TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Can I get started? Thank you so much for coming this morning, everyone. My name is Stacy Rasgon. I cover the U.S. semiconductor and semiconductor capital equipment space here at Bernstein. And it's my honor to introduce our guest this morning, the Chief Executive Officer 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 presentation, on your program, there is a QR code on the back, you can scan that. That will take you to our Q&A form is called Pigeonhole. And you can submit questions there, and we'll leave time at the end for those questions.

So TE Connectivity, like what is it? It's actually not a semiconductor company. We don't cover it, but that's okay. It's pretty close to some of the ones that we do, 500,000 probably different products. Every pervasive spot in every end market imaginable contributes connection technology to a huge number of products and services that you interact with every day on a daily basis. They span across automotive and industrial and defense and networking, even medical with hundreds of sites and thousands of people and billions of dollars in sales across a global network. Again, even though I don't cover it, it actually does come up in my conversations. I'm reasonably often, they are exposed to many of the same markets and the same drivers that many of my companies are. I think investor controversies do focus on a few things. Certainly, there's the near-term stuff around post-COVID environment and demand and all that, I'm sure we'll talk about it, but inventories and all that. But beyond that, like people ask about long-term growth targets given a pretty high share position that they have and they want to know where margins and free cash flow can go. The company's play had -- M&As played a big role in the company as well as divestitures and people wonder like where are those in terms of like achieving the company's goals and frankly what's coming next. And to answer these in many, many, many other questions, it gives me great pleasure to welcome Terrence. So thank you so much for coming today.

Thank you. And thank you, everybody, for spending the time with us here over the next 45 minutes or so.

Do you have a safe harbor or anything you need to give or?

It's the same safe harbor you've heard a hundred times, so I'm not going to do it.

Yes. I thought I'd check. So I thought just for our audience, we tend to have a lot of generalists here. Maybe if you could just give a brief overview of what TE Connectivity actually is at a high-level segments and market product types.

So I'm just going to build on what Stacy just teed up. So first off is we're next to the technologies that Stacy covers. Typically, you have a semiconductor, that's the brain. And so a lot of things that happened in a lot of architectures, how does everything move from that brain, whether it's power, data signal to really make sure an application comes to life. And really, we're the global leader in connector technologies that are around that. When you think about what we do, we are very heavy engineer-to-engineer. So when you get into an application and I'll talk about the market segments and the applications that we've really focused TE around, it is a heavy engineer-to-engineer touch that happens locally around where the architectures get designed in the world, whether that's a car architecture, a plane architecture, medical device architecture, and we'll talk about more of those markets, so it is a heavy engineer-to-engineer. We have over 8,000 engineers deployed globally to really make sure we're at the engineering nodes of where those architectures are designed. The other thing that is important, Stacy was right with how many products we have, we could be in a lot more applications we are, but we have chosen to focus on a couple of keys. And I want to break that down of how we report our segments, but also the key trends that we've aligned TE around because it comes into some of your divestiture and M&A comments, we've done a lot of divestitures to get to the portfolio we think we can play offense with and it's really around the applications that matter. So our largest segment, which is about 60% of TE, it's our Transportation segment, and that's everything that's around the car and also heavy truck area. And when you think about that, that is in both of those businesses, we have a leading position, #1 market share in the world. We're essentially on every car in the planet. And really, what we're capitalizing on is the transition to the electric vehicle, but also as you get a data network in the car, an Ethernet network that really makes autonomy and the intelligence that we will expect in the car happen. And so really, what happens there, you're not only taking a low-voltage network that exists today, you're adding a high-voltage network for the powertrain, and that brings a whole bunch of new opportunities for us. And if you look at us over the past 3, 4 years, our content per vehicle is going from $60 per vehicle to $80 a vehicle in an environment where auto production has been down, auto production is still in the recession. So it's very important in the electric vehicle trend. We are China, Japan, Korea, certainly throughout Europe, North America, we are everywhere where cars are made, and that's a trend that we continue to win in and it's going to continue to drive content as we go forward. And then also in the heavy truck, data is more important today, but you will see we're getting wins on next-generation electric vehicle powertrains that will happen in the heavier vehicles. Our second largest segment is our Industrial segment. And I really think there's 4 areas that we position TE around in the Industrial segment. First one is around factory automation. It is our largest. It's how when you get data on the factory floor to make it more productive, certainly more predictive. It's areas where unique connection technologies that bring that data from the sensor comes back into where the compute occurs, and it's an area where our business has grown about 25% per annum over the past 3 years. It's an area where we focused on both organic as well as bringing on bolt-on M&A. Second area in our industrial space, that's important from a driver from a trend perspective is around the energy complex. And while we use the word energy, energy does not mean oil and gas, energy is the infrastructure of the grid. And it's an area where about 25% of our sales are in renewables, and it's created about an 8% CAGR over the past 4 years, entirely driven by our positioning around renewables, and we think that's going to continue to grow. And it's the things that help hook up solar and wind into the grid, and it's certainly much more distributed than traditional grid. And then the 2 other markets that are important in our Industrial segment have to do with: first one is medical, where we do things around interventional procedures. And I think you're going to ask me about where we are pre-COVID cycles later. But certainly, when you look at medical is just getting back to pre-COVID procedure levels, and our Medical business just had record revenue, and it's where we actually do things around interventional procedures. And then lastly is aerospace and defense, where we get into what we have on a single aisle, dual aisle aircraft, certainly, what happens with space as well as defense side, that is still in recovery mode. So we have good content position there, $50,000, $80,000 on every single aisle aircraft. But when you get that recovery, that content is baked, and it's really how do the units produce. And then in our smaller segment, our third segment is our Communication Solutions. And really, the key driver around there is around high-speed data. It's an area where we focus very much on the highest speed. I know your world a lot around cloud and server. We benefited from the cloud and server boom we got there in COVID. It's a little bit of a slowdown now as supply chains adjust, but we also have about $1 billion of win around AI that I know you'll ask me about.

