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

Hi. Good morning. I'm Samik Chatterjee, the networking and hardware analyst at JPMorgan. Welcome to the TMC Conference, from JPMorgan. For the first session in the network and the hardware coverage that we're hosting as part of the conference, we have Sensata, a company we've followed for a long time, really a lot of discussions nowadays, given some of the changes that are happening more recently. So it's definitely a good time to have both Jeff and Paul here with us to go through some of those changes as well as the outlook for the company. So Jeff Cote, CEO; Paul Vasington, CFO, both are with us today for the session. The way we'll kind of run this is do a fireside chat for the addition of, hopefully, 30, 35 minutes. You, as part of the audience, do have the option to send in questions. [Operator Instructions] So with that, let me thank Jeff and Paul for taking the time to participate at the conference.

Jeff, I do want to start with a more kind of broader question for you, definitely, given that is the reason we're seeing a lot of discussions around the stock right now, which is it's been more than a year for you in the CEO role, although you've been much longer kind of as part of the company, how would you outline some of the strategic changes that have happened in the company over the last year? How is the company now positioning itself differently for some of the mega trends than a few years ago? And clearly, investors are expecting a lot already.

Great. That's a good starting question. I think you know what everyone knows that I've been with the company for going on a little more than 14 years now. So I'm not a new management team member. I've held a number of roles at Sensata. I came in as the CFO back in 2000 -- late 2006. and I've been in the Chief Operating Officer role and the President role running the 2 business segments. So I've had a broad range of responsibilities. And I've also had the honor of working with the 2 past CEOs with [ Tom Wroe and with Martha Sullivan, and now I've been given the opportunity to take on the CEO of this great company, and I couldn't be more thrilled. Timing is very important. So last year, in March, I probably could have picked better timing to take over the role, what we've learned a lot over the last year. In terms of the strategy, really, a couple of years ago, we started to pivot the strategy to focus on these mega trends. And the reason -- the obvious reason why we did that is because the trends of electrification, autonomy and smart connected or IOT will impact our customers' businesses more in the next 10 years than they have in the last 50 years. So there's major disruption occurring in all of the end markets that we serve, and every one of our customers are investing in these megatrends to make sure that they can maintain their strong market positions, and we're investing alongside them to make sure that we can maintain our positions and ability to serve them. And that's happening in the form of both organic investment and inorganic investment through M&A. So that there's no major shift in our strategy, although I would tell you that we and our broader Sensata management team over the last 1.5 years have really doubled down on the mega trend investments. And we've also modified our M&A element of our strategy slightly to be more of a serial bolt-on acquirer as opposed to what has historically been more lumpy M&A that we focused on. So our goal is to acquire businesses every year. Now that will be market dependent. We will continue to be highly disciplined in terms of how we think about M&A. But that more serial bolt-on M&A will be very focused on the megatrend areas. And as a result, the markets that we're focused on will tend to have higher growth. We'll have accretive growth for us as a company while maintaining on the focus of product and solution differentiation, which drives superior margin index. So that's the slight tweak in terms of the strategy, M&A focused and more serial bolt-on as opposed to more lumpy M&A.

Okay. Great. So Jeff, I already see some questions coming in, but let me get some of the longer-term topics here in most. So one of the changes as you even outlined kind of where you're making tweaks to the strategy. One of the changes I've noticed is Sensata primarily was positioned as a Tier 1 supplier to OEMs, with some of the acquisitions now you're kind of moving into the fleet operator market, for example, which isn't really the traditional kind of Tier 1 market that we see with other suppliers. You're obviously kind of moving -- you were perceived as a company with leverage to powertrain and emission regulations, and now you're kind of talking about connectivity on vehicles. So just kind of help us think about how does company looks 5 years from now? Does it look like a very traditional order supplier? Does it look very different from it, given some of the changes that you're pursuing?

