Sensata Technologies Holding plc

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 3/5

Sensata Technologies Holding plc (ST) is a global industrial technology company that designs and manufactures sensor-rich solutions, predominantly for the automotive industry and increasingly for other industries such as aerospace, industrial equipment, and energy.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Sensata Technologies is a global industrial technology company focused on developing sensor-rich solutions for mission-critical applications in the automotive, industrial, aerospace, and energy sectors. The company’s core capabilities revolve around the design and production of sensors, specialized components, and control systems that are often embedded directly into customer products. This is achieved through a vertically integrated approach, encompassing research and development, manufacturing, and sales operations globally.

  • Revenue Distribution: The company primarily earns revenue through two reportable segments, Performance Sensing and Sensing Solutions.

    • Performance Sensing (PS) segment supplies customized pressure, position, temperature, force and electromechanical solutions to OEM customers in automotive market, primarily for safety and security as well as for fuel management and emissions controls, and increasingly in electrification.

    • Sensing Solutions (SS) segment which sells to various industries for various reasons like industrial sensing applications; industrial automation; transportation, logistics, distribution, and supply chains; aerospace; and other applications.

  • Industry Trends:

A significant trend shaping the industry is the electrification of vehicles, a shift that requires advanced sensing systems for battery management and vehicle performance optimization. The company has experienced strong growth in products related to vehicle electrification. * Automotive: The automotive industry is increasingly focused on electrification and automation, which requires advanced sensor technology for safety, performance, and efficiency. * Industrial: The industrial sector increasingly uses automation and smart technologies, thus the use of sensors is increasing. * Aerospace: The aerospace sector is known for its strong requirements for safety and high-reliability components and systems, and has stringent requirements for documentation and testing, which creates barriers to entry. * Energy: The energy transition with the increased focus on renewable sources, power generation, energy storage, and automation of electrical infrastructure is also increasing demand for the kind of sensors sold by Sensata.

  • Margins:

Sensata’s gross margins are relatively good, typically hovering around 30%. However, the margins are being affected by rising raw material and component costs. For example, the company cited commodity inflation as a hurdle in 2022 annual report, and cost controls have been a major focus. Operating margins tend to vary significantly across segments depending on customer, contract, and product mix.

  • Competitive Landscape:
    • The market is highly competitive, with companies like Texas Instruments, Analog Devices, NXP Semiconductors, and Infineon Technologies all producing similar products and solutions.
    • The company claims to differentiate itself through the breadth of their sensing solutions as well as their vertical integration.
    • Many competitors are considerably larger. There is no clear evidence of the firm having some moat, which we’ll explore more below.
  • What makes the company different?
    • Sensata’s differentiation primarily rests on its deep engineering expertise and long-term relationships with top-tier OEMs in the automotive industry.
    • The company’s vertical integration allows it to control all parts of its value chain from design to production, providing cost and quality control advantages.

Financial Analysis

Sensata has seen some headwinds related to supply chains, inflationary pressure, acquisitions and higher material costs. However, it has been generating high margins and has been focused on cost reduction. Below is the breakdown of key points from the income statement, cash flow statement, and balance sheet.

