Sensata Technologies Holding plc (ST) Earnings Call Transcript & Summary

Thank you. Hi. I'm Samik Chatterjee. I cover the IT hardware and networking equipment names at JPMorgan. The next company we are hosting for a fireside chat here is Sensata. I often like to point out to investors that this is probably the company I have been covering the longest. So thanks to Sensata for sticking around with my coverage for that long. But we have the pleasure of hosting CEO, Jeff Cote. We also have Jacob Sayer from Investor Relations with us. Thank you both for participating in the conference and making the virtual conference happen. What I would like to do is just maybe start with a brief background, Jeff, on kind of what Sensata is all about, what do you do, just to kind of level-set expectations before we dive into more detail in Q&A.

Great. Thank you very much, and thank you, Samik, for your long-term support of Sensata as well. We really appreciate it. It's been a good partnership, and I know you've gained a huge amount of knowledge about the company over the years. So let me start by sharing some key elements of our company for some of you that may not be as familiar, and I'll try to be brief to allow us to jump into some questions. But really, there are 5 key points. The first is that Sensata is a 100-year-old company. It's an industrial technology company. And although you may not know us, I can guarantee you that you use our products every day, in end products that you use in your home, in your car, in your place of work, in aircraft and mass -- other mass transit. So you definitely use our products and we keep the environment safe and you safe every day. We serve a number of end markets. And we're serving largely OEMs and tiers in those end markets. And more and more so, aftermarket customers as well as distributors in end markets such as automotive, heavy vehicle off-road, agricultural, other recreational vehicles, aerospace and a number of industrial markets in segments such as smart buildings, smart factories, clean energy and other diversified industrials. The third thing is that we're benefiting as a company from a number of trends in the overall market, largely driven by the need for more clean and efficient as well as safe equipment. Many of those trends are regulated by governments around the world, but there are a number of other trends which we benefit as well from -- such as the trend toward more electrified equipment, toward more smart and connected equipment, which requires more sensor content and other autonomous-related features, which requires sensors to enable those autonomous features as well. And these trends drive secular growth in our business above what the end markets that we serve would grow. We refer to that as outgrowth or content growth in our business, and we have a very well-established track record of significant content for secular outgrowth. The fourth area is around capabilities that we have, and I think we have a very strong legacy of designing and manufacturing very hard to do, mission-critical sensors and electrical protection, which helps our customers solve their most difficult challenges. And the scope of those capabilities has continued to expand over the years in terms of the sensing dimensions and other services and solutions that we would be able to provide for our customers. And more and more, those capabilities are extending beyond just sensor components into subsystems and other areas that we would be able to deliver insight, and I suspect we'll get into some of that in some of the Q&A. The last area is that we have a long history of continuous improvement as well as a company. That allows us to generate value for our shareholders in the form of a very efficient variable cost structure. In our core business, but also in the businesses that we acquire, there's often significant cost synergies as well as revenue synergies associated with businesses that we might acquire and it generates very high-profit margin in our business as well. When you compare us to some of our peers, our operating margin is quite high, supporting the fact that we're -- we have differentiated solutions. And those profit margins generate significant cash flow because we are not a capital-intensive business. We have a small portion of our overall cost structure which is fixed. And that provides for converting a lot of the earnings into cash, which provides flexibility for us in terms of other value-creating opportunities in terms of capital deployment. And I think over the last 10 years as a public company, we've demonstrated the ability to do that. So those are my introductory comments, Samik.

Jeff, thanks for that. So before I move to questions, let me just remind investors that they do have the option of sending questions in through the Q&A feature and we'll ask it on your behalf. And I mean, this is the first company I've seen questions come in even before I prompt the audience. So we're definitely seeing already a lot of interest. So I mean, let's first hit on the first topic, which is the kind of hot topic everyone wants to discuss is given the challenges in the automotive market this year, and totally appreciate the challenges on operating in such an environment, but at this point, what are your expectations for how does the automotive market shape up this year? And how are you positioning your company right now to just navigate this tough environment?

