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

All right. Hi, everyone, welcome back. My name is Ethan Puritz, and I'm happy to have the management team of Sensata here with me. We have CEO, Jeff Cote; IR, Jacob Sayer. So yes, thanks for coming, guys.

Absolutely.

Appreciate it.

So I was thinking maybe we could just start with a discussion about current industry conditions. Obviously, been a very hectic last 2 years. So if you could kind of just give us an update on the supply chain since earnings and just what you guys have been seeing?

Sure. So certainly, has been a bit of an interesting last couple of years and in terms of supply chain challenges, and I guess in the grand scheme of things to have demand from our customers that's greater than what folks can deliver as a good place to be, but it certainly represents some challenges. Across the board from a logistics standpoint, availability of electronics, COVID-related challenges, there have been many of them. I think that our perspective on this is that the fourth quarter felt certainly as though it was the toughest quarter that we were faced with. And things -- we expected things to start to recover a little bit. And I think, generally, that is the feeling that we have. Obviously, with current circumstances in terms of what's going on with Russia and Ukraine, that throws another twist into things. But our view is that the impact to our business in the near term, given that we're not exposed in any meaningful way to that area of the world, that it's not having an impact in terms of overall supply chain challenges. I think the bigger question we would have is the longer-term ripple impact in terms of broader global economic impact that, that would have over time. But from a supply chain standpoint, we feel as though not out of the woods yet, but we'll continue to manage through that and feel pretty good about things becoming better other than worse.

I think that makes sense. It's the sentiment that a lot of companies have struck, I think, just improvement throughout the year. Are you able to contextualize it all maybe with lead times or backlog, you don't have to give the exact number, obviously, but just what you're seeing in regards to those?

Yes. So certainly, as we entered the quarter, we continue to see really strong demand from our customers, and ultimately, our customers are seeing very strong demand from their customers driving that. That has been consistent really over the last several quarters as a company, and so that's been quite positive, and we continue to see book-to-bill ratios that are quite high. NBO wins that are quite high really as indicators of long-term growth in the business.

And that's across all your end markets?

It is. Obviously, we have more exposure to our automotive and heavy vehicle markets, but we're seeing it pretty broad-based -- and we're also seeing it very focused in the areas that we're investing heavily associated with the megatrends of Electrification and Insights.

Yes. So I guess just kind of sticking with the supply chain theme. I think, if I recall correctly, you originally guided 4Q to around $9 million worth of headwinds. It ended up being stronger than that. So kind of sticking with the same theme, could you talk about how you were able to perform better than expected? And I guess you kind of touched on this already, but how you kind of think about that in the quarters to come?

Yes, I'd be glad to. So I think we've tried to provide a fair amount of clarity as to how the challenges that we were experiencing in the overall markets, how they impacted our business. And we said in the first half of 2021, we as a company ate a lot of those costs in terms of the expedite fees and the increased material cost. In the second half of 2021, we passed the vast majority of those costs along to our customers in the form of surcharges or other expedite fees, and we were able to get to a better outcome in the fourth quarter than we had originally anticipated. Interestingly, in the fourth quarter, we also said that we -- as we started our planning process for 2022, we were going to address this in terms of pricing with our customers, and we weren't taking that lightly. We understand that we have long-term arrangements with our customers, but what we were experiencing in terms of increased cost in our business and its hesitated us going to our customers and addressing that. We were able to do that. We felt really good about the progress in the fourth quarter as it teed us up for the 2022 planning process. So that's great news. The even better news is that we had record new business wins in the fourth quarter. So although they were very difficult conversations, having pricing discussions with our customers are never easy, but we were able to achieve that outcome and still have good business wins. Now it's -- we've got to execute on that during 2022, when it does taper in during 2022. So the first quarter is at lower margin than we would expect for the balance of the year, but we're very confident in our ability to execute on that.

Yes. Kind of just shifting from the supply chain. You guys have done a lot of M&A over the last few years and really last year, in particular. I don't have to run through all of the companies, but can you just kind of talk about the portfolio that you've built out? What these deals have done for you? And just kind of how you're thinking about your M&A strategy?

