TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Good morning. I'm Samik Chatterjee, the IT hardware and telecom equipment analyst at JPMorgan. The next company we are hosting at the tech forum, which we have the pleasure of hosting here is TE Connectivity. And we have the pleasure of hosting Steve Merkt, who is President of Transportation for TE Connectivity as well as Sujal Shah, Vice President of Investor Relations. I do encourage investors on the line to send in their questions via chat. Although do keep in mind that the companies are in a quiet period and will not be able to comment on specifics related to the quarter. Steve, Sujal, welcome to the conference. I know you have a set of slides you wanted to run investors through. So over to you, we can start going through the slides. Thank you.

All right. Thank you very much. If we can go to the next slide. I'll start off -- I'm Steve Merkt, and it's really a pleasure to have the opportunity to share with you a little bit of the story and the journey of TE. We're at a really exciting stage in the automotive industry, and we're happy to be a big part of the transformation that's making future of automotive safer, more sustainable and connected. And before we talk about TE, I'll just give you a little bit about my background. I've been with TE for a little over 30 years. I've been in our auto business for about 16 years. I was the General Manager of the Americas auto business during the downturn in 2006 through 2008, 2009 period. So I've seen a market cycle or 2 in my time. After that, I moved to Shanghai and I ran our Asia business out of China for 3 years. After that, I moved to Germany, where I lived for a couple of years and ran our global automotive business. And for the last 6 or 7 years, I've been the President of our transportation business, which is the businesses that contain our automotive, our industrial and commercial transportation and sensors businesses. And so within that context, I thought I'd start off by sharing a little bit of why customers choose us in this space, and it really comes down to just a few key things. The first is we have a very broad set of technology solutions. And so we're able to address applications across the entire vehicle. And we are present on every single production vehicle in the world. And so we're deeply engaged with our customers there. That technology is interesting. But probably what's more interesting to our customers is the technologists and engineers that we couple with that technology. And we have 4,000 engineers distributed around the world. Many of those engineers are co-located with our customers. So in the morning, they don't come to a TE location. Actually go and they have an OEM badge and they're residents and part of the OEM teams, as they're dealing with the challenges of designing and developing next-generation vehicles. And so they're not only to solve the problems that they face today, but that privileged position of being part of the development process across the entire industry also helps us to anticipate what are the emerging challenges in the space and how can we help to solve some of those challenges. We're distributed globally, so we're able to engage with our customers in their local language, in their local customs in the norms of their markets everywhere in the world. And then once we've designed these technology solutions, we're able to execute on that with our global manufacturing footprint. And those of you that are deeply involved in the auto industry, you know it's a scale game. We -- it's -- we are a high-volume producer of semi-custom solutions in most cases and in some cases, fully custom solutions. And we manufacture those solutions close to our customers. If you think about our manufacturing philosophy, we don't chase low-cost labor. What we try and do is position ourselves to be close to our customers to be a robust part of their supply chain to be able to deal with the challenges and the opportunities that come up within that space, and we're able to do that with expertise everywhere in the world. If we go to the next slide. So as I mentioned earlier, we're really focused on that next-generation of mobility. And today's conversation is heavily around sustainable portion of that in the EV. And we are really focused on a set of really interesting problems. You still have the existing internal combustion engine vehicles. And every day, OEMs are working to make those cleaner to deal with regulatory pressures, and we're a big part of that process. But most of what we're going to focus on today is as we get into the EV space. And the kind of challenges our customers are trying to figure out is how do they make their batteries more efficient. How do they make them more robust? How do they deal with hybrid powertrain and the interfaces that occur there? What are some of the safety challenges that you have as you have to interface with these vehicles that have extremely high voltage, but you also have to have high-speed charging as we go? The evolution of architecture, our OEMs are at very different stages in their evolution of how they think about the centralization, decentralization, wireless or wired portions of their architecture. What does that mean? And how do we help them with those solutions? And then against this backdrop of high-voltage coming into the vehicle, we have another trend, which is high-speed data that's coming into the vehicle, and it's really important that you understand the interface between the electromagnetic interference and challenges caused by high-voltage in a space. At the same time, you have to enable