Yes, definitely. So we're definitely expanding beyond just sensor components in terms of our capabilities, and we're expanding in the broader hardware and software solutions. And so some examples of that would be the battery management systems, data insights for fleets are smart and connected. And we see that as an opportunity because they're faster-growing markets, but also because our customers are pulling us there. The core sensing capability of our company remains the building block for those broader applications that we might be pursuing because those sensors and devices ultimately are measuring and capturing data to feed a broader system play. But we're getting pulled there. We're seeing opportunities from an internal development and organic standpoint to extend their. And at the core, we're going to extract value in terms of capturing information and feeding that to either customer systems or systems that our customers would prefer that we build and deliver for them. But at the end of the day, we're still delivering solutions, we're helping our customers solve their most difficult challenges. And our solution sets will match customer needs as we think about where we'll invest and what Sensata will look like. But clearly, we're migrating our product portfolio and solution set to be broader than it historically has been.

Got it. Let me get down to some of the more near-term questions. And I'll kind of ask my one and then I have a follow-up on the chat on a similar line. So coming back to kind of the near-term here, what are we hearing in terms of real impact of the semiconductor constraints on the production outlook? And particularly, I think everyone wants to know when do you start to expect that to moderate from here on?

Yes, it's the million-dollar question, right, in terms of how that's going to transpire. Originally, when we gave guidance for the year, we expected it only to be a first half phenomenon. Clearly, it's going to take longer than that to work its way out. We believe that the first half is going to be a little bit more challenged than the second half. We've articulated that in terms of how we've guided the financial impact associated with the supply chain shortage. But at the end of the day, if you think about what's causing the issue, it's because we -- at the end of the day, there's a capacity constraint, right? There's more demand than these electronic suppliers can support. And the only way out of that is diminished demand or more capacity. I'm rooting to the latter, right? None of us want lower demand to solve the supply chain problem. Based upon what we're seeing in terms of demand profile, it looks like demand continues to be quite strong. I see those suppliers adding capacity, but that's going to take some time to happen. And so we think process improvements will ease some of that constraint in the second half of the year, but we don't see this fully being resolved until that capacity is put in place, and that means probably a 2022 time frame in terms of it going away completely. Supply and demand will equalize over time, but those are long-term investments that need to be made and work through.

Let me take the question that came in here from the audience. [Operator Instructions] Jeff, getting to the question here. The question reads, there were some production cuts, particularly force cut after issuing second half and second -- 2Q and second half guidance. How much visibility do you have into these types of cuts ahead of time? Just trying to understand what assumptions were embedded in guidance?

Yes, absolutely. So our customers adopt a just-in-time model. IHS recently came out with a little bit of cut to the second quarter forecast, but they rolled it into the second half of the year. When we gave guidance, we shared that our order book was more full than it historically has been in terms of booking rate. So we had a lot of visibility into the second quarter. And so any impact on the second quarter will impact, I think, the second half of the year. We view demand with our customers to not be perishable, right? These are durable purchases on the part of end consumers. And if they can't get what they want in terms of a car or new appliance in the second quarter due to supply chain constraints, that demand will likely fall into the third quarter or fourth quarter. So I don't think it changes in a meaningful way what we expect for the full year, although we'll get a better read of that when we understand where Q2 lands and therefore, what it looks like for the balance of the year. And you'll note that we had a range of guidance in the second quarter that was appropriate given the visibility we saw and the volatility that we're seeing in the market.

So yes. And again, as a reminder, if you have questions, please feel free to send them in. Let me see if I can bring Paul in here to kind of remind investors of 2 things. One, the megatrend investments and the magnitude of that investment as well as the likelihood that it kind of ramps further into the out-year as you focus on the strategy that you're talking about? And secondly, just the semiconductor constraints and the headwinds from that, how should we think about 2021 impact, but how should we think about that moderating into 2022? And does that give you more flexibility to accelerate some of the megatrend investments?