Yes. So the M&A strategy is very focused on those 2 growth areas, right? So why are they focused there? Because the trends associated with electrification and IoT are what we call Insights will create more change with our customers in the markets they serve over the next 10 years than they have over the last 50. I think everyone understands that. Both for different reasons, but there will be more change there, and so we've been very deliberate from a P&L standpoint. We talk about our megatrends spend that we're holding outside of our market segments that we're investing more in the organic growth associated with these trends to build product capabilities and go-to-market strategies. And we also have a very specific focus from an M&A standpoint on those 2 areas. And I think we've had some really good success during 2021 since implementing that strategy in mid-'22 in terms of going after companies and being able to build out the capabilities to be able to serve this market. We did 5 transactions last year. None huge, but all very important in terms of executing on that strategy, and we feel as though we're in a great place now in terms of being able to continue to demonstrate the growth that we're anticipating. To be very specific, our electrification business will grow by 50% in 2022, meaningful growth relative to the overall company. Our IoT or Insights business is going to double in size in 2022 versus 2021. So those are really good proof points that the investments we're making are resulting in outcomes, which I think will be really great for Sensata long term.

Looking forward on the M&A side, we expect future transactions would be small to midsize in terms of the size of the transactions. Should from a product portfolio round out what we're doing in both the electrification and the IoT Insights space, they should look logical in terms of those extensions. And they should be, when we say small, but fast growing. So small commercially proven solutions in very fast-growing businesses, which is endemic of the markets that they're serving as well as the differentiated technology that they individually provide, but often constrained in some way, either from a capital or access to market perspective, which is where Sensata can come in and help them achieve their potential.

So that's the main value add you think during the integration process.

That's where the synergies will come through from the acquisitions is on the revenue side.

You brought up the megatrend spending. I'm sure you've been getting this question a lot, but could you maybe just walk through the puts and takes of how that's impacting some of the near-term margins but then obviously investing in businesses that are higher growth.

Yes. So we spent, I think, $52 million last year in the megatrend related area. And so just to be very specific, what this spend is, it's investment in creating capability or engaging with customers to help them solve their challenges that does not have any revenues attached to it right now. Our typical engagement model is, we spend money when we have a business win with our customer that's going to generate revenue in the future. But this is investment that we're making ahead of that curve because we want to make sure that we're demonstrating to our customers that we are investing ahead of that curve to be there with them as they go through this transition. And as we went down that path in 2021, we told investors that it was going to be opportunity based, right? So if we didn't see the opportunity from our customers, we would cut the spend. As we went into 2022 planning process based upon those engagements with customers, based upon the progress we're making, the new business wins that we were experiencing, based upon that investment, we did decide to increase it. So in 2022, we've guided to $60 million to $70 million, so not a significant increase, but we do recognize that it's an increase in cost that goes through the P&L that impacts our current margin profile. We're committed to maintaining differentiated margins, but we've guided to a margin that is about 40 basis points lower than what we achieved last year, largely due to the fact that we are investing more in that growth. You have our commitment that we'll continue to provide transparency around that. You have our commitment that we'll continue to produce differentiated margins based upon where we're focused. And you also have our commitment that we will be -- continue to be ruthless in terms of cutting the spend, if it doesn't demonstrate the outcomes that we're looking for.

I don't know why we added more visibility with regard to the progress that we're making both on the Insights side as well as the Electrification side in terms of the size of the revenue last year, the growth rates this year and the long-term expectations for those businesses because that's the result of a lot of this megatrend spend.

Yes. I think splitting those out definitely helps contextualize the opportunities a lot better. Kind of sticking with the M&A theme, during earnings, you guys targeted or you kind of updated your revenue model where you're going to target 400 to 600 basis points of outgrowth, driven specifically by inorganic growth. We don't have to talk to the M&A strategy. You guys touched on that. But what gives you the confidence that you can maintain that level without growth? Because I think that's an acceleration from what you guys saw last year, which was a pretty acquisitive year.

