bangalore, India-based EXA Thermometrics, which is a provider of high technology temperature sensors. The purchase is expected to strengthen its overall sensor offering and complement its growing portfolio of sensor products.

Honeywell International Inc. [NYSE: HON] is an American multinational conglomerate that provides aerospace products and services, control, sensing and security technologies for commercial buildings, homes and industry.

Lockdowns and stay-at-home orders greatly boosted e-commerce. The contagion also compelled organizations to pay more attention to automation. Honeywell’s Intelligrated (warehouse automation largely for e-commerce facilities) is witnessing rapid growth. 

It looks like both, Honeywell and TE Connectivity, are going to derive a lot of benefits in 2021 from the growing trend towards investing in automation.

On the earnings front, Honeywell reported $2.07 EPS for the fourth quarter against analysts’ estimates of $2.00.

The conglomerate’s revenue was $8.90 billion for the quarter, compared to analyst estimates of $8.39 billion, which attests to Honeywell’s ability to rise to the challenge created by the pandemic.

Honeywell operates in four segments and it has significant growth potential in all the segments. Like TE Connectivity, its valuation is also stretched a bit, but the company has strong businesses with potential for outperformance, which justifies a premium valuation.

Is TE Connectivity Stock A Buy? The Bottom Line

TE Connectivity is a robust, capital-efficient, growing company that finds itself in a good position to leverage the growth opportunities that have been reshaping the global economy.

TE Connectivity’s largest end-market is the automotive sector, and the coronavirus pandemic greatly impacted automotive demand.

However, the company was quick to spring again from the depths, with the stock price spectacularly bouncing back from the nadir experienced in March. With promising vaccines in the market, rebound in vehicle sales continues to accelerate, which bodes really well for TE Connectivity.

Automotive manufacturers have started resuming production and the consumer credit market is limping back to normalcy, which means the near-term outlook on automotive sales is extremely encouraging. This presents lucrative growth opportunities for the company.

The company is also broadening its line of sensors for harsh environment markets, like automotive and industrial, which makes sense as these two sectors offer the widest profit margins for the company.

TE is also a decent dividend player, having raised its dividends continuously for the past seven years. The dividend is paid each quarter, and totals an annual sum of $1.84, with a yield of 2.04%.

TE Connectivity’s second-largest and second-most profitable segment after automotive is Industrial solutions. TE stands to gain here as well as demand for commercial aerospace is likely to pick up pace in 2021. Then again, conditions could hardly be worse than they were in 2020 and things are only expected to go north from here.

The only concern is its heavy dependency on automotive sales, as the company can suffer if the automotive sector enters a downturn. Another worry for some investors could be its current high valuation, but, then again, price is unlikely to climb higher ad infinitum and, at some point, it is going to recede, pushed down by a downside catalyst.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.