Sure. I'll start with the megatrend investment. So we're targeting around $50 million to $55 million for 2021. We're pretty close to that run rate now. The investment is in our key growth factors of electrification and smart connected. The smart connected is probably 2/3 of that investment or nearly 2/3 of that investment. And those investments are in pursuit of new business model. So the smart connected effort is a new business model. It is segregated within the Megatrend segment because it does not today have revenues or has very little revenue, but we believe those to be large opportunity that will scale to significant revenues over time with differentiated margins as we're offering differentiated solutions to our customers. They go beyond components in some respects, where started out thinking about more integrated solutions, providing data insights to our customers. We're taking the information that comes from sensors and delivering that into a more meaningful useful way. As we go forward, it's opportunity driven. I'm not expecting it the number to grow, but it will be, I guess, determined based on the opportunities that are in front of us and how differentiated they are, how scalable, how large? And as they happen, we'll share that with you. So the amount could go up or to [ own bake ] something opportunity in front of us. As it relates to the chip shortage, we talked about the impact of the chip charge being a combination of logistics costs and material price increases of about 1% of revenue. So in the range of $40 million for the year. As Jeff said, it's 60%, 40%, 60% in the first half, 40% thereabouts in the second half. Haven't obviously given any perspective on 2022, but as Jeff said, if demand remains high, capacity grows, and it could take some time for our suppliers that work themselves out of the suppl crunch. So it could likely spell into '22, but difficult to have a read on that right now. But clearly, it's abnormal costs that we're dealing with today. And hopefully, it will libate over time. We'll do our best to work with our customers to share that cost with them over time. And our customers are raising prices. And so obviously, they're benefiting to some extent. So it's a couple upon us to go and work with them and try to pass some of that off. But again, still all work in progress.

Got it. Going to a question that I get from investors nowadays, particularly following the 1Q results, where most of the kind of auto companies we looked at or the companies that we cover auto suppliers, they tended to show or demonstrate that outperformance to the industry experted in 1Q? And that's leading to some investors to think that maybe some of the OEMs are prioritizing volumes that are like higher content, high-end vehicles and hence, the outperformance for some of the suppliers is higher than normal at this point. Just wanted to get your kind of impression of what's happening on the ground? Is that really -- how the OEMs are kind of tweaking their production lines? Are they prioritizing some of the high-end vehicles, which is leading to an outsized outperformance, which might not be as sustainable?

Yes. I think it absolutely does have an impact. So let's start with the supply chain shortages resulting in shortage of product for our customers to sell. That was exhibited in the form of 39 days of inventory in North America vehicle at the end of the first quarter. That's pretty low. And I hear frequently from people who are shopping for new cars or for that matter, appliances or other durable goods that there's a waiting period of lead time for those products. That's a very unusual time for us to be in. Now what our customers are doing is they are prioritizing their available capacity and available supply chain to go after the vehicles that are of higher value have more content than Sensata is benefiting from that and contributing to higher outgrowth. The exact amount is hard to pinpoint, but we're well above the 400 to 600 basis points in automotive and the 600 to 880 HVOR in the first quarter, we were 910 basis points about growth in auto and over 1,000 basis points in HVOR. Some of that is more permanent outgrowth in terms of content per vehicle in electric vehicles, for instance, that's going to stick with us over time. But the mix of vehicles and the prioritization that is occurring to higher value, we think will normalize over time. So we have not raised our expectation in terms of the guide, but we feel really good about not only the market recovery, the strong outgrowth and the M&A opportunities that we see to really propel growth for us as a company.

Okay. That's clear, Jeff. So that's a good segue to then move into the content-per-vehicle discussion here. Like clearly, GIGAVAC was one of the key drivers in getting the content per vehicle on an electric vehicle higher. And now I think the latest numbers that you've quoted are around $50 per vehicle, how should we think about kind of further opportunities from here? How much kind of are you seeing in the pipeline relative to organic? Or how much are you thinking kind of inorganic opportunities can be leveraged when it comes to the EV pipeline and improving or further increasing that content per vehicle beyond $50?