Yes. So it's an opportunity-rich market, right, given the change that's occurring. But we will continue to be very financially disciplined. The reason why we've chosen to guide to an inorganic growth is because we have shifted our strategy to be more serial M&A versus what has been historically a little bit more lumpy M&A and very opportunistic. It's very focused on -- in these areas. So we're not going to surprise anybody with a transaction that's outside of these megatrend growth areas. And we felt as though it was important given the cash generation characteristics of the business to be a little bit more clear regarding what our capital allocation strategy was going to be as opposed to just a generic balanced capital allocation strategy that makes it harder for investors to be able to model over the next 3 to 5 years what that is going to look like in terms of translation. We prime the pump, if you will, in 2021 with those 5 transactions. I think we generated 2.5%, 3% inorganic growth last year. But given the lapping of those transactions into 2022, we already have 2% to 3% that will occur based upon those businesses being in the P&L for the full year. We've got a great pipeline. A while ago, we announced a small, but strategically important acquisition, with Elastic M2M. It's a small $10 million business today, but it really rounds out the offering that we have in our IoT Insights business. So we're excited about that, and we'll continue to identify these targets to drive that outcome. We provided the guidance to give clarity as to where we are going. We're not going to do acquisitions just to get to that outcome and make poor decisions in terms of what the opportunity is with the businesses that we're pursuing.

Obviously, the balance sheet is in a very good place at the moment with a very strong cash pile there that we can use. We're also very cash generative as a business, forecasting $450 million, $500 million of free cash flow this year. We have capacity to do more than just the M&A. So we will also return capital to shareholders, and we started the share repurchase program back up again in November, bought $50 million worth of shares in Q4. We'll keep that program running at about the same pace going forward. So it's a balanced capital deployment strategy with the first priority being M&A.

That makes sense. Sticking with the megatrends, I wanted to touch on Electrification a little bit more. So this is a $270 million business this year. It's scaled a lot in recent years. I think you guided to 50% growth for 2022. If you could just talk about some of the success you've seen there, with the pipeline as why -- just any color there?

So I hope we did a teach-in last week.

2 weeks ago.

2 weeks ago. So it's available, I would encourage folks to watch it. It was -- I felt as though it was well attended. It was helpful in terms of getting folks to understand really what it is that we were trying to achieve in Electrification side. The market identified what our capabilities were, identified how we win in the market, identified early success points. So we feel as though there's really good momentum there. We have line of sight to a $2 billion Electrification business in 5 years. The proof points on that are $260 million business today, growing at 50% a year. Organically, we think $1.5 billion of that $2 billion can be filled organically. The other $0.5 billion will need to be filled with the M&A-related strategy. And going from $260 million to $1.5 billion, $550 million of that's already filled with NBOs that we've won over the last several years. We have a $1 billion pipeline annual revenue pipeline of opportunities that we're pursuing right now with customers. So I would expect the trend on new business win from $100 million to $180 million to $270 million in 2021 to grow going into 2022. So we feel as though the momentum is really good. That's a result of the investments and the focus on the part of us as a team to really focus our energy there, but it's also a product of where the market is going. There are more opportunities to pursue, and we're very excited about it.

Yes. I guess to add to that, right, a lot of the focus has been on the automotive side in terms of the proliferation of EVs. Not only is the unit growth growing quite dramatically, we'd expect 30% growth compound annually over the next 5 years in EVs and plug-in hybrids, which is going to benefit us from a current portfolio perspective. But we're also adding content into those vehicles every single year of the base of the NBOs that Jeff spoke about. So looking out 5 years from now, our expectation is that the content in those battery electric vehicles will be about twice that of a traditional internal combustion engine vehicle. So you put the unit growth together with the strong content growth in that particular area, gives us the conviction that, that business will be as material as it will be in 5 years' time. So $1 billion of organic -- organically generated revenue and EVs, Electrification and automotive, another $0.5 billion organically outside of automotive and industrial landscapes and heavy vehicles. And then as Jeff said, another $400 million to $500 million that needs to be acquired between here and there.

Yes. So I guess sticking with the autos piece. I know a comment that stood out a couple of quarters ago when you said that you could see yourself doubling automotive content, I think, by 2025. And then you went into a lot more detail about that during the Electrification day, but if you can maybe just kind of walk us through how you see bridging the gap from where you are now to how to get into that twice the content line?

