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

Thanks, everybody, for joining us. My name is Mark Delaney, and I cover the auto and industrial tech sector for Goldman Sachs. I'm very pleased to have with us today, from Sensata, the CEO, Jeff Cote; and the CFO, Paul Vasington. As many of you know, Sensata is a leading provider of sensors and electrical protection products, and they sell primarily into the automotive, heavy vehicle and off-road, industrial and aerospace end markets with about $3 billion in annual revenue. Jeff, Paul, thanks for joining us.

Thanks for having us.

We will be taking questions via the webcast page later in the session. So please go ahead and submit those, and we'll get to as many as we can. Jumping into it, Jeff, I wanted to start with a question for you. It's been about a year now that you've been the CEO of Sensata. Maybe you can speak to what you're most proud of having achieved so far and what your key objectives are going forward.

Yes. I'd be glad to. So I think most of you know that I've been at Sensata for 14 years. So this is a new role-free, but certainly not a -- I'm not new to the company. I've held a variety of roles including -- I came in as the Chief Financial Officer back in 2006, but I've held the role of Chief Operating Officer and President running both business segments. And now I've been fortunate enough to be given the opportunity to lead the company as the new CEO. Timing, of course, is everything. So I took over last year right around the time when the pandemic started. And in terms of what I'm most proud of, Mark, I think I'd start with how we managed through that time. I've always known that Sensata is a very resilient organization. But we, very early on, established a very clear mission for ourselves, and that was to take care of our people, keeping our people safe and serving our customers. And through what was a very volatile year, a steep drop in Q2 or a fast recovery in Q3 and what was basically a record quarter in terms of revenue in Q4, I'm really proud of how the team managed through that. And while we were going through all that, we had record cash generation. We also took action around managing the cost structure of the business. You know that we implemented a restructuring program in the second quarter. We tapped into historically low debt markets in terms of interest rates. We then announced the takeout of a more costly tranche in our debt, 6.25 tranche of our debt. So a lot of great accomplishment in what was a challenging year, to say the least. In addition, I think we made some great strides on our strategy as well in terms of where we're going looking forward, not just managing the business in the near term. We had very strong outgrowth in 2020, above our target ranges in many of our market segments. We closed $465 million of new business wins in a period of time when our customers were delaying some of those. We did a small acquisition of PRECO for radar solutions and Lithium Balance on battery management, both of which we believe will further our strategy. And we also made some good -- really good progress against the megatrends that we talk about. So it was a very busy year. I'm proud of all of that, but I'm very excited about what the future holds for us and the progress that we're making that will continue to make Sensata a great company for the many years to come.

That's a great introduction and I think dovetails to what I was hoping to speak on next, which is electrification and EVs, which is a big focus for the whole automotive, electronic component industries, including for Sensata. Let's talk a little bit about the content step-up that Sensata has. We were speaking on the last earnings call. It's about a 20% step-up on average. Of course, every vehicle is going to be a bit different. But what drives that content step-up for an EV compared to a traditional internal combustion engine or ICE vehicle?

Yes. I'd be glad to address it. So again, we are trying to be extremely transparent regarding what we're seeing. We spent a fair amount of time in past earnings calls and in investor discussions demonstrating the uplift. We're excited about the fact that the transition from combustion engines to electric vehicles will represent a tailwind for us, 20% tailwind. I think that a lot of investors may misunderstand or we're not communicating as clearly as we should about the fact that a lot of content on the combustion engines applies in an EV platform. And so our estimates are better than 50% of what we serve in current vehicle -- the light vehicle market carries over. So braking systems, tire pressure sensors, pressure sensors for air conditioning and environmental control, so there's a lot of content that applies in the new environment as well as the organic activity that we have around e-motor position, battery management from a monitoring for thermal runaway in a battery system. The acquisitions that we've done on in terms of high-voltage contactors, which is a great opportunity for us to be able to serve the market and what are really hard to do mission-critical applications. So we're excited about that. But we look for proof points, right? So that's -- those are all words, but we look for proof points. And the fact that in 2020, about 5% of our automotive revenue was from electric vehicles when only about 3% of the market was electric vehicles should be a demonstration in support of the fact that it creates a tailwind for us. The last thing I would say is we're not done, right? So that's what we see line of sight to right now. We're going to continue to go after winning new business. We're going to be very clear about what we win that are indicators in terms of our progress on that. And we're looking very holistically at the trend associated with electrification way beyond light vehicle, way beyond on-vehicle on-equipment. And so some of the things that we've talked about in terms of lithium balance and the battery management, and the opportunity that opens up in heavy vehicle and industrial on equipment, but also the broader ecosystem around charging infrastructure, grid management, it opens up big opportunities. And I think everyone knows, those will be very growthful markets, and they have a lot of mission-critical applications that we can serve as a company. So we're excited about that trend.

