TE Connectivity plc (TEL) Earnings Call Transcript & Summary

Vehicle tech and mobility for Baird. We're very pleased to have TE Connectivity with us today. TE is a leading supplier of connectors and sensors serving the transportation industrial and communications end markets. Joining us, we have Terrence Curtin, CEO and the e-mail address for this session is session5@rwbaird.com so feel free to send me any questions, I'll try to work those in. And with that Terrence, if you want to add anything to that brief introduction, feel free.

Thank you, Luke, for having us. Thank you for everybody participating today. And I think just -- I want to add a little bit to what Luke said of what we do for those of you that aren't familiar with who TE is. We are the leading global supplier of connectors in the world electronic connectors. We also do sensors. And we're very much focused on 3 primary areas: first off in the transportation area. We cover the globe around the automotive industry, benefiting both from what happens in data in the car as well as electrified powertrains, which I'm sure you'll give me a bunch of questions on that today. Certainly, also have a leading position in industrial transportation globally. And then in industrial spaces where we play, aerospace, medical, energy as well as general industrial equipment. And then the last area that we play in the third area is around our Communication Solutions business, which right now, what we do is the connections for the ultimate high speed, which few years ago was cloud, certainly, we're going to benefit from AI. And really what we've done at TE around our portfolio and where we play is when you think about an interconnect, where power and data need to come together, which whether it's an electric vehicle trend, an AI trend, you typically need our product of what we do to bring that technology together. And that's where we position TE around that I know we'll get into today, but it's really the things that we want to be focused on that drive above-market growth across the globe. We're very global business. The majority of our business is outside the United States. And it's something when we think about where things are designed in the world, that's where we place our over 8,000 engineers to start that connection with our customers. And lastly, which I'm sure will also be a question from Luke, we still have self-improvement opportunity on the margin side. Just our earnings last week, we reported about 17.5% OI, that's low 20s EBITDA, and we think we have a path to get that up closer to 20% through different contributions from our segment, but that's still a journey that's ahead of us. So with that, I'll pause and I know you'll drill down on questions.

Well, thanks for that, Terrence. So why don't we just start with a couple of questions on the macro. This is a conference that's leaning into the next calendar year. You're already into your fiscal '24. Transportation is the biggest single end market exposure for the company. Can you just talk about key demand in [ LVP ] variables or sort of just the range of outcomes that you're looking at next year? Do you take a glass half full or glass half empty approach given the current rate environment and whatnot?

I think I'll let you all decide whether it's glass half empty or glass half full, how about that. First thing is what I would tell you, we're in a slowing global economic world. So let's just -- that's a backdrop that we've been in, we expect '24 to continue to be in that. Now I think what is unique around TE that gets us excited about '24 in certain of our businesses, we've been through destocking this past year where you had inventory correction going on as global supply chains improve. We do expect that will be behind us in early '24. Secondly, that gets into where you talked about on transportation, auto production is still below pre-pandemic peak, and we expect next year auto production to be sort of just running sideways. We don't expect a lot out of auto production next year. And really what we think will drive in our transportation business where you went Luke really is probably 4 to 6 points of outperformance that we've always been consistent talking about that really revolves around 3 trends in the car. Number one, the global penetration of electric vehicles, and let me come back to that; secondly, Ethernet being put in the car which is the data in the car that creates a content opportunity for us; and then thirdly, just the ongoing electronification whether you're an ICE vehicle or an electric vehicle, safety features, infotainment stack, all of that, there are things that actually drive content for us. And that's why we've been able, over the past 4 years to take our content from $60 a vehicle globally to about $80 a vehicle today. Now let me talk about electric vehicle because there's a lot of questions out there about electric vehicle penetration and things like that. When you think about TE, you have to start with a view of TE is very global, and our biggest position in automotive is in Asia. So 40% of our automotive revenue come out of Asia. Certainly, we're big in China, leading position in Japan as well as in Korea. And when you think about where electric vehicles occur of the $20 million made last year, about $15 million were made in Asia. And we don't see that slowing down in Asia and that's been a big content driver and our leading position, where we have engineers locally, designing with our customers to bring this technology to life is critical. So as we think about electric vehicles, it's going to start with global penetration and about 20 million are made today. We think there'll be about $25 million made on the planet next year, driven by Asia lesser in Europe and certainly, the slowest area of growth will be -- unit growth will be here in the United States. So I do think that's an important backdrop to have. And we don't see that -- those programs slowing down with our customers. You see consumers making choices about what they want certainly in the United States, but that's part of any adoption curve. And we never said that auto production was just going to go -- EV is going to go up to the right. And it's something that we get excited about what's happening in EV. The only other thing that I guess I would talk about, when we think about going into '24 and whether glass have full or empty, I would tell you, one of the things that's been very consistent is order intake. While we went through a lot of supply chain moves, our order intake is very level. It's been consistent for about 3 or 4 quarters. And that is just something that also says as the world working through destocking and things like that, that are creating headwinds, we also still have places like commercial aerospace, we can't make enough areas around medical devices where we play in interventional procedures where we just have close to 20% growth. So we have a lot of nice balance in the portfolio, not just the great automotive business that we have.