So mission #1 was to make sure that the transition from internal combustion engines to electride platforms didn't hurt Sensata. And we're well beyond that now. And I think we've demonstrated that as a result of the shift from internal combustion to electrified vehicles being a tailwind for us, 20% uplift on average. So we feel really good about that. There's been a lot of work, both organic and inorganic to drive that. But we're not done, right? So we're going to continue to pursue this. There are other applications that we can pursue organically and inorganically. We have a shopping list of things that would be interesting. But you're hearing about them. For instance, the JV with Schrader is an example where we're broadening the portfolio that will broaden the base of business that we have, and it will increase that uplift from where it is today. The way we measure that is new business wins, right? That's the way were very transparent regarding the new business wins that drive that content. But more importantly, we're calling out the new business wins specific to electrification and so we're trying to be very clear about what the metrics look like. 5% of automotive business today from electrified platforms, that's not -- there isn't 5% of the fleet that are electrified. So that demonstrates the outgrowth there in terms of a higher lift. We're calling out new business wins in 2020, 180 of our $465 million of new business wins were in electrified platforms, that's not just auto, it's more broadly. And we view this as being a broad market opportunity, it's not just light vehicle. It's HVOR, it's also when the industrial markets has been gritter and big investment is being made in that area. So we're very holistic in terms of our view of this in terms of all the markets and the investments that we need to make to pursue this trend that's growing very rapidly.

So Jeff, it does sound like, based on all the drivers that you have, it should be fair to expect that at some point, the 400 to 600 basis points of outgrowth that you're right now guiding to relative to automotive market, that has to be raised at some point. I don't know if you can comment on whether that's a fair way of thinking about it? And I would assume that most investors are interested on when does the 5% of electric vehicle revenue that you have, what does it need to get to for the outperformance to more sustainably change from 400 to 600 or something higher?

Yes. So it's going to grow along with proliferation of BEVs, right? So in 2020, I think 3% of the fleet that was produced was electrified. It differs a little bit by region. But the trend of how that occurs. Most would say that in 2030, call it, 30%, 35% of the fleet will be electrified. If it's more than that, then we'll get more tailwind associated with it. If we have more business wins that will grow that uplift from 20% to something greater than that, that will impact content growth as well. So we don't have anything new to announce in terms of our guidance on that. But clearly, we're monitoring it very closely. It's a good quality problem to have. We're excited about it. We continue to invest in it. We appreciate investors' patience as we have invested in that because we've leaned in on our investment through our megatrend spend in the P&L, which Paul mentioned, but it's already seeing a benefit. And so we would just ask investors to look at the whole picture, and we're investing in these growth areas because we see massive opportunity for us as a company, and we're giving as much visibility into that trend, both on the spend side and on the commercial activity and the results associated with that. It's an exciting time, and we hope that over time, as we make these investments, we'll be able to guide to a more promising uplift in the future. Okay. Great. Let me change gears here to move outside of the light vehicle theme.

[Operator Instructions] Clearly, our performance has been really strong, more recently only you have the regulations in China that have provided some tailwinds. What are you seeing in terms of like just the general industry backdrop, particularly across different regions? And then what are the primary regulatory tailwinds that investors should keep in mind you?

