TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Good morning, everyone. Thanks for coming today. My name is Stacy Rasgon. I cover the U.S. semiconductor and semiconductor capital equipment space here at Bernstein. And today, it's my great honor to introduce our guest, the CEO of TE Connectivity, Mr. Terrence Curtin. Before I start, I want to mention if you have questions that you'd like to ask during the present momentarily, you will see a QR code come up on the screens. That will give you a link to our pigeonhole form where you can submit questions and we will have some time for Q&A at the end. So TE Connectivity, what is this? We don't cover it, but it's a very interesting company, 500,000 different products. They have a pervasive spot in nearly every end market that you can possibly imagine. They contribute connector technologies to a huge number of products and services that you probably interact with on your own basis every day. The presence spans across industrial and automotive and defense and consumer and networking and medical and hundreds of sites and thousands of people, billions of dollars in sales in R&D spread out across a very global network. To tell us all about it, it is my great pleasure to welcome Terrence. So thank you so much for being with us.

Appreciate you having me. What I'd like to do maybe for 10 minutes, and I'll sit down with Stacy, is just to spend a little bit 10 minutes of drilling down what Stacy already teed up, and I have to show my forward-looking comment, but let me just move on to what TE is. First off, we're an industrial technology company. And what does that mean? We are the world leader in connection systems as well as we're a leader in sensors. And really one of the things that we get excited about, and I think will come out today is where we position the company. We play in a lot of applications, but we really have spent the past decade plus where those applications are going to drive secular growth. And our portfolio, about 50% of the businesses we're in today weren't here 10 years ago in TE. So we've done a lot of portfolio work, and we feel very good about where we're at. I want to click down on what Stacy said about some of those applications that are important to TE, and where we've pointed our engineers because we are a very sticky engineer-to-engineer business from a design perspective. Let me start with our largest segment, our Transportation segment. We do about $9 billion of revenue in the transportation market. That is automotive. That's also industrial truck, ag equipment. And really, the trends that we get excited about that are going to drive the growth is the electrical vehicle powertrain, both in car and truck. That actually doubles the content opportunity for us between a traditional gas engine and an electric vehicle. And that trend is also not going to end at the car. With the wins we have, and we are the global leader, we're pretty even in market share around the world, it's also going to help us in commercial transportation as that trends get there. And we're winning programs with the largest truck makers of the world already. That will be revenue 5 to 10 years out. The second largest industry or business that we have is our industrial business. And that, like many industrial businesses, it's very broad, but it's really 4 areas where we're pointed. #1 is around factory automation in the factory floor, where you need connectivity, you need sensing to really get to the factory of the future. And that's where we've been positioning our engineers as well as some of our M&A dollars. Second important area for us is around energy and energy infrastructure. It's mainly in the electrical side, not oil and gas. But really, we've been pointing towards renewable applications and about 15% of our energy business today is really around wind and solar. And then the two other areas that are important in our Industrial segment is aerospace and defense as well as the medical business where we focus on interventional procedures. And both of those markets are just starting to pick up post-COVID. So while we're going to -- I know Stacy is going to ask me about demand trends, it's one of the -- those two markets are areas that we're just starting to see a recovery. And then the last area, and our smallest segment, but key secular driver in that is our communication solutions. And the big driver on that is where we position ourselves around the ultimate high-speed net. That's where we rely on the cloud, things that go up to 400 gig in speeds. Certainly also energy consumption is important there, the data centers, and it's where we've been driving tremendous growth. So I wanted to talk about those quickly because I know Stacy will ask about it, but it's also areas that point out the secular trends that we're pointed at, and we spend a lot of time on. The other thing I want to stress, and you can see it on the slide is really 5 points about, I hope, are takeaways of how we've been executing in what has been a unique and challenging environment. First off, I think if you look at TE the growth that you've been seeing demonstrates those trends. And about 20% of our automotive revenue today is electric vehicle driven. And our content per vehicle pre-COVID today has gone from $60 to $80 per car. And that is really driven primarily by the electric vehicle trends and the growth that we've seen throughout COVID. And we're only at 12 million units of electric vehicles today out of close to 80 million cars made in the planet. So that's going to be a content driver for us, and like I said, we're