Yes. So today, the content is coming in a couple of different areas. So there are a number of sensors that carry over between -- from the IC landscape into electrification landscape. And these are areas where Sensata is a leader in things like brake pressure sensor and thermal management pressure and entire pressure sensing. Those all carry forward into Electrification landscape or into an EV. In replacing the internal combustion drivetrain with an electrified drivetrain, you introduce a very big battery pack and a lot of electronics that need to be isolated from the vehicle itself. So we need a lot of high-voltage electrical protection, which we also provide. So things like contactors, infuses and PyroTactors add a lot of content. So that brings us -- just those 2 pieces bring us to a premium value on average comparable 20% uplift vehicle-to-vehicle as compared to an ICE. Looking down the road, we see a couple of things happening. One, some of the carryover content gets upgraded and some of the electrical architecture gets upgraded as well in terms of things like the pneumatic braking system going to electromechanical breaking. Purer pressure sensor in a thermal management system going to a more sophisticated heat pump architecture, requiring both pressure and thermal management, temperature and pressure sensing. And then things like the electric motor becoming a lot more efficient in future -- safer and more efficient, which add sensor content, pressure sensors, temperature sensors and e-motor position sensors, which adds a lot of content in the electrical motor itself. That's how we get to the 2x.

That's helpful. So shifting to your other megatrend, your Insights business. I know it's a lot smaller right now than Electrification, but like you said earlier, doubling this year or expected to double this year. Could you maybe just talk about some of the design wins you've had there? The business that you've seen? Just any color there.

Sure. As you can imagine, it's a very different business because we're selling this into markets outside of an OEM market. So compared to our electrification business, which has some aftermarket and outside of OEM, the vast majority of that is still selling into OEMs. So the time to market in that type of space can be a lot quicker. We've got some very early successes. Some of you may remember that back in 2019, even in late 2018, we had an organic effort that we were pursuing. So just to sort of set the context of this, Sensata produces over 1 billion sensors every year, and we put those in the market. So all of our -- we have a very, very strong understanding of how to collect data on equipment. In harsh environments and being able to get that information and most of those sensors today feed control modules of our customers' equipment. So what we're providing here is an opportunity to have more of that sensor content in an aftermarket environment to feed a telematics and logistics ecosystem to make all of that process more efficient and safer in terms of how it operates. And so we're really excited about it. We've done a couple of acquisitions in 2021 with the Xirgo acquisition, basically telematics and cloud presence to be able to get information off of equipment -- high-value equipment into the cloud. We added a high-value center element with SmartWitness, video telematics, which is a really important area of telematics that we want to collect -- our customers want to collect for accident reconstruction, driver training and so forth. And then we added a small, but important software layer. So it's about feeding this broad telematics ecosystem. We have the right to play because we bring a lot of value-added sensor content to that, and we continue to engage with customers in a way that's very promising in terms of the growth opportunities.

Yes, so I have a few more questions to ask, but I wanted to see if anyone in the audience want to ask anything? If not, I can keep going.

I'm fairly new as an investor, and I was just curious and maybe an answer that many here already know. But just comparing to Sensata and the IoT devices and sensors they provide on the commercial level, could you maybe name 2 or 3 differentiating factors on why a consumer would go to you versus other competitors?

Yes. So I know them well. I've read up on them and understand what they're offering. I think the big difference is, we have 1 billion sensors in the market that we have already on equipment. So I think they're choosing to play at a slightly different layer in terms of more software, in terms of delivering that insight, but they're certainly a company that we view as being very successful in terms of where they're going. But our differentiation is our application expertise and being able to get information off of that high-value equipment and get it into the cloud. And so I don't think there's any telematics provider out there, whether it be Sensata or CalAmp or Geotab that has the sensor portfolio that Sensata has, so coming at it from that angle. I would tell you that we'll engage with anybody in the ecosystem, right? And so what we want to do is to provide more data and information into the telematics ecosystem. And so we'll provide sensor data, if that's all that our customers want. Many of the companies that you may view as being our competitors, I would say, they're customers of ours as well because we're helping them achieve the objective that we're all trying to achieve in terms of making systems more efficient, fleets more efficient and safer in terms of how they operate.

Can you explain the value of the data that you're capable of sending to the cloud? I mean do people actually want it? Do they use it? Is it clean and valuable? Is it -- or is this a data because it exists and therefore, we do -- it's sort of irrelevant to someone with money to pay.