Yes. So we had our earnings call a couple of weeks ago, and we spoke to this topic. We, like many others, have not provided quantitative guidance in terms of the balance of the year given the overall market conditions that I think everybody is facing. However, we did share a fair amount of qualitative perspective. And in the automotive market, there is a large amount of third-party data that would be available to us and to all of our investors in terms of having an appreciation for what we're expecting in the markets. And so -- well I'll point to IHS data, for instance, which currently forecasts, for the year, for 2020, that North American automotive production will be down about 25%, similar levels for the European automotive market. And less so, call it 10% to 15% in the China market. So that results in a blended growth rate of down about 20% on a global market. In terms of what we've done to prepare for that, we announced on our recent earnings call that we believe that the second quarter will be at the low point. It remains to be seen, but certainly, in terms of the indications that we've been watching in terms of our customer end market shutdowns in terms of manufacturing plants and the expected recovery rate and restart of those, we would expect the second quarter to be the low point. On a short-term basis, we have announced a number of cost actions that we would consider to be temporary. Obviously, pretty deep cuts in discretionary spend. Our Board, myself and our senior leadership team have taken pay cuts to allow us to weather what we believe will be the toughest quarter in the second quarter, as well as all indirect personnel globally have agreed to either pay cuts or time out to the tune of about 25%. So those are the temporary measures that we put in place. And we have a very focused effort, given that the second quarter, we believe, will be the low point, and given the disruption that we're seeing that we'll be able to very clearly be able to weather through that, with lower levels of margin, clearly, but with expectations that we'll continue to generate positive cash flow during the second quarter. I think the more important question is what more normalized revenue will look like, and more normalized demand will look like. And we're spending a lot of time as a management team speaking with our customers, understanding what the indicators are to really look out to fourth quarter, first quarter of 2021 to understand what those more normalized demand levels will be, because any cost reduction actions that we have to put in place, and there will clearly need to be some cost actions that we have to put in place, more permanent cost actions. We'll make sure that we size to what that more normalized demand is. Aside from the cost structure, we've put in place a number of actions associated with reducing capital spend to manage working capital. We're monitoring very closely our payables, receivables and inventory levels to manage working capital. And we also, as a precautionary measure, at the end of the first quarter, drew down on our $400 million revolver to make sure that we had adequate cash on hand in any market circumstance that we would be able to face. And we were -- are currently at about $1.2 billion cash balance. So we feel very confident in not only continuing to generate cash, but if things were to deteriorate more quickly, we would have adequate cash to be able to manage through that.

Got it. Jeff, you mentioned kind of current IHS forecast for roughly a 20% decline in automotive production globally. That is fairly similar to kind of the 2008 kind of levels in terms of what we saw automotive production being down in the last kind of recession that we had or kind of the automotive recession in particular. When you compare kind of how the company is positioned today versus that time frame, I mean, I remember when I looked at the numbers, I think what it shows is you had actually margins improving, you had positive free cash flow during that time. But just remind us, how do you see kind of this decline in production? And how are you looking at navigating this? And how this is different from 2008 time frame, maybe on the cost side or even kind of on the content growth drivers? How are you positioned differently?