the leader in that connectivity. The second thing is, as we've gone on our journey, our journey was also one of margin improvement. And I think we've continued in what has been a challenging environment of supply chain inflation. Our margins are up at the 18-ish level. We still think we can get up more to the 20% level. And you're seeing momentum across all three of our segments. They're contributing to growth, but also in what has been a challenging environment. We've continued on our journey, and I think it just shows what our teams have been able to execute on and what we signed up for. The other thing that I want to stress is, hey, we are a global company. We're about 1/3 in the United States, 1/3 Europe, 1/3 Asia. We like being global, but certainly, one of the things we have with the current environment is how do we make sure we service our customers and region. And we've been investing for years around how do we make sure we have supply chains that are in region. Certainly, we can continue to refine it, but it's actually helped us to differentiate in this environment and really help our customers. And we're going to continue to refine as we go forward, but it's been a real differentiator for us. And then the two last things I want to highlight, one is -- I used to phrase industrial tech, and I was talking to some people at breakfast this morning, what does that mean? I think the technology piece is you're able to bring your engineering to grow faster than the underlying market. And that's the content piece. The industrial piece as we think about it is really of, hey, we have cash flow characteristics and business model characteristics that are much more like an industrial company. And that gives us choices. We're a very strong dividend payer, about 1/3 of our free cash flow always goes back in dividend. The rest, we pretty much split between how do we bring bolt-on M&A in to support our organic model as well as returning capital through share repurchases. And the last thing I do want to highlight, just a few days ago, we issued our 12th One Connected World Report, 12th year in a row. And it really lays out our commitments, we do that are nonfinancial, things around sustainability, things around social and certainly, governance that we're very proud of that I would ask you to take a look at. And I'll give you some sustainability examples as I wrap up here, and then I'll sit down with Stacy. But on the sustainability side, a couple of things. I'll give you an example in each one of our segments that really bring to life. I think the first thing I would just share is we have a lot of engineers. They like to solve problems, and this is things they get excited about. So in our transportation, I talked about electric vehicles, but what we enable with the electric vehicle architecture goes from the cell to the motor, certainly, how do you get to fast charging. We have over 1,000 patents in electric vehicle technologies that support our position. And we get excited that, that could reduce -- electric vehicle penetration could reduce greenhouse gas by about 2/3. And that's where our engineers really are working hard with all the OEMs of the world. Secondly, in our Industrial segment, I talked about what we do around connection systems, around solar and wind applications. There's been about 240 gigawatts of renewable energy put in the world over the past decade. 15% of those rely on our technology from a connection system. Certainly, we'd like that percentage to be higher, but certainly, it's something that we're proud of to make sure that those energy sources that are typically a little bit further away than traditionally are reliable. And lastly, in the data center in our communications segment, I mentioned it a little bit already. It is about high speed and what you're all relying on from a device perspective. But our customers are very focused on, "Hey, they know how much power usage they draw in their data centers." Also, they try to sit there and say, how do they maximize operating costs and energy usage is big. Some of the solutions we provide really say, you go to higher power. That means higher thermal dynamics. How do we make sure our components and where we plan their architecture help bring that energy down? And that's one of the big design elements as they think about workload architectures and so forth. So I wanted to give three quick examples on the sustainability front because it is something where we play in the architecture, we view we get a bird's eye view to really influence that architecture to make sure it has a better impact as well. So with that, I'm going to sit down with you, Stacy, and then you'll get to the hard questions.

Thank you so much, Terrence.

You're welcome.

So where do we want to start like -- in this session, as I've said a I really don't like to dig into the short-term stuff. In this environment, it's hard not to -- I'm going to get it over with, but what are you seeing out there? I mean there's been obviously tremendous amount of angst around shortages and supply, at least within the semiconductor industry. Are there similar dynamics playing out where you guys play in connectors? I know you've talked a little bit about some headwinds from COVID shutdowns in China as I think you guys had 300 basis points give or take, not all that much like relative to what we've seen -- but just, I guess, at a very high level, like what is going on out there? What are you seeing in terms of shortages, both for yourself as well as impact on your customers? Like what does the environment look like today?