Yes. No, it's very interesting. So some of the contents coming from your existing portfolio, you're winning business at some of the big important EV OEMs, but you've also done some M&A. GIGAVAC, in particular, comes to mind as one of the more important acquisitions the company did, I think, about 3 years ago now that helped to augment the portfolio. You touched on this already. You're not done. So are there other types of products like high-voltage contactor with GIGAVAC, that sort of a thing where you say, hey, there's still a piece of our portfolio that we need to go at?

Yes, there absolutely is. And so there's a lot of discontinuity in the end markets that we serve, right? We -- I -- we -- many people have talked about the fact that there will be more change in the automotive end market over the next 10 years than there has been over the last 50 years. So that discontinuity creates some risk, but it certainly creates opportunity as well. And so we've done a very extensive job of understanding what that shift means to us. We've engaged deeply with our customers regarding their road maps and what most challenging problems they have that they're trying to solve that we might be able to burn to bear. And we'll look at that from both a standpoint of what could we do organically. And when you talk about that as our megatrend initiatives, and we're investing a lot more there, as everyone knows. We're targeting about $55 million investment in developing those new products to serve that market that we know that, that comes at a price in terms of lower margin profile that investors are funding. But we believe it's a worthy investment, given the opportunity that we see going forward. As well as we will look at inorganic opportunities like the GIGAVAC, like Lithium Balance. Some will be smaller. Some will be a little bigger. But they'll be bite size, and they'll be specifically focused on those megatrend areas associated with electrification and Smart & Connected as we build that pipeline to grow the content in the markets that we serve.

Paul, maybe I can ask you this next question and how you're thinking about being efficient with your capital allocation and approaching some of these companies in the EV space. There were some EV company logos you were able to disclose in the last earnings call, a company like Rivian and Lucid motors, right? And there's a number of these pre-revenue EV startups. And so it represents a lot of growth potential. But I would think a company like Sensata has to be thoughtful about where it goes in terms of allocating resources to help some of these customers. How do you think about going after that type of a customer set, but also still being efficient with your operating expenses?

Thanks for the question. So capital allocation, we continue to look at our ability to deploy capital quite favorably. So we're at 3.2x net leverage now. We have a range -- target range of 2.5% to 3.5%, so inside that range as our earnings continue to grow. Coming out of the pandemic, the leverage -- the net leverage will come down. And we've talked about these transformational growth factors that we're focused on around electrification and also Smart & Connected. Don't want to not give a [indiscernible] to that. And so our M&A bias and focus, inorganic growth is in those 2 growth vectors. And so we're looking for high-value, high-growth targets that are strategically aligned to those growth factors. And we'll continue to pursue opportunities there and deploy capital in that area, because we see that as a tremendous growth opportunity for Sensata. We have tremendous free cash flow. We will continue to invest in the business. We'll continue to invest in capital expansion to support the demand and the growth that we're seeing. And that's part of our everyday business that we run and that we think we do very, very well. Free cash flow this year was extraordinarily strong, given the earnings. So we are at 130% conversion. Next year, we think we'll be around 85% conversion, so still very strong conversion. This year, we saw the benefit of lower CapEx, because we knew that the economic conditions were weak. And so we knowingly deferred up a bunch of projects into '21. We also started tremendous improvement around inventory. So we reduced our inventory levels. It was a concerted by a dedicated team to drive much better inventory management. So going forward, free cash flow will continue to be strength for the company significantly. It'll give us the fuel to go and deploy capital, both internally and externally and also to fund our megatrend initiatives. And we talk about the megatrends as being a significant investment in our future. We isolate it for investors to see what it is. That is not a foregone conclusion. Obviously, that spend needs to support very small effective investments in future business models that we think will be -- will scale quickly, grow quickly and be very differentiated in the markets that they serve. We're targeting $50 million to $55 million in 2021. That's the plan. That will -- that spend will be deployed based on the merits of the investments in products. A large product spend is related to our Smart & Connected initiative, which we feel -- we're very excited about. We think that's a great market to enter. We're making a lot of progress over the last couple of years. So we've only been in for a couple of years, but we're making great progress. I'm sure Jeff will want to talk about it more. But that's how we see the capital deployment landscape based on the opportunities in front us and the strength of our financials and the strength of our cash flows.

Okay. Yes, that makes sense. I have a few questions later on in the session around Smart & Connected and the efforts there. So I absolutely want to get into that in a little bit. Maybe if we could stick to EVs, Jeff, you and I have talked before about the wireless battery management system opportunity that the company has been pursuing for a few years now. You mentioned you have -- an acquisition you did recently, Lithium Balance, I think it's a little bit more geared toward heavy vehicles. But for light vehicles, I think the company has been working toward a wireless BMS product. It's still prerevenue. Can you give us an update on that?

