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ST - Sensata Technologies Holding NV


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Sensata Technologies Holding is incorporated under the laws of the Netherlands and conducts its operations through subsidiary companies that operate business and product development centers in the United States (the "U.S."), the Netherlands, Belgium, China, Germany, Japan, South Korea, and the United Kingdom (the "U.K."); and manufacturing operations in China, Malaysia, Mexico, the Dominican Republic, Bulgaria, Poland, France, Brazil, the U.K., and the U.S. We organize our operations into the Performance Sensing and Sensing Solutions businesses.

 

In laymen's terms, they manufacture high-tech sensors that are connected to the internet. These sensors are part of the Internet of Things (IoT), which is a fast growing sector that GE is making some large bets on. Rosy projections and well-liked industries are expensive and ST's valuation is no different. I was hoping others knew more about the company and industry since it seems like a high-growth area.

 

2014 revenue was up 21% y/y, finally matching investor expectations, after increasing between 3%-5% in 2012 and 2013. It's a fairly "capital light" business (that isn't good or bad), with gross margins around 33%-35% and total expenses around 18%-20% of revenue consistently. I'm guessing "capital light" doesn't matter in ST's case because they don't show operating leverage and this will only be a solid investment if the growth outpaces the lofty expectations. The business model doesn't really imply future operating leverage either. In ST's case, it seems like it will be easier to contract in bad times than it will be to grow to meet orders, since I think they rely on the availability of skilled labor. I would want to know more about how they manufacture their sensors prior to investing.

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I know a little about Sensata, it is a very interesting company. The company's sensors are very exposed to the automotive end market (60% of revenues) which is interesting because they are usually spec'd into models that are in production for on average 7 years. The development time for every new model is also at least 4-5 years so it has very sticky customer-intimate relationships. They don't have much competition either, their primary competitor is Bosch and Denso which market entire sensor packages which are slightly different than the design specific sensors that Sensata sells. Given their exposure to automotive a key input will be your view on NAM auto sales which seem high (but the average age of the fleet is old)....

 

They are based out of Massachusetts and only reincorporated into the Netherlands after being purchased by PE. The IP is held in the offshore entity and because of the royalty relationship that was created in the new legal structure their tax rate is very low, this seem like a permanent advantage but I believe the favorable tax rate will gradually diminish over time.

 

I'm not very familiar with management as they are relatively new. I also think they are actively pursuing M&A which has inherent risks so that is something to consider as well.

 

As far as the "internet of things" I think that is mostly marketing jargon, their business is sensors - pressure, temperature, positioning etc. I agree that they have attractive content growth (5% annually) but I don't see this accelerating much more because the "internet of things" theme, I could be wrong but I don't think internet of things will substantially increase sensor content.

 

I'm not up to speed on their valuation so no comment on that front.

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  • 3 weeks later...
  • 1 year later...

It seems as though this topic got dropped?

 

Bain carved out a division from Texas Instruments, old enough to be a Ben Graham favorite at one point, and bought a small division of Honeywell to create what today is Sensata. 

 

Since Sensata has fixed a troubled portion of the balance sheet (ie pension liabilities) and refocused manufacturing capabilities. 

 

Management has not made any large acquisitions in a little bit, though still in the "playbook" according to CEO Martha Sullivan. 

 

Though Bain levered its investment, it might be worth noting that the Sensata acquisition price plus the acquisition of additional investments since add to a figure well over the company's current market cap.  Not that this is a measure of value, but perhaps a way of coming to grips with what the company's stated book value is versus the underlying value of the business particularly since management believes they can buy businesses and make them much better. 

 

The risk is that Sensata overpays.  This may have happened with the last two big acquisitions, though sales growth speaks to the operational improvements.  Sensata is also in process of paying down debt.  Perhaps this makes refinancing at more attractive rates in the future possible. 

 

The company's definition for "long-term" appears to be somewhere around 5 years.  During this period, it's anticipated that net margins (I assume "adjusted" here) might grow up to 21% of sales.  Assuming that this can happen, at today's sales, we see more than doubling of GAAP net income.  If Sensata gets half of the way there, we still see a meanigful impact to GAAP net income over that period. 

 

Any one spend any more time on this one?  Where are the cliffs?

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They appear to be good, no-nonsense operators with a penchant for integrating acquired businesses and maintaining strong relationships with OEM engineers.  These are primarily engineer-to-engineer sales, so the importance of these relationships and Sensata's integrated role in OEM R&D for future vehicles cannot be overemphasized.

 

There is pretty clearly a content growth tailwind, as Sensata benefits from increasing importance of emissions control, fuel efficiency and safety features.  Autonomous is a little unclear, but there is optionality with their LIDAR play. 

 

The obviously cliff is a global downturn in auto sales.  I think investors are overly focused on US SAAR peaking, when European OEM is larger part of business and Asian is growing faster.  Even if US "peaked", it appears more likely to plateau at a relatively high level (17M+), which is great for the company.

 

Right now, they are clearly laser-focused on deleveraging balance sheet versus doing add'l M&A or repurchasing shares.  I think investor/CRA feedback in Q415/Q116 led them to this decision, which is probably wise, especially in light of high M&A multiples out there.