So I think we all know there's shortages out there primarily from the space you cover. And the semiconductor space, that's well-documented. And once again, when you think about what we do, the semiconductor is the brain of the applications we're in. You might have a power supply that's the heart. I say what we do are the arms and the legs to really make sure how you get the connection of the different modules and inputs together. Demand is very strong. So first of all, demand is strong, and we're actually seeing some areas that have been down like the medical equipment space that got impacted by elective procedures as well as aerospace. They've started to accelerate post-COVID, and that's mainly in the Western world, those businesses. So we've seen acceleration in some markets have been down. Other markets have continued demand remained strong. Our backlog is up 40%. Book-to-bill continues to remain above 1. The thing I would just stress, though, when you think about the space you traditionally covering us. Our lead times typically are something that's in the 14 to 16 weeks. It might have moved out to like a 20-week. It's certainly not semiconductor. It's not semiconductor, where you see some technologies out a year where you need a birthday candle in an order. But when you look at it, I think what we're all experiencing is somebody is not going to be short in our product. They're planning around that 1-year semiconductor. They're planning out further. And in some cases, you might be talking a quarter further out than what we normally see. So when I use that backlog figure, we're typically a business that might have 2 to 3 months of backlog, we might have 6 months of backlog. So it isn't mammoth, but it is more security. The other thing I would say is there's some markets that have been impacting more. Automotive, let's face it, they've had chronic shortages in different areas. So that production is still running well below demand. And it can't get -- seem to get up into a higher gear, especially with some of the COVID lockdowns in China, war in Europe. So demand is continually to be strong. Supply chain elements of it, I would say, for everything that gets better, something gets a little worse. So it sort of feels sideways. And every quarter, we sort of give an update to our owners about, "Hey, this is what we see this quarter." I would say it's been sideways with some things while they got better. You talked about...

Whack a mole.

It's a whack a mole. And the impact of the war in Europe wasn't a big impact on us. Our customers have adapt pretty well. And certainly, China is a fluid situation. We're in the middle of it, good news with the reopening. Not all of our business, about 20% of our business globally is in China, for China. We don't export really out of China. But it is something -- it's a real fluid situation. How do the customers get up? How do -- our supply chain get up? How does logistic flow, especially for those operations around Shanghai that we're right in the middle of?

Do you think the supply chain just sort of like broadly is going to hold more inventory going forward? I know in semis, a lot of it, especially, in auto was just in time and they're realizing they maybe need a little more resilience. And I don't know if they used to run if they typically run just in time with yourself. But do you sort of see like any sort of structural changes in customer behavior around what that might persist longer once things hopefully normalize?

I think the whole just-in-time question that comes up a lot. I think in places like semiconductors, you are seeing people probably say, "Hey, we're using more semiconductors where we're at in line in automotive." We have to have a different approach. And I don't see that in what we do. Let's face it, just-in-time does have benefits and as cost benefits. So I don't think you'll see that across the board. But in some critical areas, I think you will see it, and then certainly, semiconductor, a lot of the OEMs are trying to figure out how do they get a different approach, how with the foundries, or are they more front of mind versus work further back in line. So I think that's going to be real-time evolution. But with what we do, we have not seen any change, and we don't expect to.

Okay. And I guess to be clear, you guys do your own manufacturing. So that's a whole other issue in semis. There's you don't necessarily have control over where your supply is coming from -- you guys -- like how many manufacturing plants do you have globally, right? They're all over...

We have about 140 manufacturing plants globally. But I think the thing that since you cover semi, #1 is our engineers -- the engineering intensity of our business, our engineers at the design centers of our customers. So if you're in a piece of medical equipment, you're in Boston, you're in Ireland, you're on the West Coast, you're in Minnesota, we have engineers there. Our supply chain is built around the supply chain of our customers. So medical, Costa Rica is important. Ireland is important. That's where our manufacturing sites are tie in. We don't have foundries or outsource things like that. We tie into where the customers are, which I think gets into a little bit why the model is a little different than semi world.

Yes. I mean that was always the perennial question I have is why do you have like over 100 manufacturers, but it seems to make sense. Your customers are all over the place. They're fragmented it makes that much sense to be like -- it almost sounds like you want to be co-located.

