TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Good morning, everyone. I'm Stacy Rasgon. I cover the U.S. semiconductor and semiconductor capital equipment space here at Bernstein. Today, it's my great honor to introduce our guest, the CEO of TE Connectivity, Mr. Terrence Curtin. Before we start, I want to let you know this session is going to last about 50 minutes. We'll start out with a short presentation from Terrence, and we'll go into Q&A. And if you have questions of your own that you'd like to ask during the presentation, you should have a link for our Pigeonhole Forum on your screen where you can submit those questions, and we will have time for that Q&A at the end. What is TE Connectivity? Hundreds of thousands of products, TE Connectivity has a pervasive spot in nearly every end market that you can think of. It contributes connector technology to a huge number of products and services that you interact with on your own basis every day. Their presence spreads across automotive and industrial, defense, consumer, networking and medical. Hundreds of sites, thousands of people, billions of dollars in sales spread out across a global network. We don't cover the company, but it actually does come up in [indiscernible] conversations. And I think investor controversies do focus on a few topics right now. Certainly, there's the near-term questions around the post-COVID environment, shortages and constraints, auto demand and the like. In the near term, I think investors ask about long-term growth targets. Where can margins and free cash flow go from here given the improvement that we've seen? And given the role that M&A as well as divestitures have played toward the company's goals, like what comes next? And to answer these and other questions, it is my great pleasure to welcome Terrence to our session day. Thank you so much for being here today.

Stacy, thanks for hosting us and moderating today, and I appreciate the time you're making as well as everybody who's participating. So welcome, everyone.

I'm going to put the presentation up. Hopefully, this works.

Yes. So Stacy, I do appreciate that lead-in, and I know we'll get into some of those questions. And what I'd like to do just maybe for the first chunk of time, give an overview of TE, where we position the portfolio as well as some of our logic and some of the targets that we've set out. So let me cover that and then Stacy we'll go wherever you want to go with Q&A and the audience wants to go. So if you could flip the slides ahead. Certainly, we have the traditional non-GAAP disclosure. But I'd like to go to the slide after that, please, and let's just give a quick overview of TE. When you think about TE, and Stacy highlighted this, we are the world leader in connectors as well as a leading provider of sensors. And Stacy, we can go 1 more slide, please. I'd appreciate it. And when you think about us, we view ourselves as an industrial technology company. And an important part of who we are is how we innovate with our customers. And that innovation model is a co-creation model. It is our 8,000 engineers are based at the design centers of the world across those broad industries, as Stacy talked about, and I'll highlight a little bit more, where our customers are focusing on the next-generation architecture, and how do we truly make sure that that next-generation architecture has the connecting, the sensing elements to really make sure that how we think about our purpose is the world is safer, certainly more productive, sustainable and connected. Stacy, could you go back a slide, please?

Sure.

I'm sorry. And how we look at this and bring it to it is really through our 3 segments. And if you look at this slide, on the left, there's a pie chart in the right that shows the size of the segments. But on the left are basically our 3 segments. And Stacy it's back a slide, I'm sorry. And the first segment I want to talk about is our communications segment, which is the top on the stack. And I'm going to talk about it in the horizontals.

Sorry, but which slide did you want to be on, Terrence?

This one here you have up. Thank you, Stacy. Perfect. Thank you. And when you think about our communications segment, and I'll talk about how we're performing and where we position it is. First off, I need to go back 2 slides, I'm sorry. Click forward a couple.

Which one did you...

If you could go back to the one that has our main logo on the top left, please?

This one here?

One more back. One more back.

That's the first slide.

No. There's one before that. But I'll keep going and just follow on that...

Can you tell me when -- Terrence, can you tell when to stop...