What about the supply chain side of things and operations just in terms of your internal supply chain right now and your visibility into balancing price and cost as you roll into fiscal '24 here. Is the heavy lifting finally over at this point, would you say?

So let me take those in 2 different pieces for everybody. So let's talk about the supply side and then let's talk price and inflation, if that's okay.

That would be great.

So first off, on the supply side, other than the aerospace market, supply chains had normalized from an availability material. So what we have seen, and it's why you're seeing destocking in the world, people are hitting the lead times they're publishing, certainly, in some areas, lead times are coming back in as supply has gotten better post-COVID. At the same time, because we are global, we continue to make sure we're regionally supplying within region. We don't like shipping things between regions of the world, and that also helps as well. So the supply side is good other than aerospace, which is continuing it feels sort of like where the rest of the industries were a few years ago. It's still a supply chain that's trying to get back and meet the demand it has. And let's face it, we have about $1.3 billion of revenue in that space, and that's still an area that we still have supply chain challenges. Now on the price cost side, this past year, we benefited about 400 basis points on the top line from price where we recovered inflation. So the whole inflation element we experienced over the past few years. This past year, we got caught up on getting price that covered inflation. Where price goes from here is going to be a matter of the input cost. And when you think about TE, it's certain metals, copper, gold, resins that we use actually in our products, you get freight. Resins and metals are still very elevated. So as long as they're elevated and like we said on our earnings call last week, we sort of expect next year will be plus or minus 0 on price because of the input cost environment that we're dealing with. So I think that will be a key element we're going to keep an eye on whether there needs to be more pricing done or actually there is deflation occurring. But other than freight, we don't really see major deflation happening in the material side.

So why don't we switch to transportation solutions. So you already addressed sort of just EV backdrop that we're looking at right now in terms of growth. I'd be curious to talk about sort of the strategic considerations there. If we look at what's the trend going on at the likes of Tesla, there's been an evolution in thinking about data and power in terms of the actual architecture of the car, compute consolidation part of that as well. Just what's your perspective on how evolving car design impacts connectors specifically?

They're all good for us -- so we actually get optimistic. So the EV side, everybody is trying to figure out what is the most optimized high-power architecture you need from charger inlet, down to the motor, how you switch power go into a cell pack and really you have to realize, all those modules need connections in them. But those connections are things that have to survive up to, in some cases, 800 volts in a car, well over 1,000 volts if you're in a van or a truck. So when you sit there, there's a lot of things that our teams do. And in automotive of our 8,000 engineers, around 3,000 of our engineers are automotive placed in Munich with BMW. In Tokyo with the Toyota's of the world, certainly in Detroit and the West Coast for Tesla. And they're trying to figure out their design, our engineers are with them to say, how does this come together? Where do the connection that you need to bring this architecture together? And also, how do they make sure they manufacture it efficiently. In automotive, there is a big element around the manufacturing and assembly side. So we play in all those elements. Now as architecture changes, that creates opportunities for our engineers to lean in. So a lot of people talk about, hey, the power architecture of electric vehicle. But the other element as you get the data network in the vehicle, and you take companies like Tesla, they look for simplified architecture. You see other people looking at zonal architectures. What that means is you need more complex interconnects to occur while you may simplify our harness, and we don't -- we're not a harness maker. We're a connector and sensor maker, you have more complex headers. And actually, what that typically means for us our content goes up versus a simplified architecture. And even if you take a model S Tesla is an old architecture, a Model 3 is a simplified architecture and our content per vehicle is higher on a Model 3 and then on a Model S. And that's really due to that architecture change. And it's due to how do they help maximize the design, certainly, they take cost out, but then the interconnects get more complex.

