TE Connectivity plc (TEL) Earnings Call Transcript
March 4, 2021
Earnings Call Speaker Segments
Great. Well, good morning, everyone. My name is Craig Hettenbach, semiconductor analyst at Morgan Stanley. Welcome to the fourth day of our TMT conference. I'm very pleased to have with us today TE Connectivity. We have CEO -- I'm sorry, CFO Heath Mitts as well as Sujal Shah in investor relations. Just before we kick off, I just need to remind investors about disclosures. They can be found at the Morgan Stanley website, www.morganstanley.com/researchdisclosures.
So with that, Heath, we'd love to kick it off just at a high level from TE Connectivity kind of company strategy. I know you've done a fair amount of portfolio position in the last 5 to 7 years. Kind of where you are today and what that means for the growth and the overall business going forward.
Sure. And Craig, first of all, thank you for having us today and continuing with the strong conference even in this virtual environment. So we appreciate our ability to participate. Your question: Actually, if we're going back 5 to 7 years -- it actually, as you know, goes back even a bit further. When the company spun out of Tyco International in 2007, there was a series of assets that were grouped together as part of that spin-off. And really going back -- I've been here 4.5 years, but really going back. Even before my time, there was a journey to kind of sort out what it is that we want to become when we grow up, if you will. And if you think about it, there was a lot of things in the portfolio, let's say, associated with telecom equipment, consumer -- products that could support consumer devices. There was a SubCom business, and those things over time were either wound down internally. And in the case of the consumer electronics, it was about $1 billion of revenue that we walked away from over several years. That's now behind us. We sold the SubCom business about a year after I started here. There were some other transactions shortly before then. And as we look at the portfolio today, we're really pleased with where we sit. We don't have chunks of the business that we say are not strategic, and that's a good position to be in. I would tell you that it's allowed us to get a lot of things behind us in terms of some restructuring and footprint consolidation. And some of that still continues, but what it's really allowed us to do is to focus where we're going to grow. And for the most part, not all of our businesses, but most of our businesses have pretty strong secular support behind them, particularly in things like in the automotive business which represents about 40%, 45% of our total revenue. We're obviously benefiting from the growth in the hybrid and electric vehicle sector within that market. That's an important place for us to play. Within high-speed data and the hyperscale investment, we've grown a very nice position there and that continues to be very strong. And then in things like medical, which has seen some COVID-driven slowdown now because of the elective procedures have been deferred, but that business is -- has very good growth trajectory in an area that we continue to see and focus on in terms of our ability to grow. And so there are certain pockets within that. And then even within some of the other businesses that are a little bit more cyclical like aerospace and defense right now, it's still a strong business. It's just going through -- the commercial air side is going through a tough patch and will for a couple of years, but if you think about where we play and the moat around that business and our ability to have long life cycles, if you will, a very good business to play in. The industrial equipment around factory automation and robotics continues to play out as we thought it would. So there's a lot of pieces to the business that are going very, very well. And we're bullish about the future.
That's great to hear. Maybe we can just touch on the topic of tightening supply chain conditions. It's certainly been topical at this conference throughout the whole week in understanding if -- it's, I think, most pronounced in semiconductors, right, in terms of the bottlenecks that we're seeing in the supply chain, but what type of impact does it have on TE Connectivity in terms of the interactions you're seeing with your customers?
Well, I mean a lot of it doesn't impact us directly in terms of to our products, but what it does do is it sends a ripple through our end customers and their overall supply chain. And so there's no doubt that the supply chain is dynamic right now. It's there's disruptions not just with this but with weather-related disruptions and all kinds of things [ the team is ] working through. And as we look -- we've been able to battle through that to this point and deliver pretty strong growth. I continue to feel good about where we're positioned as we've made our way through this quarter. And then obviously we'll provide some color in our upcoming earnings in terms of our rest of our fiscal year, but the supply chain thing is real and semiconductor is a big piece of that. And it has driven people to -- I think there's probably been some things where people have ordered ahead so they don't get stuck on allocation. And because of what they're seeing in terms of their dependence [ and other ] parts of their bill of materials arriving, they don't want to be caught empty handed when it comes to what they need from us. So it's -- really it's built into our guidance assumptions. I don't think you'll hear us talk about this being something that we misread. How long it lasts, I think, is TBD. And there's probably a lot of others who were a part of this conference this week who had a more direct perspective on that because they're more directly impacted to the extent they use semiconductors.