Just stay on this one, and I'll cover the first slide here verbally, and I apologize. So when you think about our 3 segments, our first one is communications. And when you look at it, there is an element of about $2 billion or $14 billion of revenue, really 2 key factors. One is where we position ourselves around cloud applications and really benefiting from what we're using today. And the other area is in our appliance space. Global leading business also certainly benefiting from the world reopening and the consumer side of the -- consumer really is opening up and they're reopening. And this is a segment we expect that can grow mid-single digits and have high -- middle-to-high teens margins. And we're right now a little bit ahead of that due to how strong the recovery has been. But really, a segment that we repositioned over the past 5 to 6 years around the growth factors I just talked about. Our second segment, which is our largest segment and makes up about 50% of the company, is our transportation segment. And when you think about our transportation segment, and I know Stacy you will last questions about it, it is going to come around with the megatrends that are hitting auto, but also impacting commercial transportation when you deal with emissions as well as how do you get data and further autonomy in vehicles. This is an area where we've seen a very strong rebound in both of those core markets. And our global leading position there really positions us well to capitalize on the electrification trends, the electronics trend and certainly the data trends in those vehicles, and I'll share some examples in a little bit. And this is a segment we think should have around 20% operating margin. We're in the high teens right now, and there are some things that we're doing to our cost structure to really make sure, once we get through the volatility of the supply chain, we get our margins up to that entitled margin level as we see it. And then our third segment has to do with Industrial Solutions. And like most industrial segments, it's pretty broad. When you think about industrial for TE, it is factory automation. It does have to do with energy around the transmission and distribution networks of the world, which are benefiting from renewable hookups, and we're seeing the benefit of that. It's also around what we do in medical devices, which I'll highlight in a little bit, and then also commercial aerospace and defense. And really, these markets in our industrial, they're starting to see recoveries in factory automation. Other markets, we're seeing stabilization like comm air as well as medical, but still areas that we think will rebound over time, and we like where we're positioned. This segment, we think, also similar to our CS segment, will be high teens, but certainly with some of the volume pressures and some of the cost actions we've had, we still have work to do to get up to that level, but we're still committed to that. The last thing about TE that I want to stress here on just the overview is our cash generation model. I do think it's a very strong element of our business model, not just with how we've positioned the portfolio, but we do expect to have 100% free cash flow to net income this year, and how do we use it in TE. First priority is to those organic investments I'm going to continue to talk about. But then we take that strong cash generation, we do return to owners. We also do it to bolt-on M&A to really make sure we strengthen the platforms, and it's always been a nice mix, and I think we've been a pretty strong and good steward of capital. So what I'd like to do, and Stacy, if you could leave the slide that's up, is really -- I talked high level about the segments. But one of the things that's important about TE is the TE of today versus TE of the past, it's about 50% of our portfolio is different. And Stacy, you mentioned what we've done in regard to our portfolio. And it's really around the trends you see on this page of where we've pointed TE to. When you think about transportation, it's electric vehicle, which drives content. It is autonomy drives content both in the car -- you also see those similar trends in heavy truck as well as off road. And then also [ sensorfication ], where does sensors go. And in our world, sensors are an important part of the physical network of the vehicle that that's a newer place for us, but continues to [ drive ] content. In Industrial Solutions, like I said, it's broad, but renewables, how do we help medical devices, also defense and aerospace. And aerospace will recover at some point in our position, our leading position in that space. We're excited about even though it's pressured us over the past 2 years. And then lastly, when you get into Communication Solutions, it is not only about bandwidth but it's also around the efficiency. What is the data usage of the data center? How do appliance get more efficient? And our connectivity because when you get there, you're really dealing with how does data move? How does power move? And how do you move it much more efficiently, are also core aspects of what our engineers work on in the next-generation architecture. And we do with feel these secular trends, and you see it at the bottom of the slide, we do see through cycle. We expect that we'll drive a 4% to 6% growth rate through a cycle. Certainly, we were impacted last year, like everybody, certainly this year, seeing a very strong rebound. And also you're seeing how this portfolio has changed through cycle and we really get excited about as we're in a much more constructive cycle, what we can prove as we build our margin targets as well as improve the growth of where we position TE around. So if you could, Stacy, flip to the next slide.

Let me try, let's see if it...

