TE Connectivity Ltd. (TEL-NYSE) Analyst Note

Transcription

1 January 30, 2015 TE Connectivity Ltd. (TEL-NYSE) Analyst Note Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 12/30/2012 Current Price (01/29/15) $67.57 Target Price $ Week High $ Week Low $51.47 One-Year Return (%) Beta 1.62 Average Daily Volume (sh) 1,605,710 Shares Outstanding (mil) 407 Market Capitalization ($mil) $27,501 Short Interest Ratio (days) 1.61 Institutional Ownership (%) 89 Insider Ownership (%) 2 Annual Cash Dividend $1.16 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 4.0 Earnings Per Share (%) 16.8 Dividend (%) 15.4 using TTM EPS 17.1 using 2015 Estimate 15.9 using 2016 Estimate 14.7 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page SUMMARY TE Connectivity s first-quarter fiscal 2015 adjusted earnings surpassed the Zacks Consensus Estimate by 8.9% and the prior-year quarter figure by 19.5%. Continued strength in the transportation market acted as the primary growth driver. This apart, the company s appliances business, meant for the harsh environment, had higher margins compared to other businesses and this was also a positive. Further, the company is focused on cost-containment initiatives like its TE Operating Advantage (TEOA) strategy, which leverages on operational efficiency by eliminating waste and boosting the operating margin. However, continued weakness in the Network Solutions and Consumer Solutions divisions remains the concerns. Nevertheless, the company s decision to sell its weak performing Network Solutions division holds good for long-term perspective. Hence, we remain Neutral on the stock. Risk Level * Low, Type of Stock Large-Blend Industry Elec-Misc Compn Zacks Industry Rank * 46 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) ,134 A 3,265 A 3,449 A 3,432 A 13,280 A ,326 A 3,431 A 3,580 A 3,575 A 13,912 A ,466 A 3,691 E 3,886 E 3,891 E 14,934 E ,744 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) 2013 $0.65 A $0.76 A $0.88 A $0.93 A $3.23 A 2014 $0.82 A $0.95 A $1.00 A $1.02 A $3.79 A 2015 $0.98 A $1.00 E $1.12 E $1.14 E $4.24 E 2016 $4.59 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 RECENT NEWS TE Connectivity Q1 Earnings Beat, Revenues Miss Again Jan 28, 2014 TE Connectivity reported first-quarter fiscal 2015 adjusted earnings per share of $0.98, which surpassed the Zacks Consensus Estimate of $0.90 by 8.9% and also came above the prior-year quarter figure of $0.82 by 19.5%. Continued strength in transportation market acted as the primary growth driver. This apart, the company s appliances business, meant for the harsh environment, had higher margins compared to other businesses and this was also a positive. Further, the company is focused on cost-containment initiatives like its TE Operating Advantage strategy, which leverages on operational efficiency by eliminating waste and boosting the operating margin. On a GAAP basis, the company reported earnings per share of $1.14 per share, up from $0.85 cents reported in the prior-year quarter. Quarter in Details Total revenue in the quarter increased 4.2% year over year to $3,466 million but fell short of the Zacks Consensus Estimate of $3,504 million. The company s organic revenues grew about 3% in the quarter. Revenue growth was attributable to strong performance of the end markets including automotive, commercial transportation, commercial aerospace and appliances. On the other hand, TE Connectivity s total operating margin in the quarter stood at 13.8%, as compared to 14.4% in the year-ago quarter. As per the segments, revenues in the Transportation Solutions segment increased 11.9% year over year to $1,612 million. The segment s operating margin dipped 242 bps year over year to 18.8%. Industrial Solutions segment revenues were up 2.8% year over year to $784 million. The segment reported an operating margin of 11.4%, declining 160 bps from the previous year s figure. Network Solutions segment revenues declined 1.3% year over year to $704 million. However, the operating margin for the quarter increased 220 bps year over year to 8.7%. Consumer Solutions segment revenues decreased 10.7% year over year to $366 million while the operating margin declined 270 bps to 6.6%. TE Connectivity s total order level for the quarter increased 9% year over year to $3.7 billion driven by major contribution from the Subsea Communications ( SubCom ) business. Excluding SubCom, the order level rose 4% on a year-over-year basis, whereas book-to-bill ratio came in at Liquidity TE Connectivity exited the quarter with cash and cash equivalents of $868 million, as compared to $2,457 million as on Sep 26, The company s free cash flow for the quarter came in at $162 million against $266 million as on Dec 27, Equity Research TEL Page 2