high-speed data for increasing autonomy functionality within the vehicle. So if we go to the next slide. And as I mentioned, I've been in our auto business for about 16 years, and I can tell you, during that entire 16-year period, the electric vehicle has been part of the conversation. And we've been heavily in development of solutions for well over a decade. And so we're particularly excited about what we've seen over the last few years. There's a combination of regulatory pressures, and we're seeing that particularly in places like Asia and Europe, where there's been a heavy shift in regulatory requirements that really has driven the market more quickly towards electric vehicles. At the same time, technology continues to advance, which makes the electric vehicles a more compelling solution, both economically and from a joy of driving perspective. And as that's happened, we've seen consumer adoption continue to expand. And there are still questions and there are still challenges in that space. People still have range anxiety, particularly in the Americas. But we're seeing those issues being addressed. They're being addressed both experientially as people get the opportunity to really engage with electric vehicles and also from a technology perspective as the actual solutions continue to get better. From a regulatory perspective, we have not built into our forecast a meaningful change in the Americas. And I think that there may be some shift there, and we would view that as upside. On the right side of the screen, you see our forecast for the market. And all I can tell you is that this is most certainly wrong. This is based on the current assumptions that we have today. And to be honest with you, whether it's 10 million electric vehicles or 12 million electric vehicles in the short term, doesn't have a meaningful difference for us. What we do know is that it's a trend that is long-term trend. We're well positioned to take advantage of that trend. And because we're on every vehicle in the world, we're also fairly agnostic as to what parts of the world develop first or more quickly. Just that the overall trend continues, we're well positioned to take advantage of that wherever it occurs. We go to the next slide, I want to talk a little bit about what we do, what are the actual kinds of problems that we're solving. And the best way to think about TE is through the experience of an electron. Whenever that electron moves throughout a vehicle, we are the stewards of that movement. We are the ones that are taking responsibility of making sure that all happens efficiently and safely and predictably. And so from the moment the electron enters the vehicle, we make charging inlets, take that through the high-voltage cable assembly and connectivity into the battery management and protection systems. Within those systems, we make high-voltage contactors that provide relaying capability that will be able to isolate the high-voltage portion of the vehicle from the rest of the vehicle. And that's an interesting challenge. When you think about an internal combustion engine vehicle, it's unlikely that somebody servicing that vehicle is going to be electrocuted. It's unlikely that a first responder is going to be in an electrocuted situation because of an accident. But in an electric vehicle, that's something you have to consider, and this high-voltage part of the architecture needs to be isolated and protected so that people can safely engage with the vehicle. And so we make solutions that, not only isolate the flow of high-voltage throughout the vehicle in the case of an accident and servicing, but also allows people to safely engage with the powered portions of the vehicle through touch safety features as we go through this. Within the batteries, and you'll hear a lot about wireless within the battery. And so there's 2 levels of connectivity that occurs within a battery. One is kind of the sensing layer and the other is the actual movement of the electrons. And the movement of the electrons can't be done wirelessly. There'll always be a physical infrastructure within the battery for that. And there's 2 levels: there's cell-to-cell connectivity, and then there's module-to-module connectivity. And we play in both of those levels, but what I will tell you is that the cell-to-cell connectivity portion of our business is relatively small. And if you think about that going wireless, it's immaterial to the TE story. The module-to-module portion of that -- of the battery is a space where we have some key leading customers and some really interesting technology, and we're excited about the future there. Once the electron leaves the battery, it then goes out to another part of the vehicle, and oftentimes, that will be to the motor, and we are responsible for the high-voltage connectivity that makes that possible. And once the electron gets to the motor, typically, it'll cause some level of rotation. We make sensors that can determine where that motor is, what the performance of the motor is, what are the conditions of the motor, and we're able to do that. And so if you look at that through the lens of our customers, they're facing a whole range of challenges. So how do they charge a vehicle faster without creating a thermal event, without creating unnecessary wear on the battery? We create the technology solutions that allow that to happen. We create the solutions, as I mentioned earlier, on being able to touch the vehicle safely as we work our way through that. How do we provide the opportunity for greater range? And a lot of the solutions that we're talking about can be very large and bulky. And