  • Income Statement:
    • Revenue: In 2022, revenues increased by around 11.8% to around $3,979 million. The management has guided that they are expecting modest revenue growth, if any, in 2023 with a return to more solid growth after that.
    • Profitability: In 2022, Operating margins grew to around 18% on an adjusted basis and net income grew to $384 million. The company’s profitability has been negatively affected by high input costs and supply chain issues.
    • The company has been focused on restructuring and cost-cutting measures, and that has had positive effects to the profitability. * The company has a targeted annual run-rate of cost savings at $80 million which should continue to improve operating margins.
    • Earnings per share: On adjusted basis, the EPS has increased from $2.75 in 2021 to $3.49 in 2022.
  • Cash Flow Statement:
    • Cash from Operations: The net cash from operations has been strong and has been mostly used for acquisitions and debt reduction. 2022 saw cash from operating activities at around $530 million.
    • Capital Expenditures: The company spent around $300 million in capital expenditures in 2022. The high level of capital expenditure is associated to high growth strategy.
    • Free cash flow: The free cash flow after cap ex has been modest, and not especially attractive. The company does use this cash to aggressively pay down debt.
  • Balance Sheet:
    • The company’s total assets have remained around $5 Billion in the past couple of years.
    • Debt: Total debt has been gradually reduced from $3.1 billion to $2.7 billion from December 2021 to December 2022. * The net debt to equity ratio is approximately 1 which is not low for industrial companies.
    • Shareholder’s equity has increased due to earnings.
  • Recent Concerns and Controversies:
    • Like other industrial companies, Sensata has faced challenges related to supply chains, increased raw material costs, and inflationary pressures on the entire economy. * This has led to the company taking actions that include restructuring of manufacturing operations, cost-cutting, and passing some costs to customers through increased prices.
    • The company has made large acquisitions in 2022 and 2021. The risk is that these acquisitions will not perform as expected, or may not be able to integrate properly.
    • There is also always some risk related to the cyclicality of the automotive market.

Moat Analysis

Economic Moats are a business’s ability to fend off competitors, thereby protecting future profits.

  • Intangible Assets:
  • The company’s reputation with major OEMS, long-term customer relationships, and high switching costs may be considered as intangible assets, but these are not hard to replicate.
  • Many sensor producers are highly reputable, and has long track records of supplying high-quality components to the automotive sector.
  • It is relatively easy for customers to test the components from multiple vendors.
  • Switching Costs:
  • While there are some switching costs for customers using Sensata’s integrated hardware and software, other players provide similar products. This creates limited switching costs and limits pricing power.
  • Network Effects:
  • No evident network effects are associated to the products provided by Sensata.
  • Cost Advantages:
  • The company has some level of cost efficiency as it has integrated manufacturing operations. But, in reality, any competitor who invests in manufacturing can easily achieve the same cost structure as Sensata. There is no major or real differentiation here.
  • It may be considered that by having the most up-to-date manufacturing capabilities the company will have cost advantages, but that is also not guaranteed and all competitors can achieve that.
  • Conclusion:
    • Based on the criteria above, it appears that Sensata only has a minor, very limited “moat”, mainly associated with the high barriers to entry into aerospace and military equipment. In the industries they operate, it is relatively easy for competitors to create new products, replicate the cost structures, or offer similar products. Therefore, many competitors can grab the market share or put pressure on profits. This gives Sensata a moat of 3 out of 5.

Business Resilience

  • Cyclicality: The company is somewhat resilient to the economic cycle due to a relatively large mix in non-automotive industries. However, because much of the revenue is tied to the automotive industry, a decline in car sales will affect the revenues negatively.
  • Technological Disruption: There are always risks related to technological change, but Sensata has been actively investing in R&D and is on the forefront of developing sensor technology needed for electric vehicles.
  • Barriers to Entry: High barriers to entry in aerospace and other sectors limit the risk of new competitors. There are stringent testing and approval processes and high R&D expenditures involved that protect incumbents.
  • Size and scale: The company operates at a global scale, with multiple manufacturing centers. This provides redundancy and reduces supply risk.

Understandability Rating: 4 / 5

The business is relatively straightforward to understand, especially if you are familiar with the basic supply chain and manufacturing, including production of electronics and semiconductors. While the products that Sensata offers might be intricate, the business model is relatively easy to grasp. Thus the rating is a 4/5.

Balance Sheet Health: 3 / 5

The company has maintained a strong cash position and has decreased its long-term debt over the past years. However, they have a high degree of leveraging and have also accumulated more intangible assets. Their cash flow generation is still great, but it does not provide a large margin of safety, nor does the company produce a great ROIC and free cash flow when factoring in the intangible assets. The overall health is probably a 3/5.