Absolutely you want to be co-located. And it's also part of the strategy I talked about we want to be in the region where production is. And it's part of our footprint program, part of our margin program. We don't want to be shipping things from a lead time all around the world. And it's something as part of our evaluation of our supply chain, we've been doing footprint moves to localized around the world, and we'll continue. If a customer wants a China Plus 1 strategy in Asia, we have new facilities going up in Thailand and Philippines. I can give them that redundancy if they need it.

Got it. Got it. I want to ask one more other is Ukraine and the Russia war. So I had to realize this. I discovered a had a lot of like automotive wire harnesses are actually made in Ukraine. Is that you guys or...

We don't do -- we don't do harnessing when we design, we design with an OEM. So we design with BMW, we'll design with a Volkwagen, we'll design with a Porsche in Europe. But certainly, their Tier 1 network, which will be your Cams, which will be your Bosch, your [indiscernible], it will be your harness makers, your Aptivs, your [ Denso ], Yazakis. There is about, I think, close to 20 harness makers in the Ukraine, mainly Western Ukraine. They're still running. The ones in Western Ukraine are still running. They're not running at rate. We're servicing them, but also as our harness maker customers shifted to support the OEMs, we have also helped whether that was in Northern Africa or Eastern Europe.

Tunisia was the other area, right? Northern Africa.

Morocco. Morocco and Tunisia.

I learn something new every day in the show. Okay. I think that's enough on the near term. I want to ask a little more. So just -- maybe I guess, within that context, obviously, you guys do a lot of different things in a lot of different areas. Can you maybe talk about some of the more defensive characteristics of the business model itself, which -- you talked about some things, for example, that are getting better what areas of the portfolio would you maybe characterize as maybe like less or not cyclical and maybe more defensive versus some of the areas that maybe are a little more exposed to some of the cyclical things?

I think with COVID, we've proved everything is cyclical.

Yes.

When we were here, whatever 2, 3 years ago, I would have told you our medical business was probably our least cyclical. With COVID, elective procedures...

Yes, I was surprised when you said that got impacted, but that makes sense like you're only doing COVID, you're not doing...

When the emergency rooms got shut down, we play a lot in interventional heart procedures. Hospitals, the ICUs were taking over for COVID, and those procedures went down. So the thing is, we are going to be tied to underlying things like production of cars, planes, elective procedures and that I think the real thing that has made it more defensive has been more about the secular elements to it. And like I said, auto production right now is still below 2019 levels by about 10%. Our revenue is up 20%. So some of the things that are creating, we're still going to have shape to the different markets we have, whether it's auto or if it's CapEx spending, but the element is the buffer that we've gotten out of the content has been huge. And I think the real examples and to the second slide I showed, you see it clearly in auto where our content has gone from $60 a car to $80 a car. And that is 60%, that's driven by electric vehicle acceleration that is growing again 30% this year. The other 40% is core feature adds, both in combustion and in electric vehicles. That is your safety features, your comfort features, even emission things on a combustion engine, you need new connectivity and sensing into that. So that growth of that $20 of content, a big chunk is electric vehicle, but it's also the more the lower voltage. And the other thing that I think when you look at our cloud exposure, that business is up 50% versus 2019, and that's cloud...

5-0 or 1-5?

5-0. And cloud CapEx is up 25% to 30% in that period, and it's the content outperformance that's helping give some buffer to total TE.

Let's talk about some of these content and so this $80 content per -- go up from $60. So $80, that's an average, right? That's not like in an EV, it's 80 it's blended across what is the content in an EV?

So if you look on an average content for us in an EV today, it's about $140 per vehicle. And let's realize, I said a little bit earlier, there's about 78 million cars that are going to be made in the planet this year, 12 million in EV. So when we talk about the secular trend that we get excited about is as you get EV adoption, I showed some of the brands that we're on, we're basically on every electric vehicle because we're the world leader in it. Because you have a whole different electrical architecture that's been added with the electric powertrain from the battery, to motor, back in the charging, and all of that is trade in that content growth. So on a combustion engine, we have about $70. The vast majority of that $70 comes over to an electric vehicle. Let's face it. Your electrical architecture for your seats, your lights, your comfort, your infotainment set isn't really changing. You add in the electric powertrain. And the difference is that 1 to 12-volt system or a 48-volt system, the other one could be up to 800 volts. You can't cross these two. So they are duplicate architectures that get put in, and we benefit because we play in the connection systems in those architectures. So when you look at it and you say, how do you go from $70 to $140, you're adding a whole another architecture. Certainly, you're adding things that have much higher performance in a low voltage as well as much more reliability. In an electric vehicle powertrain, you touch a 12-volt electrical system in a car, traditional car, you get a little cute shock. You touch it in an electric vehicle, you're going to have hospital ride. So it's not something and safety requirements and reliability come in are key because we're playing right there, and certainly, the reliability is a big question to consumers. How can you rely on them...