Yes. So I think that clearly, the market environment has some similarity but some stark differences in terms of the speed of the decline. I was the Chief Financial Officer of the company during the '08, '09 downturn. I remember it quite well. And it was a period of time, over a year or 18 months, where we saw a continued decline in the overall market. This has been obviously much more abrupt. And it adds complexity in this downturn given the shelter-in-place orders and managing through what our primary objectives have been in the second quarter, which is keeping our people safe and making sure that we continue to serve our customers. From a company standpoint, we are a more diversified business than we were then, more diversified geographically, more diversified from an end market basis and also more diversified from a product category in terms of sensing dimensions and solutions that we would provide. And we're also significantly less leveraged. We were not a public company back in '08 and '09. We were private equity-owned, and we had more debt on our balance sheet. And so those are the things that are very different. There are a number of things that are quite the same. And that includes our focus, our strategy around really zeroing in on mission-critical, hard-to-do products. That hasn't changed in the last 10 years since that time frame. The design and nature of our products, and therefore, the stickiness associated with the revenue that we serve to our customers. Clearly, if end markets are down and our customers are demanding less, that will have an impact. But the stickiness associated with the revenue and the secular growth, in terms of content or outgrowth, which you refer to, is similar. And we've been continuing to invest more in that to have steady content growth or outgrowth, so that when you do see an environment where the market, the overall market, is down, we offset a significant portion of that market downturn with content growth. And even more so in a recovery cycle where you have content growth and market recovery, you will see some more significant growth in our overall business, albeit off at a lower base, but you'll see that play through. The variable cost structure of the business is very similar. And I think most important, our management intent, in terms of looking at the overall long-term demand for the business, acting responsibly in terms of how we run the business, aligning the cost structure appropriately for the business and making sure that we balance appropriate margin profile with investment in our long-term future are things that have remained the same in terms of how we run the business.

Great. Thanks. So moving to then kind of discussing the recovery here. And I'll just take kind of the 2 questions that already have come in just because they kind of hit on the same topic here. The first one being how are auto restarts progressing versus your expectations? And the second one is on the same lines, but it's more on the sell-through where investors are asking, how is sell-through in markets that have started production earlier than others?

Okay. Great. So on the auto restart, so we've had more dialogue recently with customers regarding their planned restarts and at what levels they expect to restart. And so we've been modeling that in terms of what we would expect in terms of our overall recovery. It started with just -- for a very broad sort of 4 weeks of shutdown or 6 weeks of shutdown. But as we've been getting closer to when those restarts will occur or have already occurred, there is very specific conversation with our customers in terms of the time of start and also how it will ramp. And I would say that that's panning out pretty similar to how we had expected it. There was a period of time over the last 6 or 8 weeks where there were some extensions associated with the shutdown periods and some reductions in terms of what the start rates were expected to be. But over the last 4 weeks, there's been more stability on that front. And so we're seeing many of our customers start to already reengage and to start to ramp up their production. I think the second part of the question is the really important one, right? Because customers restarting is one thing. But if they restart and there's no end market pull for the product, then they're just going to build inventory. And that might help us on a temporary basis, but it's not going to help us long term because that will need to unwind. And so we're all going to be watching that extremely closely, the sell-through rates in terms of how you think about North American auto. For instance, we see the data on that. It's not very optimistic right now. But clearly, our customers are starting to ramp back up with production. My sense is that, that production will stay constant because they don't want to lose share as consumers come back and start to buy. Then I think there are some very specific dynamics associated with the environment we're in, where it might be benefited, the auto market might be benefited. So the desire to do more social distancing, perhaps less mass transit. Those are factors that I think would potentially bode well for a recovery. I'm not expecting a very sharp snapback, nor is anybody else, but certainly from a consumer demand standpoint. I think a place where we can refer to in terms of what we would hope the sort of recovery would look like, we have a market that we serve in China that is recovered quite nicely. It's certainly not back to its fourth quarter of 2019 run rate, but we've seen a snapback. Our factories are operating. Our customers' factories are operating. There are a number of incentives that have been put in place, both with the OEMs and with some of the governments, to incent more vehicle or other equipment purchases. And so I think based upon what we're seeing in the North American markets and European markets in terms of the federal support and the government support, we're expecting that there will be a recovery here.

Got it. On the -- just moving to kind of the bottom line impact that you've had here as demand has come down or production's come down. The first quarter itself, you had very high decrementals, and some of that is kind of associated with the costs that are still there, which obviously, in this environment, some of the costs are tough to take out. But if do -- we do end up having a kind of a slower-than-expected recovery or kind of an extension of the downturn in volumes we are seeing, just help us think through what can you do to moderate those decremental margins? What are we looking for as we kind of go through the next quarter or the one after that? What is -- how much -- kind of how much can you compress those decremental margins? And what levels can you pull before we finally start to go up on the recovery and kind of focus on the incremental margins on the way up?