Yes, yes. And I think, even to that point, for them it's TBD in terms of when we see some loosening and perhaps into the back half of the year. Maybe we can just talk about the bookings of the business. Book-to-bill jumped to 1.15 to 1, very strong last quarter. Can you touch on just kind of near-term bookings versus does that also reflect some customers layering-in backlog later on points through the year?
Well, I mean, listen, I think you're going to continue -- everything we just talked about with the supply chain disruption, I think, is having an impact on some of those order patterns for our products. And I do think, as we look at it and we look at where we're building backlog in the business, and we disclosed that by sector -- or by each of our 3 segments last quarter, the 1.15 was a strong number. I think -- as we work our way through our fiscal Q2 that we're in right now, I think we continue to see strength there, and that's all good. Now the question is, is there bubbles in there, right, where at some point we get supply chain kind of corrected and people can get a little bit more confident in things? Do we see that kind of go invert the other way? I'm not so sure we'll see that in the nearer term. We'll always keep an eye out towards the later part of our fiscal year and see how that looks. Right now there's a few things that we do look at that are indicators for us. We've got 20% of our business that goes through some distribution partner. And within our -- within certain pieces of our business, it's a higher percentage, right? We do look very carefully at their point-of-sale data for our products and then their point of purchase for what they're buying from us. It gives us a sense if they're building inventory in anticipation of something or if it's just flowing through 1 to 1. We haven't seen them build a lot of inventory yet. In some cases, I think it's because the demand, the end demand, just continued to be strong, but we do keep a close eye on that.
Yes.
But the other thing to consider. In some of our businesses and particularly more of the industrial businesses, if you think about where we were pre COVID: We were in the process, right, before COVID kicked in here about a year ago where the industrial supply chain was kind of slowing down at that part of the cycle. And we were in the process of bleeding off inventory within that. And we had talked pretty publicly that we had a couple hundred million dollars of inventory in our -- that was built up in distribution that we thought we'd need to bleed off, and that did. So it wasn't like, when we went into COVID, there were -- we were in a position where there was already high levels of inventory. So in some cases, you fast-forward a year. You work through some of the COVID-related disruptions, and now you're going to start to see them cycle back up. And as part of that, we have to look at what's part of the cycle versus what's part of somebody worried about being stuck on some kind of allocation of parts, but so far, so good in terms of how we sit here today.
Great. That's excellent context. Maybe we can shift to some of the growth drivers and starting with auto as the biggest piece of the business. The company has talked about kind of a 4% to 6% content growth. I know EVs is a new part of that and incremental, so can you just talk about autos, what you're seeing from a design perspective and that -- the confidence in that content growth?
Sure. Well, so you think about where we are. And a lot of the people who've followed us for a while know that we use the term "content per vehicle" or CPV. We've been kind of in that $60, mid-$60s per vehicle globally for a few years. We've seen that go up into the $70s, so almost a $10 increase over the past couple years. And about half of that growth is just coming from additional electronification opportunities and content wins that we've had in traditional combustion engine vehicles, and about half of the growth in that blended content per vehicle number comes from the increase of hybrid and electric vehicle platforms. So that's been a nice tailwind for us, for sure. Whether that puts us at the high end of that 4% to 6% growth or whether that puts us -- I think you're going to have some quarters like last quarter we just came out of where you're far ahead of that. And you're going to have some quarters where you might see a little bit of inventory that need to be digested, but over a cycle we feel good about that 4% to 6% number. But the other thing you have to keep in mind -- and you mentioned hybrid and electric. Hybrid and electric is an important piece for us because our content per vehicle on hybrid and electric -- or particularly the EV side of that is about 2x what our normal content per vehicle is, but look at the total. We're going to go -- from last year, there was about 6 million vehicles made in that category of hybrid and electric. This year, it's going to be about 9 million, so it's up 50%, but that's going to be on a base of, say, 83 million vehicles built in our fiscal year. So important to us. And we're certainly benefiting because our CPV for hybrid and electric is far superior than in combustion engine, but it's still, let's call it, 12% of the total production this year and we do see as the fastest-growing piece of that production. But there's still going to be another 75-plus million vehicles made outside of that this year.
Yes. And to the point of 2x the content, how do you think about that on a much longer-term basis in terms of, as this becomes a volume market, is it natural to see some of that content down a bit? Or how do you think about EVs longer term?