And I would like to wrap up, just go into some of the applications that we did, so. And it's really around -- and I'm also going to tie it to the way we think of ESG because there's been a lot of ESG questions that we get. When we think about ESG, it's really on 2 vectors. The first vector is for, when the slide comes up, it's around how do we impact the applications and the engineering we do with our customers. And I want to give an example on each segment and some of these I've touched upon briefly. And then the second vector is, what are the things that we directly control, that's in TE, and I'll cover that next. But let's talk about the applications first. And the first one has to do with what happened in transportation. You're all very aware what's going on with the electrification of the powertrain. And when you look at that getting electrified, what we get to work on is, as our OEM customers evolve the technologies to make sure they get to batteries, electric cars that are safe, have the range as well as the reliability for the long term to make sure consumers buy them, we work with our customers on that electrified powertrain. And with our global position, it is truly a global business with very strong penetration. Asia is our leading market, followed by Europe and North America. And it's not just about the connectivity that occurs from the power, from the battery pack to the motor, but it's also to make sure how do we help solve the fast-charging requirements. And one of the things that we've worked and it's on the Porsche Taycan, that's an 800-volt powertrain. And you can charge that powertrain in 20 minutes up to 80% load. And that's something that we work with Porsche on, and they're the types of innovation we're working on to really make sure that how does EV not just be niche, but continue to evolve to be more mainstream globally. And we're pretty excited what that also drives for content. Our content in a battery electric is typically 2x what we have in a combustion engine. So -- and I'm sure Stacy will ask some questions on that. The other area in our industrial segment is what we do with the medical device makers of the world. And we do a lot around heart -- interventional procedures around the heart with the leading providers. And about every minute, there's 120 people touched with devices that has TE content in it. And if it's a heart procedure out of every 3, 2 have TE's product in it. And these help better outcomes, lower costs, and certainly helps us from a content perspective in our industrial segment. It's something we've really invested in what our capabilities we bring there as things get miniaturized, smaller, certainly with our core capabilities. And then lastly, when you deal with what I talked about a little bit on the data center side in cloud, while we work with our customers on what cloud speed can be in 800 gigabits, the real business model that the cloud makers look at is total cost ownership, which is also power consumption. And how do the thermal dynamics of what we bring also help in that total cost of ownership, not just throwing in a new box, it is a total cost of ownership play. And what we're able to do is a pretty big part of our equation. And so that gives a little bit on the application side. And while they are sustainable, they also drive content opportunities for us that help that growth rate that we've articulated to everybody. And then if I could just go to the last slide and talk briefly about the second part of ESG, which is how does TE think about the impact it makes, not where we only deal with customers, but also our direct impact on the world. And we just issued our 11th corporate responsibility report, which is One Connected World. I hope you all read it. It's very broad, and it's on this last slide. But what it's about is how do we continue to reduce the amount of greenhouse gases we have? How do we keep our employees engaged and make sure we are more diverse as well as how do we have great governance, procedures and protocols from a Board perspective that cascades in? And when you think about greenhouse gases, since 2010, we've reduced our greenhouse gases by 35%. And we're signing up to 2030 to reduce another 35%, and we expect to get halfway there in this decade. And when you think about TE, the amount of energy we use is equivalent to 120,000 homes a year. And that's what we're trying to make sure our footprint as we continue to grow, reduces our impact. Social, like I said, it comes down to how we engage our employees, include our employees and certainly, about 1/3 of our women are in management positions. And that's up almost 100% over the past 5, 6 years. So it's progress we're excited about. And the Board, we continue to get recognized about our governance procedures, and our Board is about 50% diverse. So -- and you can see the recognitions we get. But really, what does it justice is what's in our One Connected World report. And I would ask you all to take a look at because it shows both what we've done as well as the commitments we're making. So with that, Stacy, I'll hand it back to you and we can jump into Q&A, and we'll go wherever you want to go and the participants want to go.

Fantastic. Thank you, Terrence, for that. So let's jump in. Terrence, as you probably know, I don't like to use this forum for shorter-term stuff. In this environment, it's kind of hard to avoid it. I'm going to start there. I think we can get to the more fun stuff soon after that. We don't [indiscernible] spend a lot of time. But I do especially want to focus on, obviously, the shortage situation, which at least in my sector, in semis has been a huge issue. And automotive is kind of at the forefront of that. And you guys really do have a broad view of that auto market. I was wondering if you could maybe just talk to us a little bit just in generalities, how are you seeing the shortage situation? Like what's your best read on -- obviously, we kind of know some of the causes. But from your standpoint, like what did you see as kind of we went through last year and as we get into the situation now? And you may not have a view, but if you do, any sort of view on when you think things might ease up? And I'll be honest, myself, I don't know when things are going to easy up. So...