Right. Yes. So absolutely, they want it, but Big Data is something that -- you're just bringing more data to the cloud without providing insight. And that's why we called our business the Sensata Insights business because it's not about just providing data, it's about providing insights. So let me give you an example of the type of thing that we would be able to give to a fleet operator or to an operator of the equipment itself that would be valuable. So imagine you're running a depot that has hundreds or thousands of vehicles in it and you have a staff of people that are going around essentially monitoring the road readiness of that equipment, checking tire pressure or other aspects of road readiness on the fleet of vehicles. If you have a number of tire pressure sensors in the field or you have a bearing wear monitor on the wheel end so that you can understand if the vibration characteristics of the wheel are changing so that it would indicate a failure that was about to occur. That's high-value information associated with improving the efficiency of the fleet. And so these are examples of things that we're implementing. It is about providing that specific insight that will allow them to reduce their cost or to improve the overall safety features of their overall fleet. We do other things. Xirgo has very specific things that we're working on with companies like Amazon, where we're tracking packages in terms of understanding how to feed, where the package is in terms of the location of that device. So there are many specific examples where we start with the problem, what is the customer trying to solve for, and then we implement the solution that enables that to happen.

Yes. So we have about 5 minutes left. I wanted to shift back towards the financial model. So we talked about the 4% to 6% outgrowth from the inorganic side, but then that also leaves 4% to 6% on the organic side. I know you don't guide directly by end market, but kind of how should we be thinking about those, the potential for outgrowth across autos or HVOR, industrial?

So this year, we've guided to the high end of that range in terms of company outgrowth. And really, if you think about the sizes of the businesses inside of the overall company, the only way we get there is if each of the pieces, auto, heavy vehicle, industrial are delivering at the high end of their own ranges. So auto is 6%. We'd expect heavy vehicle at 8% or better. This year, outgrowth is what we'd expect. Those individual targets don't go away. We're not trying to back away from them. It's just trying to simplify it for the street in terms of what the overall outgrowth picture looks like because all of our end markets, all of our industry should be outgrowing the markets. We'll begin to see more outgrowth within the industrial space as a result of Electrification, in terms of their presence within the charging system and with electrical -- the upgrading of the electrical infrastructure, the grid. So that should be contributing as well. So rather than talking to each one of them individually, we decided to put them all together. If there were big variations, if there's something that's notable in any one of the individual end markets in a given quarter, obviously, we'll talk about that as well. But all we should be performing at the high end in order for us to get high into their individual ranges for us to get to that 6% outgrowth organically this year for the whole company.

And it's intended to be a long-term measure, right?

Yes.

So you see a little bit of lumpiness within quarters, but over the last 4 years, it's been above that range for the company and above it on the individual targets. And so we feel really good about our success in the past, but we do want to be very measured in terms of our confidence in that being sustained in that range as we are very comfortable with it.

And I guess last question, just looking at the guidance you gave for the year on the top line, I forgot the exact number, but I think it was around 10% growth, maybe a little bit below. And you said your end markets you expect to grow around 4%. So I guess, how can we kind of bridge the gap between -- and I know you said, it's lumpy. It's not as simple as just saying 10% in the middle and add that to then market outgrowth for them. How should we kind of think about the delta between what you guided to and maybe what the revenue model would imply?

So that obviously includes the outgrowth piece. So our total revenue growth would include the organic outgrowth piece, and it would also include the contribution from the acquisitions that we've closed so far. It does not yet include the acquisitions that are on the comp. So it doesn't include the 4% to 6% inorganic. Yet only the ones that we've included so far, plus the market growth, which is what you mentioned, which we measured at just 4% for the -- across the different industries with obviously some differences between the industries.

I think I can fit one more actually. Just with the end market outgrowth, the autos piece. So you guys guided to 7% growth. That's below IHS, which you called out during earnings. I've gotten questions about that, so I guess I'm sure you have a -- just any color on just what's kind of bridging the gap between those two?

So we were consciously taking a look at -- we gather data, not just from IHS, but also from our conversations with customers, also from our own fill data. And perhaps unique, we tend to be more open about what we're seeing in the marketplace rather than just relying on IHS when we set our guidance. We don't get to get the benefit of updating our numbers as we go through the year like other people do. So we expected the electronic shortage will continue to impact the automotive space as we went through the year. That's still our expectation. The shortages are improving. We think Q4 of 2021 was probably the worst quarter from a shortage perspective, and we still expect that to improve here. Looking at what's going on in Ukraine and the potential impacts that will probably shift production to different parts of the world. But we feel that conservative stance when we set guidance is probably the right place to.

No, that's very helpful. And yes, thank you very much for your time and that's it.

Thank you.

Thank you. Appreciate it.