We'll talk about it for sure.

And it's really in our world, it's how speeds continue to extend, create content opportunities for us. And it's really nice that, that is the next leg for growth around our business there. So net-net, that's just a quick overview by our segments and the trends. We do not do consumer electronics. And I just want to make sure where we do play and why we play there, got laid out a little bit, and we'll bounce around that.

I promise I want to ask you about the subsea business back in the day. So...

It doesn't exist. It's not -- I'm happy about it.

They used to do underwater cabling. It was -- before we drill down onto the businesses, I'd like to start high level, if we could. I know you guys have a model that you run the company. Maybe you could talk a little bit about like the financial model where you set your targets, how you run the company? And then by segment, like how are each of those contributes to that?

So every one of our markets, we're going to have some sort of cycle to it. So we do think through cycle. And from a growth through cycle, we sort of view we'll run 4% to 6% organic. Our Transportation segment due to the EV trend will be higher than that. We'll be in high single digits and really you have auto production, what that will be, then certainly the content that comes above it from EV will be the big driver there. In our Industrial segment, we'll be right around mid-single digit. There are like most industrial markets. There are some places that sort of grow industrial CapEx, but certainly, the drivers that I talked about will get us up more to mid-single digit. And then in our Communications segment, which will probably have the biggest shape of cycle, similar to some of the things you cover. It's an area we sort of think will be around that mid-single digit as well, really being driven by what we talked about on high-speed from how does that flow down to where we -- our margin targets are. We sort of -- our Transportation segment, we expect to be around 20%. Industrial Solutions will be higher teens, mid- to high teens, and then you sort of have in Communications, we'll run 20% through cycle. Like our Communications segment last year when we were in a very hot cycle, ran about 25%, well above that target, it's cycling now. We think that will normalize through cycle around 20%. And then the other thing that's important is our cash -- our business model is very cash generative, probably around 95% free cash flow conversion. When you look at that, and we sort of think about it, 2/3 roughly go back to our owners between dividend and share repurchase. And then from an M&A, which you talked about in your leadoff, we sort of think about M&A, how do we bolt things into the position we have. And really, obviously, think about organic growth first with the trends we have, but it's really around bolt-on acquisitions. And in the past, I guess, a year or so, we've done about 4 of them. We're about $350 million, so we'll continue to bring smaller bolt-ons and to strengthen our position or to fill a gap, we may have.

Got it. And these growth targets are these organic or are these combined?

That's organic. That's organic only. M&A would be on top of it.

Do you have a feeling for what M&A adds on top or...

Could be a point or 2. It's been a little bit less than that due to just where things were trading. We do have an ROIC mindset, but it's nice to see some of the things happening in the market. So hopefully, it's got a little bit more normalized.

I'm jumping ahead, but I probably should ask that like what are you seeing in the M&A, it sounds like prices are coming, valuations are coming -- becoming a little more powerful now?

