TE Connectivity

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

TE Connectivity is a global industrial technology leader creating a safer, sustainable, productive, and connected future, offering a wide range of connectivity and sensor solutions.

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.

TE Connectivity (TEL) designs and manufactures products that connect and protect the flow of power and data inside of all sorts of equipment, particularly for harsh environments, making them a critical component for infrastructure across many industries.

Business Overview

TE Connectivity operates through three reportable segments: Transportation Solutions, Industrial Solutions, and Communications Solutions.

  • Transportation Solutions (55% of sales): This segment is the largest of the three, providing solutions for a variety of transportation vehicles, including automotive, commercial transportation, aerospace, defense, marine, and sensor technology, energy, data communications, and the rail market. Their products range from sensor solutions to electronic connectors, heavy-duty connectors and sealing, and more.
  • Industrial Solutions (35% of sales): This segment offers solutions for the industrial equipment, factory automation, energy, heavy equipment and machinery markets. Some examples of the solutions are control systems, industrial connectivity, power, and more.
  • Communications Solutions (10% of sales): Provides connectivity solutions for data and devices in the application markets. This is a smaller segment, but still significant. These products are mainly used in various industries, including network infrastructure, home equipment, data centers, mobile devices, and wearables.

The company’s diversified revenue streams across various industries and geographies make it relatively resilient, and less reliant on a particular industry.

Competitive Landscape TE Connectivity operates in a very competitive market, which includes competitors of different sizes, geographical focus, and expertise, especially from competitors in Asia like Molex and Amphenol. The company’s scale provides a big advantage over the competition in certain situations, but innovation from both large and small companies can prove problematic.

The company acknowledges the presence of strong industry headwinds including macroeconomic uncertainty, lower global demand and destocking in inventory by customers. Despite headwinds, they continue to leverage their global scale, leading technology, and operational efficiencies to capture market share.

Financial Analysis

  • Revenue: Net sales decreased to $4 billion in fiscal Q3 2024, compared to $4.1 billion in the same quarter last year. The decline is primarily in their industrial and transportation segments. Full-year sales guidance was also reduced because of the market uncertainties. However, the business is still generating substantial and profitable revenues.
  • Margins: Adjusted operating margin in Q3 was 17.4 percent, compared to 17.8 percent in the prior year period. Despite some pressure, their operating margins remain decent. The Transportation and Industrial segments have the best margins with close to 20% compared to the Communication segment at around 12%.
  • Profitability: Diluted earnings per share (EPS) was $1.79, up by approximately 6% compared to the same quarter the year prior. However, the adjusted EPS was $1.94. For fiscal year 2023, the net income was $1.4 billion which is much lower than previous years. The main reason was a result of impairment charges and restructuring related to their business.
  • Capital Expenditure: While some might have some issues around a decline in operating profits in the last years, it is important to note that CAPEX has decreased significantly in recent years as well.

Financial Condition

  • Balance Sheet Health: The company is relatively healthy, with $1,001 million in cash and cash equivalents as well as a strong capital structure. They have good coverage ratios, but they have a quite significant portion of intangible assets.

Their Debt-to-equity ratio for the quarter ending June 30, 2023 was 0.47 which is good for a company of this size.

  • Cash Flows: They are generating substantial positive cash flows, which gives flexibility to weather economic turmoil and invest in the long-term potential of their business.

In fiscal year 2023, operating cash flow was 2.6 Billion, showing that the company was able to make cash even with their issues in their results.

Moat Analysis

TE Connectivity’s moat is largely derived from three distinct components: First, switching costs, which occur due to the intricate integration of its products into customer applications. Second, they have a proprietary product design that makes replication very hard for the competition. Third, they can create a network effect in areas like data communication where they are providing both parts of the network.

  1. Switching Costs (2 / 5):
    • TE Connectivity’s products are deeply embedded in the complex systems of their customers, such as data centers, manufacturing equipment, automobiles, and airplanes. Switching costs do exist, but they are not particularly high in all their businesses. Some sectors are more competitive due to commoditization. While this may provide some advantage, it doesn’t offer them the same high profitability as other types of moats.
  2. Intangible Assets (2 / 5):
    • The company has built up a strong reputation for the quality and durability of their parts. However, some competitors also have very good quality. The company also boasts a broad patent portfolio, but those patents are not absolute barriers to entry and can often be designed around.
  3. Network Effects (1 / 5):
    • The company derives some benefit from network effects, especially in its communications solutions sector, because its products help customers connect to the internet. However, this is only present for a small segment of the business, and they don’t see as high returns as companies that benefit more from network effects.

Moat Rating: 2 / 5 TE Connectivity possesses some sources of competitive advantage, such as switching costs and an engineering advantage, however, due to intense competition from competitors, it doesn’t have a very large moat, and thus its returns on invested capital are not consistently extremely high. Thus, an average economic moat is assigned at a rate of 2.

Understandability Rating: 3 / 5 TE Connectivity’s business model, while complex due to its diverse product and industry exposure, can be understood on a relatively high level with a good understanding of what a supply chain is. Their annual reports and investor communications do a good job of explaining their operations. However, fully understanding their technology and competitive landscape requires further reading and research. Hence, a 3 out of 5 is given. The company has many diversified products which can lead to an individual investor making mistakes in understanding them.

However, if you do the research, there’s no shortage of financial reports, transcripts from earnings calls, and analyst reports available online.

Balance Sheet Health: 4 / 5 The company shows very good indicators of solvency and has high levels of cash, giving them a high degree of flexibility. Also, their capital structure is not problematic and can be managed well. Although they do have some debt and goodwill, they are manageable, thus earning a 4/5 balance sheet rating.

Risks to the Moat and Business Resilience

  1. Technological Change: The technologies that make up TE Connectivity’s business are always improving and shifting over the course of time. Their products must be at the cutting edge to allow them to maintain profitability and generate a sustainable advantage over other competitors. Competitors may also gain a competitive advantage by having new and innovative technologies and products, and thus the company’s moat will be under pressure.
  2. Economic Downturns: Since the company has exposure across many different industries, it is subject to their cyclical fluctuations. These fluctuations can have an effect on their revenue, margins, and consequently their profitability, and ultimately their value.
  3. Intense Competition: The markets that the company operates in are very competitive, they are full of many large and small companies that are all competing over market share. As a result, the company needs to consistently invest in research, product development, and a good cost structure to compete and protect its market position.

In earnings calls and other communication, it seems that management’s approach to the present market uncertainty and supply chain issues is positive and forward-looking. The company is trying to strengthen its ties with customers and create an agile production model. The company’s large scale and good cash flows will make them more resilient to adverse market conditions.

Despite these risks, the company is well-positioned to continue generating long-term value, if they continue to improve their position and increase their ability to make differentiated, high-quality products at a low cost.