How should we think about TE leaning into these trends? You mentioned just the closeness to customers being on the engineering desks in Asia, in Europe, in Detroit, how can TE benefit relative to peers and take change and make it something that 1 plus 1 equals more than 2.

Well, I think a unique thing that we bring to that space and other spaces are we are Tier 2 -- we are not a Tier 1 supplier in any of the industries we serve. And therefore, when we bring interconnect solutions, we're completely agnostic to the Tier 1. Our design is with the OEM. And in those things, when we sit there, we get to work with all these different car companies, there are elements we do a lot of customization for the car companies. There's also elements we build standard building blocks at low scale, and that's true in every industry we serve. So when we look at it, when we have a leading position like we have in most of our businesses, that provides us an advantage where not only the customers that we get to touch every day, but other companies that are coming into the space, like you had in EVs, of course, they want to make sure they get our expertise. And we don't try to pick a winner. We try to make sure we design with everybody, and that's one of the things, especially in automotive. We aren't tied to any one OEM. Any -- some platforms have a little bit more content than another. We care that cars get made in electric vehicles continue to get penetrated and the architecture you talked about, that's what we went from. So we're pretty agnostic when it comes to that.

Why don't we talk about the Chinese market that, of course, has been a focus area recently. And you've said you're similarly exposed to both the local and multinationals there. Can you just expand on that dynamic, especially how you position TE to be perceived as a local company in China and how that competitive backdrop is developing?

So when you sit there and you take China today, about 60% of cars that are on the road in China are Chinese produce, 40% are multinationals anymore. And for those who have been to China, you went back, you would see very much the opposite of that 10 years ago. And what really our team is focused on and it comes back to the resources again. We have 1,000 automotive engineers that are in Shanghai and Suzhou and that we actually used to cover the whole country. So once again, we don't try to pick winners. And what we have done is our market share on a local Chinese vehicle is the same as a multinational vehicle. And certainly, when we talk about EV with China being the largest EV market, any of the content things I've said already, if we weren't winning there, you wouldn't see the growth that we've had, and you won't see that content expand. So in addition to the engineering touch, also, how do we manufacture. We have 5 dedicated automotive facilities in China. We're actually building a 6 and Nantong. And it's really around how do you cover them? How do you do the engineering like we do anywhere in the world. And then that team completely focuses on the Chinese market. So it's a substantial team. It is led by Chinese. It's a business that when I started with the company, it was $50 million. This year, it will be well over $2 billion and about 2x the size of our North American automotive business just in China alone. And it's from the penetration we do and really to make sure we help bring their innovations to life and we work with all the OEMs.

Last thing I want to touch on in Transportation Solutions is the margin trajectory in the business. We've seen improvement and moved into sort of the mid-18% range in the back half of fiscal '23. Is it on schedule from your point of view, from a margin standpoint and a little [ added ] schedule? And what are sort of the key levers we should be looking at into fiscal '24?

So I think the first thing that you have for everybody, are entitled margin, we view in transportation to be with our size and scale to be a 20% OI, 25% EBITDA, and we're at 18.5% in that segment. I think there's a couple of things that when you think about the drivers, how do we go from 18.5% to 20%. First one is there's probably a little bit of volume we're going to need probably more in the mid-80s from where we are today. Secondly, that you're going to see is as EV scales, our EV products, the high-voltage products that actually go into powertrain are below the segment average. We've been marching that up because they were subscale. It was an investment we put in. So as that scales, we've been moving that margin up is important as well. And then the last thing that you really have when we look at transportation is our commercial transportation business, that market has slowed. That 18.5% had that business in it. It was down 7% this past quarter due to a slowing in the global commercial transportation business. That's something we probably need to see getting closer to neutral and troughing than being negative. That's a little bit of a headwind we have right now from a market mix.

Okay. Well, why don't we shift the conversation to communication solutions. So AI has been [ leasing ] 2023. We're thinking about data and devices. You said TE has booked well more than $1 billion in future sales at this point. Can you just talk about where you're winning? It seems like spending there has been [indiscernible] earlier innings somewhat consolidated, just what's reflected in your backlog?