Yes. So the speed of decline has a negative impact on the decrementals, right? So Paul Vasington, our CFO, on our most recent earnings call, talked about what makes up our cost structure. There's obviously a big part of that cost structure that's purely variable. It will move largely with the volume that we see from our -- in terms of demand from our customers. There are other portions of the cost structure that are semi-variable, meaning that they need management intervention in order to align those costs. And so given the dramatic drop that we saw during the first quarter and into the second quarter, we hadn't aligned our cost structure. So we saw more dramatic decremental margins in terms of the impact to the high 50% range in terms of drop-through of the volume to the bottom line. We've talked in our call about the fact that we're not planning to size the organization to the second quarter run rate because we think that's the low point. So decrementals into the second quarter will continue to be quite high. But as we start to come out of the second quarter, depending on the pace of recovery, so if we align our cost structure and then we get to more normalized margins and then there's a recovery, you won't see the snapback in margins because we will have normalized those margins in terms of sizing for the overall business. But if there was a quick snapback, then you would expect to see that come back very quickly. If it takes us a quarter or 2 because there's a new normal in terms of demand, you'll continue to see, not to the extreme that we've seen in Q1 or Q2, but you'll see margin profile, in terms of what you normally expect for Sensata, to be a little bit muted. And then once we get that cost structure in place, we'll get back to more normalized margins, and then you would see more of a variable recovery along with volume from that point.

Got it. Let me move to the kind of the segments or the end markets, in particular here. And one of the end markets, kind of the heavy truck market was -- I mean, was kind of challenged even pre-COVID in some sense. So wanted to get your thoughts on how you're thinking about kind of the magnitude of declines there. And when do you start to expect a recovery? Because some of that kind of downtick doesn't seem to be COVID-related, it seems to be kind of more of a usual business cycle-related downtick that you were seeing.

Yes. It's a good point because we started to see some of our -- some of the impact associated with the cycle, if you will, of the heavy vehicle off-road market starting really in the second, third quarter of last year. At that time, we had talked about what we historically have seen in terms of market cycles in that end market to be somewhere in the 18-month period. So without -- take the COVID situation out of that, you would expect that, as you go through the balance of 2020 and start to enter 2021, you'd normally expect to see some level of recovery. In terms of 2020 now, in terms of third-party forecasters, some examples would be on the on-road truck in North America, they're expecting a 2020 decline of 40%, 45%. On-road truck in Europe, again, around 40%. China is less so, around 20%. These are all numbers, end market-focused rather than net, because remember, we have very strong content growth. The first quarter in the heavy vehicle off-road market, we saw about 900 basis points or 9% content growth, which offset these market declines. But pretty significant overall market declines. Across agricultural and construction, again, forecasters would predict somewhere in the 15% to 20% decline range during 2020. I think these are a fair bit steeper given the COVID impact than we would have originally anticipated. But nonetheless, the market cycle would continue. And as we start to think about this market going into the first quarter of 2020, we would start to see -- excuse me, 2021, we would start to see some level of recovery in those markets from that point forward.

Maybe then just kind of on the heavy truck market. Because you started to see the declines kind of even pre-COVID, as we look at the recovery in this end market, are you kind of differently placed given the combination of higher content growth as well as kind of the cost structure being more aligned to get higher incremental margins in that business on the recovery?

Yes. Well, that business is pretty consistent with the overall margin profile of the company. So we have a number of different end market segments. The heavy vehicle off-road market is pretty consistent in terms of the overall margin for the company. But if you will look at that business segment on a stand-alone basis, it's not dramatically different from some of our other business in terms of the mix of the overall cost structure. Certainly, in a higher growth recovery market, you do tend to see a little bit more leverage in terms of your fixed cost structure in the business. So higher growth will benefit us in terms of being able to manage through that. I think it's important to sort of highlight, though, that we're constantly balancing what we invest in the future, and these are all very long-cycle businesses. This is one which we have -- we see lots of future opportunity. It's also an area where many of our megatrend-related areas is focused in terms of on-road truck. So there's a lot of investment that's occurring, and we'll moderate what drops to the bottom line in terms of long-term growth investment associated with the future. What we can promise is high levels of differentiated margin profile. But the balance between how much we invest and how much we drop to the bottom line will be something that will be based upon what we see for opportunity.