Well, honestly, Craig, the -- some of those comments we make and frame up around the 2x content takes into consideration some of that scaling that you mentioned. It is natural that, when you're subscale, we are obviously charging and -- a premium because they're making thousands of vehicles. They're not making millions of vehicles in that category. And you need to break it down by OEM. As we look at -- if you were to pick particular models of some of these vehicles, our content per vehicle in some of those is significantly higher right now than 2x, right, but they're not at full scale.
Yes.
So as we model it out, that bringing that down to $120 to $130 per vehicle takes some of that into consideration already, but there is going to always be natural elements on price as you start to get to certain volume levels because they know that, as we get blowing past our fixed cost structure, there's a lot of margin. And some of that [ productivity deals get shared ], but the 2x comment really takes a lot of that into consideration already.
Got it. And I know the company has had a presence in China for a long time, decades. And so certainly there's a lot of activity in EVs in China. Can you maybe just talk about how that helps you in terms of where we are on EVs and then just maybe broaden it out globally in terms of how you're thinking about the EV market?
Sure. There is -- you're right. I mean there's a lot of different local manufacturers of EV platforms in China. We participate with all of them. It's not an easy process because some of these are making very few vehicles. Or they're still at the design and concept stage, but in this world -- and I suspect within that China OEM world there will be consolidation over time. It's just there's -- it's just very, very fragmented right now, a few big players and a lot of small players trying to make electronic vehicles. For us, you don't necessarily know who's going to win, and so sometimes we're -- we have to be a little bit more agnostic about that and help them each with their engineering in that respective piece of the platform towards that. There is a lot of activity in China. And there's a lot of push and there's a lot of central support to move that along, but we're also seeing a lot of strength in Europe and with the European OEMs, some of which produce in China for that China market. And a lot of it does get produced in Europe. And then obviously, in the U.S., which is a smaller piece of our auto business, we participate as well, but there's no doubt that China has been a leader in pushing this. They've kind of battled through some of the COVID downturn and largely things in China are back to -- almost back to pre-COVID levels across the board.
Yes. And I know EVs get the bulk of the attention, but beyond that, within autos there's applications like ADAS and things like that. Like how important are some of these other drivers in terms of that 4% to 6% over time?
Well, ADAS is interesting. And there's multiple stages from where we sit today to full automation, right? And there's things that will be adopted gradually over time. We benefit from things like collision avoidance systems, lane warnings and when the car veers different directions, braking systems. I mean there's a lot of things that we participate in, maybe not on the sensing side so much but on pulling that signal back into the brains of the vehicle. So that type of content is helpful for us. I think our primary focus is more on the EV side of things and with the thinking that some of the EV will enable some of the -- that a lot of that will be what ultimately ADAS evolves to longer term. And that has -- there were trade-offs made when things took a hard turn down last spring. I know some of the OEMs had to kind of focus in on how far -- is that far out versus what they needed to do [ on EV ]. And we did see EV get more of a focus. And some of the ADAS kind of get pushed out a little bit with their design cycles and their intent there as they made some pretty meaningful cuts in their world too, but things cycle around. And as things recover, we expect those investments to continue.
Got it. Maybe we can talk about just automotive sensors. I know that's another incremental opportunity for you. Just high level, how you feel about kind of the pipeline of activity and the type of traction you're seeing on the sensor side of things in autos.
Sure. And we've got about -- last year, we did about $900 million of sensors -- revenue in our sensors business last year. So as you think about it at just under 10% of the total company in terms of at least last year's performance, of that, let's say a little bit more than 1/4 of that is the auto side, but that's -- but that side -- the auto side where we have roughly $2 of content per vehicle within sensors. So call that $2 to $3, so a couple -- $300 million. We expect that to double over the next 4 or 5 years. One of the things that we bring to the table with our -- with the sensors businesses that we've acquired and primarily Measurement Specialties being the biggest piece of that is our understanding and the design efforts within automotive and how that works. You're dealing with different engineers on the sensing side versus the connector side, but it still is a process that we bring a lot of credibility to in terms of our ability to operate at an automotive level of quality and rigor and supply chain dynamics. The OEMs understand that we know that business well. So I see it being a nice growth opportunity for us. We continue to win platforms. We did see some platform launches move to the right a bit during the COVID downturn, not just on new vehicle launches. And we're starting to see some of that ramp back up in some of those things that we know we were spec-ed into over the last couple of years that haven't even been launched into production yet. And we are well ahead of where we need to be in terms of getting the tooling in place, where we're going to manufacture it and being there to make sure that the customer is supported. So it hasn't been without its challenges, as automotive production dropped to the low 70 million in the last year but no different than the rest for our auto business.