what we've done, over time, is create really space-efficient solutions that leave room for other functionality within the vehicle. And some of that other functionality can be storage, battery storage for greater solutions. One of the things that we're seeing as the EV starts to scale, up to this point, most EV manufacturing has not been at the same level of automation as internal combustion vehicles. That's got to change. If this is going to be economically feasible in the long run, there has to be a high degree of automation. In many cases, that requires custom packaging and solutions so that automation can be built that serves the specific needs of the platform or vehicle that's being built. And that's something we've been doing for 70 years is engaging in the space of making sure that our solutions are automatable within the assembly of the vehicle. And then finally, I talked about it earlier. It's a really interesting world where you have the intersection of high-speed data and high voltage, and we provide expertise in, not only understanding each one of these discrete applications, but understand the ecosystem of the entire vehicle, which is becoming increasingly important because it's absolutely critical that you understand as we add more and more functionality of the vehicle, at the same time, we're adding more and more higher performance, higher voltage solutions, those things have to coexist, and they can't be mutually exclusive. And we're able to model that, we're able to anticipate what those challenges are and we're able to consult with our customers early in the process so that they can make decisions when it doesn't cost them any money to make any changes rather than suddenly, they're at the prototype stage of their vehicle, and they're running into these challenges. We're able to help them anticipate them and solve those problems before they're really problems along the way. So if we go to the next slide, and we've been rewarded for our capabilities. I think from an investor perspective, it's probably a good motto in your head to think about the typical internal combustion engine vehicle is about $60 worth of content for us. And the typical electric vehicle, for us, is about double that. And so as you go from an internal combustion engine vehicle to a hybrid, our content goes up about 50%. When that transitions to an EV, that doubles. And there's a wide range of what our content can be, and we've shared a few examples on this slide. If you're talking about a low end high-volume electric vehicle, where performance, 0 to 60 in less than 3 seconds and being able to fast charge the vehicle may not be the ultimate priority, but it's more of a functional vehicle that meets consumers, but also doesn't have every bell and whistle. Our content in that vehicle is about $100. And from the same company, they make a performance vehicle that has super-fast charging, an 800-volt architecture, 0 to 60 in less than 3 seconds, there's a whole bunch of technical solutions we bring to enable that performance, and that drives that content up to over $300. If you think about the largest electric vehicle manufacturer in the world, a U.S.-based manufacturer, our content on that vehicle is about $180 compared to $60 for our typical internal combustion engine vehicle. And there are cases where we're providing kind of full vehicle architecture solutions with some value-added battery management, power distribution, battery disconnect unit kinds of things where we can drive our content up north of $500. What I would say is we are uniquely positioned to service customers at different stages of their evolution. And so we are agnostic. We're not betting -- our strategy is not to pick 1 or 2 winners and bet heavily on those. Our strategy is to be a real value differentiator across the entire space, but we do have to have different approaches there. So if you're talking about an established OEM who's got volume production, we'll engage engineering at a very detailed level early in the process, create custom solutions for them. If you're talking about a start-up, we have a portfolio of existing solutions that we can come to them, we can consult with them, we can help them get off the ground when they're in their low-volume stage. And if they do achieve high-volume stage, we're resident within that vehicle. We're resident within their teams, and then we can start to create more custom solutions as they start to scale their business. And that's been an important part for us because the one thing we've seen is that the electrification of the powertrain has disrupted business models. Every OEM is thinking about this through a different lens. There are different approaches that are coming. You've had really exciting innovation come from startups, and you've had some really exciting innovation coming from established players in the marketplace. And we can't afford to be out of any part of that ecosystem. So what we had to do is create a mechanism by which we can engage with everybody in a way that makes sense, brings them solutions and then we can scale as they scale. So I'll leave some time for questions. What I will tell you is, in my 16 years in the automotive industry at TE and my 30 years here, I've never been more excited about the solutions that we're bringing today, but also never been more excited about what lies ahead for us. I think that the electrification of powertrain is a remarkable opportunity, not only for TE, but also for the entire automotive supply chain, and we're excited about the role that we play in that. So with that, we'll turn it over and -- to the Q&A session.