Yes. So we're at the very early stages of the HVOR up cycle, right. So that started to turn down in mid-2019. So it was a tough 18 months of market cycle for HVOR, and we're now starting to see a turn. So we believe we've got a fair amount of time when we'll see that market recovery. We were really just at the early stages of that, and we look at much the indicators that others do vehicle orders and so forth in terms of the third-party forecast to help us predict that. There are much like auto there are a number of drivers, right? So there are regulatory drivers around efficiency and safety on the HVOR side. And so there's no 1 application that's driving that out growth. We've called out an NS VI in China as being a major driver. That's not to suggest that it's the only one by any stretch of the imagination, but it's an area where we saw a lot of uplift over the last 6 or 9 months in terms of NS VI adoption. But that's much like auto, we see those efficiency regulations get fan held globally and they drive the outgrowth in HVOR. I think at the last check, there was something like not just HVOR, but more broadly, it's 2,000 regulations across the globe that are fanning out at different stages. So the opportunities are significant, and there are many. There is -- the area in HVOR that creates content growth opportunity, that's a trend that does not exist in auto, and that is areas of conversion from mechanical hydraulic applications in construction and agricultural equipment to electronic control of those devices. So think of a joystick or an integrated armrest versus levers that control hydraulic valves. And so that started in North America and Europe and it's panned out across the globe. And so we made an investment in an operator sensing technology business needs going back 5 years now, and that's adding to the outgrowth in the HVOR market. We see that in some industrial segments like material handling and aerial work platforms and things like that. But obviously, that's not a trend that we see as being an opportunity in automotive that adds to the content outgrowth in HVOR.

Very helpful. So moving to Sensing solutions. I think the broader recovery in the industrial end market, that's definitely something very visible across like most companies that have reported recently. How are you thinking about growth here in the back half of the year and what's the impact of channel stocking in terms of benefit to the first half that probably doesn't recur in the second half?

Yes. So it's a more completed supply chain because we do use some distributors, and it's just harder to get a read on what we're seeing in the -- certainly in the industrial markets. Sensing Solutions also includes aerospace, which has a lot of visibility that the automotive and HVOR business does have. And specifically in the industrial markets, we do see a small amount of inventory building in the channel. Again, it's hard to really get a clear view on that. And we don't sense that it's an enormous amount of inventory build, but we do see a little bit in terms of how our revenue is playing out versus what we would expect it to look like, given market indices and so forth. We expect industrial revenue to be down a little bit in the second half of 2021 versus the first half. So the first half typically is stronger. We have an HVAC market that we serve that tends to be stronger in the second quarter of the year as you ramp up for the summer seasons. And so there's some normal seasonality to that business that we would expect. And over time, could some of this inventory get destocked potentially. But again, I think that will depend on consumer demand and how it slows or grows over time and how our customers tend to respond to that.

Great. So moving to the acquisitions. And again, I'm not seeing any new questions in here. So if you have questions, please feel free to send them in. Jeff, moving to the 2 acquisitions or 1 acquisition and the JV separately, so Xirgo, I think, overall, obviously, marks a notable change in the company's strategy of how you're trying to position. But also, given this is a broader transportation logistics TAM that you're really going after how do investors get comfort that Sensata can execute in a market where you've traditionally or had exposure, you were not part of the supply chain as such in this part of the market?

Yes. So I think the way to get comfortable with it is we acquired a business that knows how to do this, right? So we had an organic effort around our smart and connected initiative, where we were developing a solution set, which was born in the OEM world, right? So as we started to roll out tower prior monitoring in the OEM environment. We've realized as we built out that solution that it wasn't just a component sale that are needed to be receivers that were built out around the vehicle to collect that information, entire pressure monitoring and the vehicle area network was more. If you have a vehicle area network, then you can collect all kinds of other sensor data. What Xirgo brings to us is an extension of the ability to gather data, to provide insights in not only the OEM world, but also in the fleet world. And so this is a company that's been around for 15-plus years. It has a very strong management team. They know how to go to market. So they bring end-market expertise, but they also bring strong revenue, strong growth, a lot of visibility into that. We quoted 80% of the 2021 revenue. It's already committed by customers. So we're confident that they'll be able to deliver, and they also add a very complementary product categories. So they have the telematics device. They have a cloud solution. They also have some interesting sensing parameters as well around asset tracking, prognostic, capturing and interpreting prognostic data, some infrared camera technology for capacity management inside of trailers. So they bring a really nice complementary set of solutions that combined with our smart and connected initiative, but more broadly, our Sensata offering, I think we're pretty compelled -- we offer a pretty compelling offering to the markets that we can serve. And this is a -- we forecast this to be a $15 billion market in 2030, right? It's about a $2.6 billion market today. But it's growing very fast. And I think we have a compelling value proposition here.