3 BNS Business Divestiture In conjunction with the earnings release, TE Connectivity declared that it has penned a $3.0 billion deal with CommScope Holding Company, Inc. (COMM) for divesting its Broadband Network Solutions ( BNS ) business, which is a part of its Network Solutions division. The business did not include TE Conncectivity s Subsea Communications or Data Communications businesses. The deal is anticipated to complete by December this year, upon fulfillment of customary closing conditions. Outlook TE Connectivity expects second-quarter adjusted earnings per share in the range of $0.98 $1.02 and revenues in a band of $3.55 $3.65 billion. For fiscal 2015, the company reiterated its adjusted earnings per share in the range of $4.05 $4.35. TE Connectivity revised its revenues guidance and now expects it to be in the range of $14.45 to $14.85 billion (previous one being $14.7 $15.3 billion). The above guidance includes the results of the company s BNS Business. Also, TE Connectivity expects to report double digit adjusted EPS growth in fiscal 2015 driven by the improving SubCom market and continued momentum in its harsh environment businesses. Equity Research TEL Page 3

4 VALUATION Currently, shares of TE Connectivity are trading at 17.1X TTM earnings, a discount to the peer group average of 31.2X and to the S&P 500 average of 18.4X. Over the last five years, shares have traded in the range of 9.0X to 23.7X trailing 12-month earnings. Therefore, it is currently trading in the middle of its historical range, which indicates chances of upward movement. Hence, we have maintained our Neutral recommendation on the stock and expect it to perform in line with the broader market with a price target of $71.00 (16.7X 2015 EPS). Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low TE Connectivity Ltd. (TEL) Industry Average S&P United Capital Corp. (UCAP) N/A N/A N/A N/A N/A Kyocera Corp. (KYO) AU Optronics Corp. (AUO) 14.1 N/A N/A TTM is trailing 12 months; F1 is 2015 and F2 is 2016, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA TE Connectivity Ltd. (TEL) Industry Average S&P Equity Research TEL Page 4

5 Earnings Surprise and Estimate Revision History NOTE THIS IS A NEWS-ONLY UPDATE; THE REST OF THIS REPORT HAS NOT BEEN UPDATED YET. Equity Research TEL Page 5

6 OVERVIEW TE Connectivity Ltd. (TEL) primarily manufactures and designs about 500,000 products that connect and protect the flow of power and data inside millions of products used by consumers and industries. The company partners with customers in a broad array of industries ranging from consumer electronics, energy, and healthcare to automotive, aerospace and communication networks. In 2011, the company s name was changed to TE Connectivity Ltd. from Tyco Electronics Ltd. after a formal shareholder approval. TE Connectivity primarily operates through four segments: Transportation Solutions, Industrial Solutions, Consumer Solutions and Network Solutions. Transportation Solutions (contributes 44% of the total revenue in fiscal 2014): This segment is a leader in electronic components comprising, connectors, relays, wire and cable, circuit protection devices, sensors, and heat shrink tubing and molded parts, as well as application tooling and custom-engineered solutions for the automotive and aerospace, defense and marine markets. Industrial Solutions (24%): The segment is one of the world's leading suppliers of electronic components, including connectors, relays, circuit protection devices, antennas and heat shrink tubing. The products under this segment are used primarily in the industrial machinery, consumer devices, data communications and household appliance markets. Consumer Solutions (21%): This segment is a top supplier of electronic components, including connectors, circuit protection devices, relays, antennas, and heat shrink tubing, for the consumer devices and appliances markets. Network Solutions (11%): The segment is one of the world's largest suppliers of infrastructure components and systems for the telecommunications and energy markets. The products under this segment include connectors, heat shrink and cold applied tubing, fiber optics, wire and cable, racks and panels, and wireless products. This segment is also a leader in developing, manufacturing, installing, and maintaining some of the world's most advanced sub-sea fiber optic communications systems. REASONS TO BUY TE Connectivity is the market leader in the in the connectivity business with a comprehensive portfolio. The company s market position was further strengthened by the successful integration of the Deutsch Group SAS business which was acquired in This acquisition complemented TE Connectivity s solutions by providing the technology for connectivity in Harsh environments, leading to a significant increase in the company s market share. Further the company s four segments together command a $100 billion worth of market share, and the company s business is expected to grow at an annual growth rate of 5% for the next five years. This apart, in the fragmented connector industry which is about $50 billion (as in fiscal 2014), TE Connectivity has a 17% market share. TE Connectivity recently has been considering strategic acquisitions primarily in the sensor segment and the harsh weather management segment. Pertaining to this, the company, from Jun 2014 to Sep 2014, has closed about three acquisitions SEACON, Measurement Specialties and American Sensor Technologies. Further, the company has a strong Research & Development team, as the company every year invests significant amount on process engineering and development, which is essential for the Equity Research TEL Page 6