Got it. And I guess you sort of made the point like your revenues in auto were up, but it was at 20% production is 10% lower. And we see something similar in semis, although I think it's an even bigger dichotomy. One thing people are worried about in semis is like double ordering and [indiscernible]. Now if your lead times are still relatively short, I feel like I would be less worried, and you have control over your supply. So I guess was there any other elements of that increase? Was there premiumization like there's been a shift of way for lower and cars to higher end cars -- has pricing been an aspect of that. I mean...

It's twofold. Let's take them separately. One is a quick answer. The other one I want to talk about pricing broadly, not just automotive. So if you add options to a car, that might add $1 or $2. It's not going to add something that is all of a sudden adding $10. That big jump we have from a $70 combustion engine to $140 that's not an option. You've got a completely different powertrain in there. So option, we can be benefiting a little bit, but there's also things OEMs can't put on the car because they can't get components. My wife got a car recently, couldn't get wireless charging. I mean, it's not the highest tech thing, but they couldn't get the parts for that. So there's going to...

She could get that later?

No. It's just where you don't get it. But then on pricing, one of the things I think that I'm excited about what the team has done our business model because we are in the technology space, we typically get back 1 point or 2 a price a year of productivity. It's mainly in our automotive business as well as in some of the cloud business that we do. We're going to be running positive price this year. And we've been doing price increases now. I mean, it seems like every quarter, for those areas, we can do transactional, we do them every quarter. For those that are contractual we're having customer discussions. So we will be price positive this year. If you look at our most recent quarter, where we grew 8% organically, about 1/3 of that was pricing. So pricing is a factor, but it's not like it's 10%, 20%. It's a cost recovery, and we basically tell our customers, this is about cost recovery. as we've helped them, and we expect to help them, we want to maintain the business long term.

Got it. What have you guys been seeing with like your input cost and everything? You've got more control over your supply chain. Has there been less -- do you think there's been like glass input cost increase for you guys versus others that maybe have a little less control over that manufacturing?

No, I think I don't -- probably from a rate, yes. But I think we're all dealing with an environment where, whether it is your core input materials, in our case, it could be things like copper, things like oil-based resins because what we do could be on semiconductors in our sensors business, you have certainly price inflation. You have it on freight around the world and logistics have been significant. And then you also have in the energy complex. Certainly, we manufacture in Europe like we talked about. So inflation is pretty broad. I think our teams have been doing a nice job both on pricing and productivity to really make sure we continue to keep the margin up at that 18-plus level.

Got it. And I guess one last question on this. If and when hopefully, things normalize, what happens at that point? Do you think you can kind of go back to the historical pricing trends, but off of the new base? Or like is there a reset if costs come down? Like what do you think?

Well, I think what it will be is, certainly, it will probably be on a lag, no different than pricing has been on the lag. So I think you'll have a lag. I think what will occur, like we talk to our customers, "Hey, we want cost recovery." If costs came off, we would give them a cost rebate. Otherwise, it would be sort of a normal productivity discussion. Volumes, we expect to drive productivity. Our customers, that's part of our value prop, costs went like this. We have to drive productivity.

Got it. That makes sense. One more on automotive. Obviously, again, in semis and everything, there's a big push around things like ADAS and autonomous driving itself. Do you guys benefit from that? Like how does -- what happens with your content? Is that hopefully becomes more prevalent over time?