I was going to ask you the same question because you cover semi so much, and we all have opinions on it. Let me tell you, we think about at TE, what we're seeing and probably similar to you. I'm not going to have a crystal ball for everybody. So I'm going to be similar to you in my answer probably when we get towards the end. But I think there's an element of, let's just keep the big environment in check. Last year at this time, the world was making about 11 million or 12 million cars in the quarter we're in. It has ramped up quicker than any of our OEM customers saw, anybody in the tiering have thought. And it's created a lot of volatility, both as they're trying to make vehicles and in automotive being a just-in-time inventory situation. We don't have lead times in the automotive. They expect -- they give you an order, they expect to get it. And the whole industry is ramping, and there's a good problem in there. Consumers are buying. And that is something, last fall, we were talking about a lot. We'll get auto production up and running, will consumers show up? And certainly, consumers have shown up greater than I think anybody expected and in this recovery and it's been quicker than we thought. So I think we have to keep that as a backdrop. As we've gone through there, from our standpoint, being a Tier 2, early on, we were very much worried about how do we get our labor back up because we're dealing with COVID at the time. And we also, in some parts of the world, are still dealing with COVID. I know there's a lot of U.S. people on this call, realize in certain parts of the world where certain parts of the automotive supply chain is we're still dealing with COVID and vaccinations are nowhere close. So the labor element was -- an element early on was how do we get the labor where you still have quarantine to make things happen. And I would say that was probably more of a last fall event. I think we've managed that well. And we've also managed getting our capacity up and adding some capacity in places where demand has come back quicker. So right now, it isn't as much of a capacity. It comes down to the volatility that our OEM customers are trying to do, where they do have shortages in places like semiconductor. We have seen in the March quarter and the June quarter. And I do want to remind everybody, TE is a September quarter, so if I mentioned some quarters that feel out of sync, September year-end, just realize March is our second quarter. We do think there's about 1 million cars made in each of those quarters that can't be made due to shortages. And so both in the March and June quarter, we think you're going to have about 19 million, 20 million cars made in the planet. And they're probably about 1 million cars short. And with how the consumer's showing up, it doesn't feel like that demand is going to be destructed. It just feels, hey, as the supply chain can do it, it moves forward. Now some of the things we've been dealing with real time that has evolved, not only what our customer volatility -- because what's nice with the OEMs is they can make cars that people really want instead of the traditional model. They keep the factories running, run incentives. So there is pressure to keep it running, but one of the things is other than semis, there have been some supply chain impacts that, from a material side, has even impacted us. Places like plastics and resins. Places like where we had some of the storms around the world, and that has created the volatility in the supply chain that, not only you have semi shortage, you do have some other things that are creating stress on it that I view the industry will work through. I do think you're probably -- we're still going to be in this, at least through the rest of our fiscal year through September as we continue to get to pure normalization. And the question that usually comes in is, are the orders that sometimes -- we even talked last quarter, orders were much higher than what we thought it was, is this pull in? What is this? I actually believe it's much more around specifically in automotive is, it's not only real demand for cars, it's also, hey, supply chains got taken too low and just in time when we went down to 12 million. We're trying to get supply chains back to normal levels for this just-in-time, and we're still in the middle of that. So I do think you're going to continue to hear about volatility from OEM all the way down to the supply chain as we get to some normalization. And I think there will be pockets like you can cover in semis, that it's going to continue to create customer volatility. I think all of us are trying to support an industry recovering, and what's great is the consumer's showing up. So I don't think it's going to disappear in a month. I think we've been muscling through it as an industry. We're committed to get our product to our customers because what's really nice is what has been a real benefit for TE as well as I think the industry is how EV survived COVID. EV grew during COVID. You saw Europe, have the growth. Asia is regrowing. Certainly, more interest in the United States. And when we think about where we made our bets 5, 10 years ago about EV platforms, you continue to see that mounting EV element of production growth. And that's also different processes, in some cases, for some customers, and new platforms, which is great because it's new innovation.

Yes, I do want to dig into EV in a minute. But one more question for you just here, maybe then we can move off. Obviously, the just-in-time aspect of auto and especially auto as well as some other areas has caused, I think, exacerbated the problem. Just-in-time in general has to go away. We're starting to hear that now that just -- the industry, you're sort of trading efficiency for -- resiliency for efficiency, and maybe that's not the right way to go? Like, what are your views broadly on how supply chains may need to change in the wake of COVID and the disruptions that we've seen?

What I would say is, I'm sure they will evolve. Supply chains evolve. So when you get the question you asked, most people say, does just-in-time live? Or does it disappear? I don't know if you're going to have 12 million to 20 million units in 6 months, be reality in automotive, I don't. But I do think there could be some product sets where there is a little bit more inventory stacking up. But other products, that's not. I think there's other things where you see some OEMs say, hey, do I want to vertically integrate some things? You see that in the EV space as that evolves. So I don't think it's going to be an either/or. I think there will be evolution. But I think it's also of, hey, where does the volumes go? And doing this and this, like we saw, that's not normal. And I'm not sure taking out just-in-time supply chains, you would solve for that because there is a cost to not having just-in-time supply chains. And we all have the volatility cost now. But if we're just going to stack up inventory everywhere, there is an economic cost to that. And we just have to -- and that's what it'll be solved for, the liability, the quality. And I think the supply chain to be looked at overall, what -- when we think about how TE is positioned and when I think about customers, I know it might my lead in -- there was a lot of discussion around how we cover the world with engineers. Just as important as how do we tie into where our customers' supply chains are. And let's face it, not every auto company makes things in one part of the world, they make it all over the world. And that's part of our value prop is TE makes things all over the world, how global we are in that space, and it's really an advantage and I think we can support our customers wherever they go, and however it modifies, and we'll follow them.