Yes. And what is it -- if you -- if I think about the capabilities that you have; and very strong in the connector market, in terms of leadership in autos and kind of the sensor emerging from customers, like what are they interested in, in terms of what you can do? Like is there an element of like co-packaging from a sensor and connector perspective? Or is it more on a discrete basis? Like what are you seeing in kind of that growth driver?
Well, we've seen all ends of that spectrum, and it really depends on the auto OEM and the Tier 1s. In some cases, we've solved some very gnarly problems for people by coming up with a package design that we can deliver to them that involves both sensors and connectors and takes a lot of engineering and quality testing out of their processes, right? Versus them buying discrete products for us, we can sell them a fully qualified and tested module, if you will, or submodule. That has worked, yes, with some OEMs. I would say it's not as -- it's not a major driver, though. A lot of OEMs still want to have their sensor -- sensing team kind of deal with discrete components and their connectors teams dealing with discrete components. So it's something that we bring to the table in terms of our engineering and understanding of how the signal works in a vehicle. I mean we -- when you connect everything in a vehicle, it gives you a lot of knowledge on the data flow, data flow rates, voltages around the car, all of those things. And we start getting into EV, around battery technology and charging technology, the connections and all of these things. There's a lot of things that we bring to the table, and we try to integrate a sensor solution into some of those conversations.
Got it. And if I think about 1/4 of the business roughly in sensors being automotive, can you maybe just touch on some of the other segments or applications where you see some good growth drivers in sensors more broadly?
Sure. I mean there are some things and even some things we acquired with the recent acquisition we did at First Sensor, [ which is a ] German-based company doing low-pressure sensing. And we're in -- still in the process of integrating that into the rest of our sensors business, but there's things in there around industrial applications, around factory automation. There's things in medical that we like within that piece, what we call I&C, which is the industrial and commercial side of sensing. There are pieces of it that we like. And then quite honestly, there's pieces, like anything you acquire, that you say, well, that's an interesting project, but is it just a project? Or does it have a long life and the design-in annuity stream that we like from the rest of [ what we just do around TE ]? And so over time, I think you'll see us really focus in on those areas that we like, particularly around industrial, in medical. And then there'll be some things that you could see us wind down or jettison and take out some costs accordingly with that too. So it's like anything. When you're as acquisitive as we are and you buy something, you're probably going to love 2/3 of it. And there's probably 1/3 of it that you say, "Well, we'll see if we can make that fit in our portfolio, and if not, we'll do what we need to do." So -- but I think that is where that non-auto piece of sensing comes into play quite a bit.
Got it. Maybe we could shift to the industrial market more broadly. And factory automation is a big, important piece of that segment for you. Certainly there are some near-term cyclical drivers and recovery, which is encouraging, but just how do you think about that factory automation business kind of near and long term?
Well, it's one of our growth drivers for the company, for sure. And we are in a good position with our relationships with all the design houses that are -- and the ones who were aggregating some of these more complex systems on behalf of their customers, so we're bullish about it. We think that our position globally in -- and we're well positioned in the Americas, Europe and in China. The investment around automation and robotics that come as part of that is huge as we get to more of a where things are produced and where we have labor shortages and all of the macro drivers that enable that. It's huge. So that -- we're in good position. I think you'll continue to hear us talk about that from a acquisitive standpoint as well. There are some pieces within there where there are subsectors that are more fragmented; and where there's opportunity for us to buy something where we already have a lot of knowledge and bring it into our fold either operationally or commercially, hopefully both. And so I think that should be one that you should expect to hear us talk about from an M&A front as well.
Got it. Maybe we could shift gears to margins. And I know you mentioned kind of you've been onboard just over 4 years. I know, when you came in, there were some things you wanted to focus on, efficiency. Particularly in the industrial market there's been some consolidation of the footprint. Can you just give us an update on where some of these initiatives stand and what that means for the margins of the business?