What I would tell you is, even with everything going on in the capital markets, activity, discussions are happening. You would think maybe things froze. I do think people are getting a little bit more realistic than where they were because there's a lot of opportunities just the math that makes sense. So hopefully, that continues.

Got it. So what are you seeing sort of just like near term? Obviously, we're in a pretty dynamic environment right now across all these different items. I mean, across auto, across factory automation and industrial. I mean just in my space, I mean, I'll just -- clearly, anything consumer-related that was strong in COVID has collapsed. My own feeling is we're -- these are inventory cycles primarily as well as demand. We're probably close to the bottom on some of those consumer areas. Things like data center, enterprise has been weak for a while and cloud is rolling over, although we talk about AI. Clearly, spending is happening there. Industrial, we're just starting to see the first hints of some of that. And then auto, so far is pretty robust, although I've been nervous about auto. I've been wrong apparently. But the magnitude you're talking about content increase -- like just the sheer magnitude of semi sales versus SAAR and that widening gap has been concerning. So like what are you seeing across all those end markets?

So a couple of things, and I know you follow [ semi ], our lead times are not [indiscernible] lead times, so our lead times are sort of in a normal time 8 to 12 weeks, so it's a little bit of a different thing.

You guys haven't -- you guys were a little bit on the shortages like in COVID, but it wasn't like incredible, right?

No. We had areas where we could not meet that 8 to 12 weeks as consistent and you had some buffering -- that's work off supply chain other than in places that are still recovering like medical and aerospace, I would tell you, our supply chain is pretty normalized, and we're serving our customers 90% of the time in that 8 to 12 weeks, so I know semi still has some issues. I guess, if you think about our business as the way I laid them out, we had 2 businesses that really benefited in COVID. They were both in our Communications segment, the cloud side of it. And then also, we have an Appliance business, that's a great return business. We have leading share, that benefited from everybody, stand at home. Both of those are cycling down, some for inventory, some for demand. But net-net, there are things you would probably expect to see one area that is similar to what you said that I would say, a lot of strength pre-COVID, showing some signs of weakness in certain pockets as the general industrial and equipment space. So when we think about our Industrial Solutions segment, I mentioned 4 businesses. Three of them are very strong. Aerospace is strong, medical is strong, certainly around the grid and the energy side strong. Industrial is showing some times weakening. We're seeing some of our distributors pull things back. And then you see things where industrial automation that went into consumer electronics could be companies like FANUC that does robotics that play into the big consumer electronics space, you see weakness there, you see that in warehousing type applications. So probably similar to what you see, so we see that sort of plateauing having a little bit of a downturn. Elsewhere, we still have strength, like I said, across the 3 businesses in our industrial. And then Transportation, what I would tell you, it's been very stable. Auto SAAR has been at 80 million units globally for the past 3 years, and it's still down 10% from pre-COVID. So auto has been stable. Certainly, a lot of people have that nervousness because of some of the economics, but it's sort of consumer demand is still up here, car production is still here. And certainly, consumer demand with what's going on [indiscernible] where do they meet, but it's not the typical inverter where production is here, demands here and the auto makers chase. So we continue to see a stable SAAR environment, and that's what we've expected right now with what's going on economically.

Got it. Let's move into auto, that's probably a good segue. So first of all, you talked about your content moving from 60 to 80, I just want to verify, so that's not you taking your auto revenues and dividing by SAAR. Is that you knowing we're shipping these parts into these cars, and that's on average what our content is?

That is us divided by production.

Okay. That is your revenue is divided by production.

That is our revenue divided by production. And so when you sit there, you talked about ship ahead, our backlog and everything in auto is pretty normal now. It's back to 90% ship the request. So when we look at it, while you might inter quarter have some anomalies due to what's happened in the supply chain, we went from [ 60 to 80 ] And when you think about that [ 60 to 80, ] about 2/3 of that was [indiscernible] driven by electric vehicle. Now you got to realize the electric vehicle is still only about 20% of total car production.

And your content in EV is what like 140 or?