Got it. Okay. Maybe just one more quick one. I just want to -- I know you've not seen evidence of pull forward. The customers are ordering farther out. And your book-to-bill is, what, 1.2 right now, something like that?

Yes.

Just -- can you just give us where are your lead times sitting right now versus kind of where they would ordinarily? Like how much have they pulled out? And do you think they're kind of stable at these levels?

So a couple of things. First off, in automotive due to just-in-time. Any time you have just-in-time, you really don't have a lead time. So let's carve that out. Our lead times right now are -- we've held them at sort of our normal 6 to 12 weeks depending upon the product family. Now that being said, with some of the material elements that hit us, you do have -- we're not hitting some of those lead times that we did put out there. But it isn't like some of the things you're experiencing. We do have some product sets outside of automotive that have very extended lead times because of what our capacity is. But that's pretty much a minor part of our portfolio. We do see people scheduling orders out because of some of the things that happened in other product sets. So I would say, we do have more orders scheduled out than we would -- normally would do. And I think in some ways, that's just protecting position more than pulling.

Got it. Okay. That's enough for the short term. Let's have a little [indiscernible]. Let's talk about EVs since you bring it up. So I know you said content doubled. Maybe could you give us just a better overview, what exactly are you selling in EVs? What's driving the content? And where is the content per vehicle you're targeting for your side [ of thing ]? Is it $80 or something, which is up pretty considerably from where I think you were seeing it like not even that long ago?

So when you think about a traditional combustion engine, and please remember, of the 80 million cars made in the world, 70 million-ish are still combustion engines, we run around $60. And what is that? That's your low-voltage architecture in the car. That is the things that, guess what, help connect all the ECUs and the computer on the car. It's the things that have the comfort features in the car. So you think about you want to move your seat, and it also has things to do with safety features: connectivity around your airbag, your antilock braking systems, et cetera. And so when you sit there, that's a low-voltage network. A lot of that low-voltage network carries over to an EV for us. You're still going to want to move your seats. You still want those safety applications. And so what happens for TE is a lot of the legacy low voltage does carry over. But then you add the high power or the high voltage due to the motor. And when you sit there and you think about that, starts at the inlet charger, and I talked about fast charging, goes into the connectivity that goes in, and also some of the embedded electronics in the inlet charger because that's a big safety feature. You plug in your car into your house, that is something, and you want to put more power into it to make sure it charges faster. It then goes into the connectivity from there into the cells. You have cell-to-cell connectivity that monitors the battery pack. And then you also have the power transmission that happens off to the motor, and that is really high-voltage connectivity because you can't run that on the traditional 12, 24 volt, low-voltage network that a car has. So when you sit there, it does add incremental content along those basically 3 primary vectors. And what occurs is that helps us as we design, we get the benefit of the legacy coming over. Then you also get the elements of, really, you would have had lower content on a combustion engine because you would have been putting fuel into the pump, would have been going through a mechanical pipe into the engine, and that's where we benefit. And what has occurred is, like I said, we used to be around $60. We're up to about low $70s today. That $10 will grow just in a couple of years. Half of that growth is due to hybrid and electric vehicles.

So that's an average number over your entire?

That average -- about 2x on average across the portfolio when you deal with hybrid and electric vehicles.

No. I guess the $70 is an average across the whole portfolio, that includes...

Absolutely, absolutely.

And the $10 increase is from hybrid factor, which is still a very small portion of the overall in terms of volume.

It's $5 of that increase over the past 2 years. And then the rest is due to the car continues to have electronics put into it, whether it's a combustion engine or electric car. Think about the features you have. And they're also putting features in to make sure autonomy, the data network is in, and we benefit from that. So we're benefiting from what we would have traditionally benefited as a car has more electronics in it as well as you go to the electrified powertrain. And we view -- we're going to get up into the $80s as that path continues to go. And then on top of that, what we've added with the sensor portfolio is going to add about another $5 as that -- as we continue to commercialize the programs we've won. So the trends that are happening in the auto that drive content, electric, autonomy and certainly how -- what's more in our hand is how we continue to develop our sensors platform.

But I mean, if the entire fleet was electric, like if I snap my fingers and tomorrow, it was electric, would your content be like $120 plus? It sounds like it would.