TE Connectivity (TEL) - A quality industrial stock I am watching
The Company designs, manufactures and markets products for customers in industries ranging from automotive, appliance, aerospace and defense to telecommunications, computers and consumer electronics.
TE has been doing great efforts in restructuring to boost margins as costs are pulled out of its business. The company is considered the world´s largest connector company with significant presence in the major markets, including auto, industrial, computer, and datacom markets.
Connector manufacturing generates strong free cash flow throughout the industry cycle, as the business model has high variable costs and low capital requirements.
Furthermore, it is considered that the company has plenty left over to service interest and pay dividends.
That is not all. TE Connectivity is permanently launching new products. Indeed these new products have accounted for 30% of sales in the last three years.
There is still a headwind TE may face: the cyclical and volatile demand for connectors and electronic components. Furthermore, the company is highly exposed to the auto and Telco sectors, which jointly represent 51% of the company´s revenues.
Despite these two not so good factors, connectors have long grown at rates above GDP growth because of a secular shift from mechanical to electronic products, and the industry has averaged 6% growth during the last 25 years.
Management's goal is to add 2%-3% inorganic growth to its top line annually, and the recent announcement of TE's intent to acquire ADC Telecommunications supports this claim.
Chief Executive Officer Tom Lynch said: “We’re also gained strength in many of our end markets by continuing to invest aggressively and engineering during the downturn. We now have about 7000 plus engineers around the globe, close to our customers designing products. We feel that’s our real strength of our company.”
What about last quarter results? Q4 has been a strong quarter for the company. With over $3.1 billion in revenues, the company has performed well.
Its adjusted earnings per share were $0.72, which involved a rise of $0.42 from last year.
Its adjusted operating margins also increased to 14% this quarter and that can be considered as an indication they have strengthened the company’s operating leverage and its consistently delivering about 14% margin at the $12 billion sale level.
Free cash flow was very strong at $443 million in the quarter as a result of increased earnings and continued solid working capital management.
Terrence Curtin, TE CFO has announced the quarter reports and has said: “Our free cash flow for the year was a record at $1.4 billion, an accomplishment we’re very proud. Our performance to the last two years continue to show our resiliency of our company’s cash during and certainly some economic turmoil.”
TE is a good pick. It presents an EPS ratio of 2.81. The stock is considered to have a reasonable value with PE of 13 and forward PE of 10, Price-to-sales of 1.26, PEG of 1.04 and ratio of Enterprise Value to EBITDA of only 7.35. As we can see in the chart, TEL is trading in the middle range of its most important multiples.
I like TEL at the current levels thanks to the cost saving strategy by means of which the company is closing inefficient plants and moving capacity to China. Altogether, they will create benefits on its bottom line in the coming years.
Long-term margins won't be as high as management expects, given the challenges that exist in connector and electronic component manufacturing. They will remain at roughly 13% even as the company grows revenues in future years, well below the 15% levels management believes it can achieve.
Anyway TE Connectivity has growth prospects, given the increasing electronic content in mature segments as well as expectations that the firm's share in markets such as medical and aerospace/defense will be expanding in the coming years.
Sales have increased 16% in 2011 and are expected to grow 6% thereafter in 2012-15.
What happens with Management?
Tom Lynch was named CEO of TE Connectivity in 2006. The remainder of the management team has deep experience in the electronics industry.
Positively, financial reporting is very transparent, with the information provided quarterly going well beyond the disclosures normally expected of a company.
Finally, 75% of Lynch's compensation was in the form of shares and stock options. Tom Lynch has talked about shares and stock options:
“Last month, we announced our board of directors approved the $750 million increase to our share repurchase program and we also planned to request shareholder approval for dividend increase of 12.5% as part of our annual meeting in March. This increase would be effective in June 2011 quarter when approved.”