Orbon Alija
In September of last year, I saw a connection in the case of TE Connectivity Ltd. (NYSE:TEL), on the back of a sound position, long-term growth, and reasonable valuations. The trouble with the company is that despite its positioning, the company has not fully lived up to its promises in terms of sales growth, although recent margin progress has been impressive.
While the sales performance is not yet too impressive, I am pleased with the margin progress, and, therefore, I am willing to stick to a modest long position, with no intention to alter this position anytime soon.
A Connection Business
TE Connectivity is an industrial technology business which focuses on connectivity and sensor solutions. These solutions are designed to create a safer, sustainable, productive, and connected future. A massive business, employing some 85,000 workers, is active in some 140 countries across the globe, with business operations split out across three segments.
The company is a $16 billion business which is dominated by a $9.6 billion transportation solution business, responsible for about 60% of overall sales. This is complemented by an industrial solutions business, responsible for nearly 30% of sales, complemented by a smaller $1.9 billion communication solutions business which had seen a tougher 2023.
Each of these segments post operating margins in the mid-teens, yet despite the sound long-term positioning, the business has seen a tougher 2023. The company posted a 1.5% fall in reported sales to $16.0 billion, driven by adverse currency moves and weakness in the communication business, mostly revealing itself in the final quarter.
Amidst some margin pressure and restructuring efforts, net earnings fell by about a fifth to $1.9 billion, with earnings reported at $6.03 per share. Adjusted for some items, and benefits in the year before, adjusted earnings were down 6% to $6.74 per share.
Net debt was reported at $2.5 billion, ahead of some manageable pension liabilities, yet this is much less than reported EBITDA, not creating any concerns on the leverage front.
Softness
The company did see momentum decelerate throughout the year, with fourth quarter sales down more than 7% to $4.03 billion, entirely attributed to a 30% fall in communication solutions sales, which fell to just $463 million. There is no real indication of an immediate recovery, with the order intake for the quarter seen at $3.9 billion, for a book-to-bill ratio below 1 time.
Making use of its strong financial position, TE announced substantial capital allocation decisions in December, as it hiked the full-year dividend by ten percent to $2.60 per share, with another $1.5 billion buyback program being announced.
By mid-month, the company closed on the previously announced acquisition of Schaffner Holding, a deal which the company announced last year. The company offered a 79% premium for Schaffner, the producer of electromagnetic compatibility filter products, in a deal valued at EUR 335 million.
Performance Is Modest
Despite a solid positioning, the reality is that in the decade-long period since 2014, TE Connectivity Ltd.’s sales have been rather constant, having risen from just about $14 billion to $16 billion, not keeping up pace with inflation. This is in part masked by modest margin gains, but moreover continued buybacks which reduced the share count by a fifth over this period of time.
Despite the solid positioning, the issue is that TE Connectivity is not living up to its positioning, as growth underwhelms the positioning, amidst a relatively conservatively financed balance sheet. Amidst a largely fair valuation, the investment proposition looks quite fair, although some better growth execution is desired.
The near-term performance provides no reason to get really upbeat, with first quarter results for the fiscal year 2024 being released towards the end of January. First quarter sales were essentially flat at $3.83 billion as the company did see a solid increase in gross margins, driving a 20% increase in adjusted earnings to $1.84 per share. Growth is driven by the key transportation solutions, with weakness continuing in the communication solutions business, albeit this resulted in posting higher margins.
Orders were reported equal to reported revenues at $3.8 billion, although orders were 4% on the year before. For the second quarter, the company sees sales of around $3.95 billion, with adjusted earnings per share seen at around $1.82 per share, putting the firm on track to post earnings of around $7.50 per share in 2024. Growth on a per-share basis is aided by share buybacks, and amidst this and dealmaking activity, net debt remains relatively modest at $3.0 billion here.
With shares trading at $144, a 19 times earnings multiple seems more than fair, as a further re-rating has to come from better (organic) growth, something not on the immediate horizon after the second quarter sales guidance calls for modest sales declines (as first quarter sales were flat year-over-year).
And Now?
The truth is that while TE Connectivity Ltd.’s valuations look fair, the long-term performance has been lagging for a while. Weakness in the communication segment, which is seeing substantial revenue declines, is now spreading to the industrial solutions segment as well. Sales are hurt by inventory de-stocking trends, something which hurts the communications market as well.
The company indicated that it expects a $200 million contribution from AI solutions in this segment as well in 2024, although the real question is the degree of cannibalization of the older product lines of the business as well, as it feels as if TE suffers from larger legacy product groups as well, whose lunch is eaten by new technologies and growth areas.
Given all of this, TE Connectivity Ltd. shares look largely fairly valued, and after I held a modest long position on dips last year, I see no reason to alter this position. While recent margin gains are to be applauded, I am really on the lookout for sales growth here.