I guess, maybe if I just follow-up on that, Jeff, like is the initial opportunity more of a retrofit with the operators and then you start targeting OEMS? Like you talked about the $15 billion opportunity. How do you break that down between just doing more retrofits in the aftermarket for fleet operators versus going directly to OEMs and being designed in?

So a little of both, right? So remember, as I mentioned, our internal offering started with the implementation of tire pressure monitor. So we've sold $100 million of business or almost $100 million of visits with our OEM customers with tire pressure monitoring and vehicle area network. So that's being fanned out as regulation associated with tire pressure monitoring is panning out in Europe and North America. And then there's the Xirgo acquisition, which is all fleet related. That we're offering a even broader solution to that. Now if you think about where the growth near-term is going to come from. It's going to come more from the fleet market as they find these different solution sets out. But eventually, over time, what I think we offer here, which is very unique, is not only the broader sensing portfolio to feed this telematics ecosystem, but we have the OEM relationships. So if I'm a fleet manager over time, I'm going to be pushing my OEM suppliers to build the equipment that has all of the equipment on it so that when it gets put into use, it already is, if you will, compatible with our fleet management system and the data insights that they're looking for. And so we have this unique opportunity to play both sides of that and help our OEM customers bring to market for their fleet customers more compelling equipment. At the same time, we're building out that broader solution in the end market. So it's interesting. It will be we'll watch to see how that develops over time, but it doesn't matter to us where that equipment ends up. If it gets put in at the factory at the OEM level, that's fine. We can supply it there. If we do it in the aftermarket, we can we can do it in that channel as well.

Got it. Let me end here with the topic on the joint venture around with Schrader. Now definitely, maybe if you can start with talking about how it's different from the GIGAVAC kind of high-voltage contactors that you have. What incremental kind of opportunity or TAM does it bring relative to what GIGAVAC had and I think you've talked about retaining the license to deploy this product in outside geographies. So if you can talk about kind of the financial implications of this as well? How should we -- how do we think about seeing it in the P&L in the long run?

Sure. So why don't I touch on what it brings from a capability standpoint. And Paul can speak through some of the -- how we'll see it in our P&L and who covers which markets. So essentially, this just broadens our contactor portfolio, right? So we were really clear that what GIGAVAC brought to us was high-end, high-voltage contactors. And what I mean by high end is higher voltages, right? So higher-end vehicles are not necessarily just luxury vehicles, but they are vehicles with longer-range and shorter charge durations, right? And that's where we believe the market was going. But there's a lot of the middle market, these mass market EVs that don't need those high-end contactors because they may not be aiming for 350 miles a range and a 30-minute or an hour-long charging session. Consumers would be very comfortable with shorter ranges or longer charge times. And so this product capability essentially help serve that medium voltage ranges, and it broadens the market segment that we have available to us. Paul, maybe you want to touch on the JV and the operating mechanism and so forth?

Sure. I'll keep it simple. I mean, we're going to consolidate this joint venture. So you'll see all the operating results in the P&L through operating income in the office, they have a minority interest amount that will be below operating income, low net income attributable to shareholders. So it will be very clear in the P&L once it becomes worth calling out. And so as MBOs are one and the product is launched, we'll start to see the revenue, you'll start to see it in the P&L. JV serves will serve the China market. It will also be able to cell product, to Sensata, serve other markets outside of China for the automotive and heavy vehicle space. So it will give us a global position in this product range.

Great. I think we're out of time here, but Paul, Jeff, thank you both for taking the time and thank you for attending the conference as well.

Absolutely. Thank you. Appreciate it.

Thank you, everyone, for dialing in. Thank you.