About 140 on an electric vehicle versus on a combustion engine, 60 to 70, and on the plug-in hybrid, you're going to be 110 to 120. So you sort of have different steps as you go up there, but if you say, why do we get that content? First off, when you go from a traditional combustion engine vehicle, I realize there's a whole electrical network that you rely on for all your features. And that electrical network -- that low-voltage network comes over into an electric vehicle. Then you add an additional high-voltage architecture that really is the powertrain, that starts at the charging inlet. The charging inlet is a connector, believe it or not, so that's where it starts. It goes down. It goes down into your motors at work, certainly into the cells that drive it. And that's what drives that incremental content for us, and it's much higher content because you're also dealing with higher voltages. It's not a 12-volt or 48-volt technology, you're dealing with [ 200 to 400 ]. And it's very different and it adds to what drives the incremental.

How does your content vary between like a high-end like battery EV versus like a plug-in hybrid versus something lower in this like selling into China?

So you'll look at it, each one of them has a content increase. So if you look at us, we're benefiting from hybrid and BEVs in China. So you look at it, a real high end, you would have more content and relationship to probably the low voltage architecture due to features than the high-voltage architecture. We have some battery electrics that have $800 of content on them where, in some cases, an OEM may be asking us to do more, more like a Tier 1.5, we're typically at Tier 2. It does not go traditionally as you would think, like we have more content on the Model 3 than on Model S. So how we deal with -- also how the architectures change and the complexity that you have. So there isn't a rule of thumb because a lot of the architectures are still evolving, but we're truly great as we're on everyone in the world.

Do you see that EV content over time continue to go up like on a like-for-like basis?

I think it will go up incrementally as electronics change. So similar to that, if you take a combustion engine today, even when you think about how we went from 60 to 80, 2/3 was electrified powertrain. The other 1/3 was core electronification of a car. Safety features, infotainment stack. So as you add those other things also you add the data network, I think you'll see as you've got the more fuller penetration, you'll see a more traditional content growth due to electrification.

Got it. And so that 1/3 of content that wasn't -- that was like new features in units. It wasn't like pricing coming up?

No, we'll get a little bit of pricing this year, but the bulk of that was due to features: safety, infotainment stack, anything like that. Certainly, we've done pricing. It's one of the things in our Transportation segment. We're below our target margins because we saw pricing coming in this year. This year, you'll see our growth rate being higher due to the pricing impacts than we normally would think.

Got it. Were you guys impacted by cost increases like over the last couple of years in the wake of all the inflation?

From my word, Yes.

So as you think -- reset the prices then.

So it's different by our businesses. So if over the past 3 years, we've incurred about $1 billion of inflation, and inflation for us is in many different elements. Core materials like metals and plastics where we start. We don't -- we make what we do. We don't -- there is not a TSMC and connector.

You've got a ton of manufacturing...

So about 120. The other element you had the freight lift up, and then you also had things that related to just the utility complex around the world where energy prices went up, so it was about $1 billion. The only place we've really seen it come off meaningfully is really in the freight and logistics side, you've seen that sort of class elsewhere has been sticky. I sort of think it's plateaued. In our Industrial and Communications segment, we got price pretty much real time. In our Transportation segment, it's a lag.

Like price reset or...

It's an annual price discussion. And we actually did a separate 1 last year, and we're getting the benefits in now. So we expect that our Transportation segment will be running back up at the 18-plus percent range as we exit this year as those prices...

Where is it running now?

It's been 16% to 17%, so we're going to get some of that back.

Got it. Got it. Was there any pushback from customers in terms of trying to roll those through or...

Of course, but it will -- when we get through this year, we'll be made whole on that $1 billion.

Got it. Got it. Do you have a -- do you guys have a targeted point of view for like growth above SAAR for your business? Or just -- is that just what's incorporated?

No. So the thing when you think about SAAR, you do have to break SAAR down to what's happening on electric vehicle because the content is different. If you sort of had core combustion and core overall growing at like a GDP rate, we'd say [ 4 to 6 ], we have to get into -- if you get more EV going, we're going to have higher. If you have less, we'll have a little bit more just do the mix.

Do you guys have a point of view that you've ever talked about in terms of like when say EV penetration gets to 50%, I mean there's -- because it seems like it's...

Right now, we're around 25%. I think there is -- you took over the next 5 years, I think you can see something that gets up to more of a 40 million unit, which will be closer to that depending upon where the total SAAR is. But the adoption rate that has been so consistent around the world with Asia certainly being the leader, then Europe, North America is still a small number. But you still see that penetration rate, which is exciting that's going on.

Got it. What's different in terms of selling into the large trucks versus the cars?