7 company, to match up with the market trends and customer demands. During fiscal 2014, the company had invested a total of $675 million on its processes and product technology. The company had a good rate of return on its investments, and generated as much as 25% of its net revenues from new products in TE Connectivity has initiated restructuring process in order to remain competitive by reducing costs. Therefore, the company is in the process of simplifying its global manufacturing footprint by shifting facilities from higher-cost to lower-cost countries, consolidating within countries and transferring product lines to lower-cost countries. These initiatives are designed to help the company maintain its competitiveness in the industry, by improving its operating leverage, and position TE Connectivity for growth, moving forward. The company has a strong cash generating capacity. In first quarter, the company generated free cash flow of $266 million and returned $315 million to its shareholders in the form of share repurchases and dividends. In Dec 2013, the company had hiked its quarterly dividend by 16% to 29 cents (or $1.16 annually). The increased dividend was paid in the third quarter of fiscal Further, year to date 2014, the company generated $1 billion in free cash flow. REASONS TO SELL TE Connectivity s business primarily depends on end market dynamics and is therefore subject to cyclical risks that the end markets suffer. The company s DataCom business has recently been affected by the sluggish demand which are proving to be a drag on its upcoming high- speed solutions. Moreover, the company business, especially in automotive and aerospace and defense industry are significantly prone to get negatively impacted by the deteriorating global or regional economic or credit conditions. Also, the telecom networks industry has been experiencing fluctuations in demand resulting from changes in carrier activity and capital investments by customers while demand for industrial equipment is dependent upon economic conditions. The consumer devices industry can experience variability in demand depending on the underlying business and consumer demand for computer and consumer electronics products, as well as the market share of customers. Recently, this segment has been significantly affected by the declining demand for desktop PC s. The company has historically experienced and expects to continue to experience, continuing pressure to lower prices across its businesses and especially in its transportation segment. TE Connectivity has been experiencing price erosion of about 1% - 2% each year. In order to maintain margins, the company must continue to reduce costs by similar amounts, which is a pressure to stay at par with the competition in the industry. The company is majorly impacted by foreign currency fluctuations. Approximately 55% of the company s net sales for fiscal 2014 were invoiced in currencies other than the U.S. Dollar and management expects non-u.s. dollar revenue to represent a significant and likely increased portion of future net revenue. Therefore, when the U.S. Dollar strengthens in relation to the currencies of the countries where TE Connectivity sells its products, the dollar reported revenue and income will decrease. However, changes in the relative values of currencies may have a significant effect on the results of operations, financial position, and cash flows. TE Connectivity operates in a highly competitive market for electronic components and expects that both direct and indirect competition will increase in the future. The competition is across product lines from other companies ranging in size from large, diversified manufacturers to small, highly specialized manufacturers. In the recent times, the electronic components industry has become increasingly concentrated and globalized and the major competitors have significant financial resources and technological capabilities. A number of these competitors compete on the basis of price and in some Equity Research TEL Page 7

8 cases enjoy lower production costs for certain products. Therefore, increased competition results in price reductions, reduced margins, or loss of market share, any of which has an adverse affect on the results of operations, financial position, and cash flows. DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of TEL. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1116 companies covered: Outperform %, Neutral %, Underperform 6.4%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Coverage Team QCA Lead Analyst Analyst Copy Editor Content Ed. Reasons for Update 6B Supriyo Bose Lekha Gupta Lekha Gupta N/A Lekha Gupta Analyst Note Equity Research TEL Page 8