Description

Sensata Technologies (ticker: ST): $7bln market cap; $10bln EV; Trades @ 9.5x '24 EV/EBITDA; ~3x net debt/run-rate EBTIDA

Background:

• Manufacturer of sensors and controls for harsh environments across a variety of end markets:
• Auto (52% of rev), heavy vehicle and off-road (22% of rev), industrial, HVAC and Commercial Aero
• Sensor products include temperature sensors, tire pressure monitoring, speed and position sensors (Auto/HVOR Applications)
• Control (protection from heat/electrical damage) products include circuit breaker, fuses, high voltage contacts
• In 06, ST was carved out of Texas Instruments by Bain and subsequently IPO'ed in 2010
• In 18, redomiciled to the UK -- pays a structurally lower tax rate and enabled a share repo plan
• Organic top line growth is projected at 4-6% ex. underlying production cycle -- revenue base $4bln
• Strong operating margins (low 20s) -- well in excess of other auto suppliers and on par with TE/Amphenol -- base of EBITDA ~$500mm

 What’s The Thesis?

• Over the last few years, ST has underearned thanks to:
• Auto/supply chain pressure on margins
• Ramping Megatrend spend geared towards EV wins
• Weak auto production environment
• Limited content uplift on 1st gen EVs
• Inflection Point:
  • Beginning in 2024 and accelerating into 2025, ST will begin to see the fruits of its R&D and M&A efforts in form of higher GoM
  • Growth to be bolstered by a): increasing content on 2nd gen EVs (faster GoM) and b): increasing penetration of EVs (production)
  • Though manageable, ST's leverage is high relative to auto part suppliers and TEL/APH
• New Business Opportunities (NBOs) growth has grown substantially ($1bln versus prior $400-500mm) as ST has assembled all the assets needed to hit/exceed its 2026 goals:
• Pivot in capital allocation to debt paydown (target 1.5-2.5x versus 3.3x today):
• Restoration/achievement of 21% margin target will shift investor focus back to ST's GoM:

• ST is expected to be P/C positive this year, pushing margins well past their trough at 18.7%
• Incremental volumes associated with higher GoM and pickup in auto production to help as well

• What It Translates To?
• Accelerating top-line growth, particularly in 2025, leading to upwards EPS revisions
• With strong FCF conversion, ST can hit its leverage target in 2 versus 3yrs
• More bullish management commentary on LT growth algorithm

Why Does This Opportunity Exist?

• ST has not historically been viewed as a beneficiary from the shift from ICE to EV:
  • TE and Amphenol already demonstrated 2x connector growth in high voltage applications such as an EV
  • By its own admission, ST was slow to expand into EV specific sensors:
  • ST has repositioned business to capture materially more content in 2nd gen Evs (2x)
• Historically, ST had higher CPVs on diesel vehicles, whose falloff accelerated post dieselgate in 2015
• Currently EVs and ICE vehicles CPVs are close to parity
• Counterargument:
• ST's has a net leverage ratio (3.3x) well above peers:
  • Pivot away from M&A to debt paydown is a game changer
• ST's 3.3x leverage is well in excess of peers TE Connectivity (TEL) and Amphenol (APH) at 1x EBITDA as well as other auto suppliers
• Counterargument:
• ST's margins have declined more than 400bps since 2018 with management slow to respond to inflationary pressures and necessary catch up on EV R&D:
  • With supply chain/production normalization and price recapture, ST is well positioned for margins to ramp back to 21%
• Management had some communication missteps, particularly in late 2022 relating to timing of hitting its 21% near-term operating margin target
• In 2022, EBIT margins stepped down to an all-time low of 19.3%
• Counterpoint:

Valuation:

• Between Amphenol and TE, TE would appear to be the more appropriate peer given their more comparable organic growth profile and higher exposure to transportation (ST = 75%; TE = 57%):
  • Using TE's next year P/E of 16.4x (and '25 $5.10 in earnings), discounting by 10%, we get a $76 stock or > 60% return
• TE has a bit more end-market diversity and historically higher FCF conversion (100% versus 75%) while ST has higher beta to trends in electrification and higher margins
• In the 2014-2015 timeframe, ST traded at a premium to the SPX and had an avg NTM P/E between 16-20x -- as recently as 2021, traded >14x next year's P/E
• For a downside case, we've seen ST trade as low as 9x forward earnings in 2022 -- this would equate to a ~$40 stock or 15% downside
• Note: One could also use a basket of high growth auto suppliers like Visteon, Gentex and Aptiv which trade closer to (15.7x, 13x and 17.3x), which trade closer to 15.5x forward EPS:
• Would imply ST share price of $72/share or 53% upside

Risks:

• Slowdown in global auto production and potential for additional destocking
• Market doesn't like that new 'normal' EBIT margins is 21%
• Market doesn’t like that hitting a full year margin of 21% may not happen until 2025 --> the Street is still below this level for 2024

Catalyst

Catalysts:

• Positive inflection in electrification revenue beginning in 2024 and scaling in '25/'26:
• Quarterly progression in margin expansion to get close to 21% in Q4 '23 -- shifting focus back to strong GoM
• Better FCF generation enabling ST to delever in closer to 2yrs versus 3yrs -- conversion of FCF improving to 75%
• Investor day to affirm GoM to be at the higher end or potentially exceed range of 4-6%
• Production volume normalization in both autos and HVOR pushing revenue and margins higher
• IHS continues to revise up their expectations for BEV sales as a percentage of overall global auto sales
• Potential divestiture of Insights business to generate proceeds for debt paydown --> IOT (Samsara) trades at 9x forward revenues ($846mm in rev) -- if Insights ($200mm+ in rev) traded at 1/2 the multiple, the business would be worth ~$1bln (1x leverage)