Sure. Well, if you think about our industrial segment -- which within our industrial segment we really have 4 businesses. We have a medical business, our aerospace and defense business and energy business. And then we have our industrial equipment business, which is really the factory automation piece that we just talked about. And because it's a bit fragmented and it's been the beneficiary of a lot of acquisitions over time, we took a look at the footprint. And we had over 70 rooftops, manufacturing rooftops, within that segment. And a few years ago, we laid out a plan where we had duplicative capabilities within region, where we could do things otherwise, where we could use outsourcing partners so we didn't have to do everything ourselves; and then came up with a plan. And we're about 2/3 of the way through that plan. And that's elimination of rooftops, move in to low-cost regions or consolidating where we have duplicative capabilities. We still have a few more sites to go. And now I don't know that we're ever done because, every time we acquire somebody, it comes in with 3 or 4 sites that generally we can leverage the TE footprint to consolidate, but I think we'll in the next couple of years be at a point where -- that kind of initial plan that we laid out back even into 2017 publicly, I think we'll be kind of through most of that in the next couple years. And the team has done a lot of work. And what it's done is, quite honestly, if you look at the type of pressure the margins in that segment have been in, with medical being down so significantly, again elective procedures being down; and our commercial aerospace, which is a very [ profitable piece ] of our business, being down; commercial air being down 40%, right, that's a couple of hundred million dollars, a very profitable business -- and yet we're able to maintain margins in that 12%, 13%, 14% range kind of shows we would not have been able to do that had we not eliminated those rooftops. Now the plan is -- has always been -- and I'm not trying to reiterate here. The plan has always been that we'll make [ this through consistently ] in the mid- to high teens, and that continues to be the plan. We need to finish executing on a couple fronts. And we also need to see a little bit more support than what we're getting right now out of the commercial air side, which can take a couple of years, but as that business grows back closer to a $4 billion segment for us, I think you'll see us be able to flex our fixed cost structure in such a way or leverage our fixed cost structure in such a way that we'll enjoy those consistently improved margin numbers.
Got it. We did have a question that came through the webcast link, on EVs. And just on a rough basis, if you think about kind of what you're winning in that market, does it match up with your share in autos more broadly? Are you doing better or worse in EVs? And any other new competitors to think about as we move to kind of EVs?
It's a good question. Right now I will say that we enjoy the same kind of leading share that we have in combustion engine vehicles. So call that 35% or so of the share for those products. Now what is a little different is that, that space is still evolving, right, the platform. There's not been a standard created necessarily. Maybe by OEM it has, but across the industry it has not really a standard created. So what we're doing for one OEM could [ look ] a little different from what we're doing for another OEM. So when you start getting into then market share positions and so forth, that calculation gets a little bit harder versus when we look at a more mature market like the combustion engine market, but we have looked at it. And I know Sujal has done a lot of work on this with the auto team. And we feel, well, the stuff we're bidding on where -- and winning, where we have a comparable amount of share, we'd like to see get a little bit higher, but before we say that, I want to see a little proof in the pudding.
And I think just to add to what Heath said. I mean, the same things that we have on traditional ICE vehicles, [ those hold in EV ]. There's more of an engineering challenge to doing connectivity at high-voltage, high-current levels. And that's something we've invested in for some time, but there's a lot of material science involved. And things that matter on ICE also matter on EV, right? Things like the ability to scale, quality and reliability, what Heath mentioned, you can't fail for the entire lifetime that the application and the connector is in use. So those trends still hold and there's a little bit of a higher degree of difficulty on [indiscernible] [ which helps us ].
Understood. I appreciate the color there. In the interest of time, as we're getting close here, maybe we can just wrap up, Heath, on just capital allocation. I know you take a disciplined approach to M&A. The company over time has targeted 1/3 of free cash flow to M&A, 2/3 return. Is that still the right number to think about? And if you can just, more broadly your approach to capital allocation.
I think that's a fair number to think about through a cycle. The M&A piece is never going to be linear. It's never going to be exactly 1/3 every year, so -- and there will be times when we offset that with some additional share repurchases as it makes sense; and then also times, including where we are now, where we might put a little bit of extra -- be comfortable putting in a little bit of extra cash on the balance sheet as we look at the M&A market and see what we think is coming and what's opportunity out there. And at the same time then, we're still active in the share repurchase market. We think we're still in a value that there's a lot of upside to where we've been -- where we trade today. So I think, as you model it, 2/3, 1/3 is fair, but you've got to -- I think really you've got to look at it back. I mean you're kind of looking in the rearview mirror every 3 or 5 years and say, "Is that how the math works?"
Yes.
And that really is how the math -- but you're just going to have times and there -- where M&A all of a sudden spikes in the year [ because you didn't do a bigger deal than not ], but I feel pretty good about that being a number for now, the number [indiscernible].
Okay, I think we'll wrap there. So Heath and Sujal, it was really great to spend some time with you this morning, going through the business. And appreciate the investors on the webcast as well. So thanks so much. And I hope everyone has a great day.
Thank you, Craig. Have a good day.
[ Thanks ].
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