Great. Steve, that was great. Let me start with some of the questions that have come in. And again, I encourage investors on the line to keep sending in their questions. But let me start with the first one that kind of goes -- is directly related to what you mentioned in terms of the content per vehicle in EV being 2x, what you have in an internal combustion engine vehicle. Investors are looking for a bit more details in terms of what components or systems specifically are driving that 2x increase. And the other part of that question is what is the risk that OEMs decide to do some of the content in-house rather than go to suppliers?

No. It's a great question. And so I'll break it down into content that is kind of at the heart of what we do, which is the high-voltage connectivity part of that. That doesn't exist in an internal combustion engine. So if you think about that movement of that and the requirements of dealing with high voltage, that's highly, highly unlikely that an OEM will engage in that. It's -- these are -- we have scale, we're able to build building blocks. And if you think about that kind of connection, essentially what you have is a piece of metal, which is our terminal, surrounded by plastic and oftentimes sealing. And those building blocks are consistent across all solutions. They may be created into custom solutions, but the fundamental -- think of them as Legos. We have tremendous scale in being able to drive that as we go. And then we create that application-specific knowledge for the packaging around that, that we deliver to a customer. And that's the connector model of the industry. And we've seen very little -- very, very little verticalization of connectors through time because OEMs have other things to spend their time and energy on that provide more differentiation for them within what their value chain is. So that portion of it, we don't see a great risk of verticalization, and we've got decades of experience. And if you think about the cost of that relative to the risk of getting it wrong and the entire build material of the vehicle, there's much more robust and meaningful places for the OEMs to mine if they're thinking about the own vertical. Charging inlets is very much the same way. The charging inlet is something that, that base technology is something that we can scale across multiple platforms, and we're well positioned in that space. Within the battery space, every OEM is kind of -- not every OEM, but there are many different models as to how OEMs are approaching batteries. And in some cases, they want a vertically integrated solution. In other cases, they want a more market-based solution. And the role that we play will be impacted by that. Now to put it in context for you, that $60 of incremental content that we're seeing in vehicles, resident within the battery is less than $1. And so as you think about an OEM model of how do they deal with the battery itself, we're pretty agnostic. And yes, there's opportunity for us if an OEM decides that they want to engage with us deeply. But at the end of the day, even that opportunity isn't material to the story that we have and the engagement that we have. And that's -- it doesn't mean we're not interested in that space. But as you think about it from a modeling perspective of what our growth is, I would say, it's interesting, but not material. So we are -- now what ends up happening is as OEMs take different thought processes around what do they do with batteries and how vertically integrated they are, it does change their view on battery management systems. And so a good way to think about this is if you think about a battery disconnect unit, which is something that allows the vehicle to be serviced or something that engages when the vehicle has an accident, there's high-voltage connectivity that goes into that box. There's sensing, current sensing that happens in that box. There's a contactor that happens in that box, and that contactor is essentially a high-voltage relay. You may have somebody that decides that they're going to vertically integrate the assembly of that box, but the components within that box are really what the heart of our business is and really where we're focused as we go. And those are not things that make sense for a specific OEM to vertically integrate. So if you think about the nature of the space where we play, it's not really within the field of great interest of an OEM and a great deal of return for them, for them to try and vertically integrate the spaces that we're in.

Got it. Steve, I've got about 10-questions in here. So I will probably try and go through as many as I can and kind of maybe send the rest of Sujal to kind of -- for you to have a look later. So continuing on that, another question is how sticky are your solutions once in a vehicle? What is the typical length or -- sorry, what is the typical life cycle? Do these life cycles shorten as we transition to EV and AV platforms.

So what we find is our solutions are very sticky because there's a very -- there's a high degree of certification and qualification that goes into these solutions. And you have to think about them. These are in very harsh environments. They're very robust and the cost of failure of our solutions is extremely high. So the cost -- the initial stage of getting engaged. In many cases, we're talking to an OEM 7 or 8 years before where we're actually designing -- the final design is in production and at a high volume. And so what ends up happening is that there's a very high level of carryover between vehicles. So you'll have a platform. We get designed in on that platform and then that platform will run 3 to 5 years. And then when it comes time for the next platform, there's a good portion of that bill of material that continues to the next platform, and then there's a portion that's innovated. And what we find is that the value of incumbency is extremely high. And that's why initial incumbency is really important because just like we have a large moat around the positions that we already have, competitively, it's very difficult to access that business once -- going in with a 3% or 4% or 5% lower price doesn't change the sourcing decision of an OEM because the weight of replacing that component is -- it's just too high. The risk is too high relative to the return. So it's a very sticky space, but it also reinforces -- you've got to be there at the moment that the design is taking place because if you're not, it's difficult to come back in later.

Got it. Great. One more. Can you elaborate on the EV production cadence and -- which I think you've had the slide with the production estimates. But the second part of that question, I think, is also more interesting here, whether the participation of luxury automakers and EVs can drive better content and margins for TEL.

So what I would tell you is that if you look at our margin structure, our margin structure is not wildly different, whether somebody is in a luxury vehicle or if they're in a B or C class vehicle. Because what ends up happening is in those luxury vehicles, oftentimes, these are custom solutions that require a good bit of engineering and the volumes aren't as high. And so when you think about -- and we use the word agnostic a lot because the way you think about us and model us, really, you need to think about it through that lens. Whether you're talking about a battery that has high nickel content in it or you're talking about a battery that doesn't, doesn't really change our margin structure or our opportunity. If you're talking about a lower-entry vehicle versus a luxury vehicle, we don't have the opportunity to create differentiated pricing versus the engineering content that we have in a luxury vehicle versus an entry-level vehicle. What we have is a greater content opportunity. That luxury vehicle has more functionality and more content per vehicle. And so that's really the upside opportunity that we have. It's not being able to drive a broader margin structure, but the greater content opportunity that we see is there. Now the -- somebody was talking about the cycle, the one thing we have seen, and this is a positive cycle, is that the functionality that gets put into luxury vehicles used to take a lot longer to filter its way down to kind of what I'll call core mainstream vehicles, the B and C class vehicles. And so what we're seeing is the migration of some of that enhanced functionality is happening faster, and we're really excited about that. And as that migration occurs, typically, there's a pretty big moat around that because people don't want to go out and requalify a solution to something that they've already validated.

Got it. One more, I think, there was a 5-minute warning, so I'll try and squeeze in a couple more here. Can you elaborate on TEL's exposure to auto CapEx? And can the company be a beneficiary of the massive wave of auto CapEx towards automation equipment.