No. The bigger opportunity is electric vehicle for us because putting in that electric vehicle architecture is big content. But when I talk about the other content growth we've seen, ADAS is part of it because what you're doing is you're putting an ethernet network in for the data. So what occurs so that, that network that you talk about ADAS, as you get Level 1, Level 2, Level 3, Level 4 [ autonomy ] put in the car, you're adding to the infrastructure card, and we get content increase in that. That can be like $10 of content over time. When you get to Level 5, it's mainly software. But up those steps, we continue to get incremental content as the infrastructure gets put in for the compute that you need for the ADAS and the electronics. So that is a content driver. It's not as big as electric vehicle, but it's one of the things that shows we sort of call it electrification, which is the electric engine and then electronification, which is the electronics that continue to get into, and we sort of break them between the two.

Got it. What about the other piece of within transformation to trucking? Like how big is that like relative to automotive? I don't think it's -- I don't get the impression that it's small.

No, it's not small. It's about $1.5 billion 10% of our revenue. And I know we spoke a lot about content and cars content on a big truck is probably $400 to $500. As we move, number one, you're probably getting more of the electronification in the heavy truck due to emissions also due to telematics and things like that. We continue to benefit from content. What we're seeing now is our design wins with our large truck makers, you see them putting in more larger programs around electric vehicle architecture that has the opportunity to take that $400 to $500 a truck, up well over $1,000. So you're seeing the content trend. I don't think that will give us meaningful revenue probably for 5 years, we probably have like $20 million of it today, but it's some...

On the electric pieces?

On the electric piece in heavy truck, but it's something we get excited about with the wins, that's going to be a tail to continent growth coming out.

Got it. Got it. And what are your -- just to level set, what are your targets for growth and margins within the transportation business?

So when you look at that, so we believe we'll grow 4% to 6% over production due to the content element.

Overproduction.

Overproduction. The other thing you have from the margin side, we run sort of at company average in our transportation we see the opportunity to get it up to 20%. A couple of things driving that. Number one, we're still scaling our electric vehicle platforms. We put a lot of investment in around engineering, around footprint. That is going to continue to scale, and we've been moving the margin up on that. Also, we have elements around footprint programs that we've been doing that are still in progress through this. Those two together as well as volume, will get us up close to 20%.

Got it. Got it. How much of the sensor business is within transportation?

Sensors is about $1 billion of business in transportation. It's an area where we made a big investment, probably about 5, 6 years ago. We've been really trying to get focused on the portfolio we got between transportation applications like I talked about earlier, as well as in the nontransportation applications, factory automation and medical. So we have a lot of applications that we're sort of deprioritizing because we really want that to be pointed towards secular trends.

Okay. Got it. I guess whether you do that deprioritization, does that impact growth in sensors or...

It has been impacted our growth in sensors as we make sure our engineer is going to focus on those future programs, but it has impacted our growth as we work through that transition.

Are you through it now or like we're...

We are midway through it.

Midway. Okay. When does that start to grow again?

It will be growing here probably about a year.

Okay. Got it. Got it. Let's talk about the industrial business. Again, you talked a little bit about some of the pieces that are there. But where are you most excited within the industry? Is it common data center? Is it like broader industrial automation? Like what excites you most within...

Common data centers and communication.

That's communication. We'll talk about that in a minute.

When you look at Industrial, I would tell you, we've been building out our industrial business -- in our Industrial solutions, really around factory automation because when you sit there and we're a discrete manufacturer, we're not a process manufacturer. You look at the thousands of machines we have, the first thing you have to do is get them connected. So you can monitor, so you can predictive test them and certainly automate them. And that's an area we've been investing in. So factory automation is an area that, whether it be robotics, whether it be what's happening with semiconductor equipment we benefit from all of that.

What are you doing semi-cap equipment?

What you have is the connectivity that actually it all works. So some of your customers that you've had here we're on their equipment.

Shortages are not coming from you, though, right?

I'm sure that they're also complain about their so conductor customers that they need their equipment. But you get the connectivity that we need to bring data and power to that equipment. So that is an area. And certainly, when we look at what we've been through COVID, we get very excited about factory automation. The other area we do -- even though it's been a tough cycle in medical, we do get very excited about interventional procedure, both what it brings to outcomes...

What does that mean interventional procedures?

Actually, the device that actually is the connectivity in the device that can actually put in.

Like a pacemaker or something?