Got it. You mentioned the megatrends, and that's been kind of a focus for Sensata for a while here. But just given this disruption, are you seeing any need to push out the investments on the megatrends because the customers are looking to push some of that as kind of not being that high priority at this point? Anything moving on that front?

Yes. So we've been focused on megatrends associated with efficiency and safety and so forth for our tenure as a company, right? So those have been megatrends we've been focused on. More recently 2, 3 years ago, we've started to focus in on more associated with electrification, smart connected, autonomy-related as megatrends which we think will be opportunities for us in the end markets that we serve. We're seeing no evidence, in terms of our customers, meaningfully changing their point of view as to where they need to go on these megatrends. I know there's a lot of talk around the world in terms of potentially pushing out some of the regulation associated with emissions because of COVID-related, but we're talking about pushes that are 90 days, sometimes 6 months. They're not meaningful changes in terms of the regulation that our customers need to meet and the customer pull that they're seeing associated with these other features associated with electrification and others. The interesting thing is even with oil prices where they are, our customers want to continue to invest in platforms going forward associated with electrification because at the end of the day, that's really about emissions management as opposed to the oil price. Clearly, total cost of ownership comes into play on that. But I think we're getting to the point where there's close to parity associated with that even into lower ranges of fuel price.

Let me just remind investors that we -- you can still send in questions through the Q&A feature, and I can ask it on your behalf. Jeff, just continuing on kind of that megatrend thought. Relative to a few years ago, like when I was kind of -- I remember you had to kind of consistently defend the bear thesis on content on electric vehicles for Sensata. And that's an aspect, I think, where the company has made significant strides over the last few years. So just -- I mean, help us kind of understand what those big changes have been. And right now, how are you positioned if the industry does still move towards electric vehicles, in fact, in a more assertive manner coming out of this, how are we kind of -- how do we see Sensata positioned for that?

Yes. Thank you, first, for acknowledging our progress on this megatrend. I feel as though we've made huge progress as well. If you rewind the clock to 3, 4 or 5 years ago, the notion of electrified vehicles was always viewed as being something that was much further out, primarily due to the fact that the range of these vehicles and the charging times associated with these vehicles didn't meet consumer expectations. And as well, the infrastructure associated with being able to charge vehicles had not been invested in at a level that would allow that to be a viable option. Obviously, all of that has changed. The cost, the battery pack cost, the range of electric vehicles has changed dramatically. And we acknowledge that very early on, given our intimate understanding of what was going on in the automotive market. And we started investing organically in capabilities that would allow us to serve this. And our mantra has been quite simple. It has been that as there's a shift from combustion engine to electrified platforms, that should be a significant tailwind for us as a company rather than a headwind. And we knew that if we didn't invest in capabilities, in solutions that would allow us to be able to maintain our significant relevance in the automotive market in an electrified world, that we would fall behind. And so there are a number of investments organically, and there were some very strategic inorganic investments, such as the acquisition of GIGAVAC, which is a -- one of the 3 or 4 global players in high-voltage contactors, which is a mission-critical application for electric vehicles. That was a strategic acquisition that we did at the end of 2018 to allow us to make sure that we were able to go to investors, go to our people and tell them that the trend toward electrification was going to be a tailwind. And I feel really good about that. We've been sharing some data points that prove that out. So for instance, in the first quarter of 2020, about half of our total new business wins in the first quarter of 2020 applied to electrified platforms. Now that's not only in the automotive space, right? There are other trends in other end markets. The charging infrastructure in our industrial business is a very fast-growing business that also uses high-voltage contactors and other products and solutions that we have. So we feel really good about the progress we've made and the position that we have in electrification broadly as a trend impacting our customers.