What's -- it much more fragmented. The whole supply chain is much more fragmented. But when you look at it, you also get into a quality element that's different. Car life span versus a truck lifespan and...

Truck life span is actually?

It's long. It's very long and you also come into -- you're dealing with somebody's productivity. So it always come back to a productivity model on the fleet. So it does come into when you get into it, there are things around data that are more important that drive productivity today, but 5 major OEMs around the world we're working with on what could be an electrified powertrain. [Audio Gap]

It didn't to me feel like it fit exactly, so like why does -- talk a little bit like what that actually does. What are you doing in there relative to the other business? And why is that a good fit for you guys?

So a couple of things that we do. So we start with the interconnect, but the other thing that we've always done was we're excellent at really fine things. So if you think about high-speed connector and so forth, they're very fine. We also have done that medical technology for quite some time. And as interventional procedures started, we partnered and we also did some acquisitions to say that is things that go right into our skill sets or what our engineers do. So what we actually do, we will work with the Bostons, the Edwards of the world, and we will actually help as they design their devices and make parts of their devices for them. So it very much comes into some of the fine wire things that we do that go into connectors and it's something that our customers were asking us to do. So that's about an $800 million business today, something we think can grow high single digit, especially as procedures get back on. And it's something where it's that heavy engineer-to-engineer touch and certainly, that we get to make an impact and help those innovations come to life, we always get excited about, too.

So you talked about, I guess, that's recovered. So that took a dip during COVID procedure, volumes went down.

Yes. I mean if you think about our portfolio, we would have told you pre-COVID the medical industry and the device industry doesn't cycle. If you get hit with a pandemic at cycle, people stop doing procedures. And then the other thing that I would say you would slow in the recovery, not only the procedures went down, the supply chain, the medical supply chain is one that's still trying to recover. A lot of small shops in there. We're still impacted in helping our customers continue to ramp up, but I think there's many medical device companies out there that are talking about supply chain challenges, which also could be an opportunity for us as we take more on.

Yes. interesting, you talked about it at least a view that it was noncyclical and not exactly correct. But are there pieces of the business that you would sort of view as maybe more cycle exposed versus less cycle exposed?

Certainly, I would say because of how global we are, everyone is exposed to a cycle, even medical anymore. But what -- how we think about it is how do we set up with secular trends to really say it could buffer some of the cycle. And I think the best example that you've seen with that is what you've seen in our Automotive business as we've driven content while auto production is still off versus pre- COVID. So I do think you have some that have a little bit of a sharper shape, like communications typically does. Some are a little bit more steady. I wouldn't say there's one rule of thumb, one versus the other.

Got it. Got it. I guess what else about health care? What kind of like ASPs do you get for a device like that?

Well, if we're doing more of a device, it's similar to automotive, we could have something that's pushing a $1,000 a device. If we're just doing some of the componentry in it, can be $5 to $10. So it depends upon how we want to win that project, what do we bring? Do we bring value to it, can we capture margin, but it can range similar that you could have on a vehicle.

Yes. I guess more generally across your businesses, how much of your efforts are maybe geared more toward that sort of system approach and higher value-add versus components? Is that a move that you've been making over time towards more like systems and value-add?

I wouldn't say it's a move that is one that we say we're going to always be there. We like to be at Tier 2, so we do start with a component mindset. However, due to when you say system, when I think about our understanding of the architecture, our customers do, and I would call it more of a Tier 1.5 than a Tier 1. We are not a Tier 1. We don't want to be a Tier 1, but there are opportunities that could be on a module, could be on something like that device where we do see there's value capture for us and that we bring to the customer. So net-net, I would probably say 85% to 90% still components, and we're very purposeful of, hey, are we moving up? Are we getting real engineering design and value capture or we just selling labor. We don't want to be a labor seller. We don't want to be a contract manufacturer. We want to be somebody to provide engineering value, and so that's typically the rule of thumb, we think.

Got it. Okay. And I guess within -- to move on to the aerospace and eventually the other piece of industrial now. So is it primarily commercial like the aerospace piece or...

It is split pretty half and half. It's split half and half. It's a little bit lower in commercial due to dual-aisle, planes aren't being built. So they're heavier content. They are $200,000, $300,000 a plane on a dual-aisle versus [ 50 to 80 ]. So our revenue is still off a good 20%, 30% in that business versus pre-COVID. Single-aisle aircraft, they're getting the build rates back to where they were pre COVID. Dual-aisle still has a way to recover.