Yes, I'd be glad to. So we continue to believe that we've got some interesting technology in terms of being able to do wireless battery management. And really that stems from the fact that we probably are among the leaders of wireless sensors, given our position in tire pressure monitoring. And so we have a strong capability there in terms of being able to transmit data wirelessly. And so it continues to be an area of focus for us. But certainly, with the investment in Lithium Balance, which is a small company, but an important one because of the size of markets that it opens up, their focus was on wired battery management. And what they brought is the software side of that battery management functionality. So it very much complemented our, if you will, hardware and wireless communication protocol expertise with the software side of what they're doing in terms of managing the charging and discharging process itself. Right now, the wired battery management market is well served in light vehicle. And we see some opportunities in both industrial applications associated with grid management and also with more medium-duty or heavy-duty vehicles as that transition occurs as well. It opens up large markets, right, the industrial, HVOR, on-equipment market, it opens up another $500 million market for us. When you think about going into broader energy storage, that's a much larger market. That is inevitable as well. And so we're excited about that. We continue to invest on the wireless side, but we believe, right now, the more near-term opportunities will be on the wired. And over time, we'll be able to complement that with our wireless capability as well. So more to come on that, but we're engaging with customers, but it's just it's a slower take rate, and we're seeing more on the wired side currently.

Okay. That's helpful. Charging infrastructure is one of the big investment opportunities when we think about what's going to need to happen in order to enable the transition to electric vehicles. Is that an area that Sensata can participate in?

Yes, absolutely. So it's inevitable, right? With the increase in EVS, thinking about the charging infrastructure and broader grid management to have distributed generation and storage will be necessary. And so that is an area where we can focus not only on the content side, because we provide contactors into charging stations and other applications in energy storage today. But the battery management aspects allows us to go further up the stack. So it's an area that we're focused. It's a pretty hot area right now. But it's something that we believe we have a right to play. And we'll continue to serve these markets, and they represent some meaningful growth opportunities for us, both organically and through potential add-on acquisitions like the Lithium Balance or maybe a little bit bigger in terms of where we might go.

Okay. That's helpful and certainly something we'll keep an eye on going forward. Maybe we can transition into the Smart & Connected opportunity. We've touched on it a little bit, but I'd like to discuss it in more depth if we could. I think the company said on the most recent earnings call, it's now recorded about $100 million of business wins in Smart & Connected. You're engaged with some heavy fleet customers for that product and potentially could be getting some revenue sometime soon. So maybe talk a little bit more what that product is, what the revenue opportunity is and when you expect to start reporting revenue.

Yes. So the $100 million relates to the sold business on the OEM side. So in addition to that, which will convert into revenue as those products launch, we've taken this offering to the fleet market or the retrofit market as well. And on that side of the house, we have about $145 million of quotes outstanding, total contract value quotes, which translates to about $45 million of annualized revenue. Now we're not going to realize all of that, but it's just to show the magnitude of the momentum that we have on that side. That's with 5 fleet managers, 5 large fleets. So let me talk a little bit about that some of the quantification of the opportunity -- let me talk about what the opportunity is. So if you think about on the OEM side of the world, on-road trucks for North America and Europe are required legislatively through regulation to implement tire pressure monitoring. I think it's late this year for Europe and 2022 for North America. We're an expert, and we have a leading position in tire pressure monitoring. But there are some unique requirements associated with an on-road truck because of the distance between the sensors and also because of the need to have a seamless truck-to-trailer link. So when a tractor backs up to a trailer and you want to be able to link all of the tire pressure monitor sensors to that system, so you understand what's going on there. And so we developed what was the vehicle -- what is now the vehicle area network, WiFi for the vehicle that would collect that information and feed that tire pressure monitoring system. As we developed that for OEMS, we realized and started to get pull from fleets that said, okay, if you have this WiFi network, if you will, or vehicle area network on a truck or on a trailer, you could now start collecting other sensor information to feed a broader fleet management system. And fleets are are really looking for more data to make their fleets safer and more efficient. And so there's a pain point there for them in terms of improving how they operate, both from a safety and efficiency standpoint. And so that's what led to the opportunity there. Now it's a complicated ecosystem, right, because you have telematics companies, you have fleet management offerings, you have some fleets that have their own fleet management software. But we believe that we have a developing offering that will be able to provide sensor content, if they want, vehicle area network content. We have a cloud that we've stood up to serve those fleets. So if we can pull that information to the cloud and provide more data insight, to the fleet, we can do that. So we've got what is a, I think, a really exciting and compelling offering to be able to drive more efficiency in this ecosystem. So more to come, but it's an area that we're investing and we are quite excited about.

Yes. It makes a lot of sense. And I think the business model is a little bit more of a subscription one. Maybe talk about how you think about pricing that. Any other implications around the business model and how that's different than your current approach?