Jeff, another megatrend that we've kind of seen Sensata significantly ramp up on is the Smart & Connected megatrend and you've kind of steadily built a portfolio that has started to gain traction with customers on that front. So maybe help us think about kind of what's driving the traction? How much of this is relevant to the heavy truck market versus kind of the automotive market? And where do you see kind of this portfolio eventually sizing up in terms of are you looking for more kind of acquisitions on this front? Or is this going to be more of organic opportunity longer term as well?

Yes. Great. So we've labeled Smart & Connected -- you think of it as an IoT play, right? And IoT is a very broad topic. It's impacting all of these end markets. At the core, it's about the need for more -- or the desire and need for more data to make operations more efficient, to make vehicles more efficient and to just drive more efficient, safe environments. And so really, where this was born for Sensata is out of what was an acquisition we did back in 2015 of our tire pressure monitor business. So we bought the Schrader tire pressure monitoring business. When you start to think about tire pressure monitoring being required outside of a light vehicle environment into an on-road truck environment, there are significant added complexities associated with moving to tire pressure monitoring in what is an 18-wheel vehicle with sensors being further apart and also having tractors and trailers not be permanently mated with each other. So the ability for a tractor to back up to any trailer and have a seamless connectivity between those 2 pieces of equipment to be able to do tire pressure monitoring. As we engaged with our OEM customers on the implementation of tire pressure monitoring in an on-road truck environment, that turned into more the development of a vehicle area network. So think about a mechanism to enable that pairing, to collect the wireless sensor data, connect it to a telematics device, whether it be OEM-owned or aftermarket, and feed a broader telematics ecosystem. And so that vehicle area network then clearly has the capability to collect a lot of other sensor data, right? It's not limited to just tire pressure. And so it really started as an opportunity with our OEM customers. We've got significant traction there. We talked about that in our last call that we have over $90 million of won business associated with our Smart & Connected initiative, but this is what our Smart & Connected initiative is within the company in our OEM business. But even more exciting, we have a number of engagement with fleet customers. So we have 5 pilots going today with some of the largest North American fleet managers to implement this solution in an aftermarket scenario and to collect other sensor data. So we've been working with them on the really critical applications other than tire pressure, load management and also wheel end monitoring to make sure you don't have a bearing wear or failure situation, which obviously can cause a major disruption in terms of the overall logistics chain. And we're working with them to actually collect data and to pursue this. And it's all with the notion of feeding a broader telematics system to provide more data to improve operations and safety in fleets running around the world, but in North America primarily today.

Jeff, as we start to wrap up here, the last question that I definitely want to hit on is, I mean, over the kind of time I've covered Sensata, there has been this kind of initiative to look for acquisitions to diversify the business and kind of -- outside of the automotive market and not necessarily that you want to stay away from the automotive market. But given the growth -- higher growth in the automotive, it kind of naturally increases your exposure, so you want to diversify to some extent. How are you thinking about kind of that as a long-term priority? Do you want to accelerate that? I mean, you've just recently taken over the CEO role, how are you thinking about that as kind of the time line of that priority?

Yes. So it will continue to be an important part of our long-term strategy, M&A, there's no question. We think we're really good at it. It allows us to diversify, add on additional capabilities, end markets that we might serve and making sure that we do that in a very shareholder value-creating way, right? It's not just diversification for diversification's sake. We have a very strict and appropriately strict methodology to understand the right returns that we'll be able to generate, that will be a good return for shareholders. And we also temper that given overall market environment. So in the current market environment, we're not stopping our M&A activity, but the -- how big the moves would be, we're making sure that we do it in a very responsible way so that we don't do anything that would be endangering the core part of the business, which is so valuable. So it will continue to be important, and we'll continue to be very focused on the areas that will provide significant growth for us going forward.

Got it. Jeff, Jacob, thank you. That's kind of -- we're running up against time, and I do want to keep everyone on schedule given how back-to-back kind of all the meetings are. But thank you, both. Thanks a lot for attending the conference and making the virtual conference happen. We can't do it without you guys. Thank you.

Very good. Thank you very much for having us.

Thank you.