 

 

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Not sure if luck, coincidence, or good capital allocation but the timing of their buybacks has been ideal. They bought a lot in 13' and 14'  when stock was relatively cheap and nearly stopped the program in 15' and 16' when the stock was more expensive.

 

I really like companies that display patterns of behavior like this. Generally not a deal breaker/maker either way and for ST it's probably not even worth mentioning in an investment write-up. Just an interesting detail that could affect confidence/conviction. I forgot about this company but I remember thinking there were a lot of small positive details present that are relatively uncommon to see.

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Just had a quick look. The compensation scheme seems pretty decent (EPS growth and ROIC targets). As well as meaningful CEO ownership. Trading at 13 x FY17 adjusted (not sure what they've removed? Stock comp?) EPS guidance and a long term target of 21% net margins. Seems impressive. But isn't it just a leveraged manufacturer of fancy car parts, ie very dependant on car sales (thus earnings might be at a cyclical high)? Only spent 45 mins on this so sorry about the ignorance.

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  • 4 weeks later...

The more I research, the more I think this looks interesting. Management seems quiet impressive, has a long historiy with the Company, have skin in the game and seem to invest for the long term while constantly working to increase short term earning by driving out cost. It also generates a ton of cash. I just have no idea as to what tax rate to expect going forward; anyone have some insight?

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  • 1 year later...

ST is trading near 52 wk lows and looks pretty appealing here...as everything is selling off, it might be an interesting place to invest should the stock decline another 5-10%

 

Anyone have thoughts on the Chinese business?  My guess is that despite the brouhaha, the China business should at least double in the next couple years?  Thoughts?

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It's a nice business with capable, transparent management.  I was invested for a few years, but the cyclical risk was always looming in the back of my mind.  Management does like to tout how (relatively) well they performed in the 08-09 downturn, but IIRC there were some major plant transitions going on simultaneously, which helped cushion the downswing in decremental margins.  They are obviously trying to build out China / non-auto businesses to spread cycle exposure, which I think they are doing.  Also, the stock definitely trades on US auto cycle sentiment, when that segment is <20%.  That said, we are probably on the wrong side of that cycle. 

 

I think I will wait until sentiment bottoms out again like in 2016.

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  Looks like they are guiding to 650 of fcf for 2020 which puts their market cap very close to that 10 percent cash on cash return.  That is a good value for this business imo cause they will likely grow over time even with the cycles.

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  Looks like they are guiding to 650 of fcf for 2020 which puts their market cap very close to that 10 percent cash on cash return.  That is a good value for this business imo cause they will likely grow over time even with the cycles.

 

I don’t like the low  gross margin (36%) and low R&D spent (4%). This looks like a commodity business and there is a lot of leverage.

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  Looks like they are guiding to 650 of fcf for 2020 which puts their market cap very close to that 10 percent cash on cash return.  That is a good value for this business imo cause they will likely grow over time even with the cycles.

 

I don’t like the low  gross margin (36-) and low R&D spent (4%). This looks like a commodity business and there is a lot of leverage.

 

Well I wouldnt say its the best business but they do have some advantages (very close to customers operations) along with a low cost position and a great track record integrating acquisitions up to their higher margins.  So the post acquisition multiple (of acquiree) falls to levels that deliver attractive returns.  I absolutely love that model, the way Tom Murphy did it at Capital Cities long ago. They are well managed and value excess cash highly.  Not only is application of sensors growing but ST is capturing some share and growing a bit faster.  Growth in units is better than it looks because prices fall by a couple percent annually.  They have succeeded in shifting lots of revenue into less cyclical end markets.  Fcf is considerably higher than net income.  They were in a very high debt position but delevered quickly to a comfortable level imo.  Starting with a high single digit fcf yield gives me confidence of 13-15 compounded returns with a constant multiple, a very good place to be. 

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  Looks like they are guiding to 650 of fcf for 2020 which puts their market cap very close to that 10 percent cash on cash return.  That is a good value for this business imo cause they will likely grow over time even with the cycles.

 

I don’t like the low  gross margin (36-) and low R&D spent (4%). This looks like a commodity business and there is a lot of leverage.

 

Well I wouldnt say its the best business but they do have some advantages (very close to customers operations) along with a low cost position and a great track record integrating acquisitions up to their higher margins.  So the post acquisition multiple (of acquiree) falls to levels that deliver attractive returns.  I absolutely love that model, the way Tom Murphy did it at Capital Cities long ago. They are well managed and value excess cash highly.  Not only is application of sensors growing but ST is capturing some share and growing a bit faster.  Growth in units is better than it looks because prices fall by a couple percent annually.  They have succeeded in shifting lots of revenue into less cyclical end markets.  Fcf is considerably higher than net income.  They were in a very high debt position but delevered quickly to a comfortable level imo.  Starting with a high single digit fcf yield gives me confidence of 13-15 compounded returns with a constant multiple, a very good place to be.

 

I have trouble understanding why the market has been so negative on the stock ... I hate all of the adjusted figures, but revenue growth has been strong and even if sales of autos decline in total, the growth of electric and hybrid cars should be a material tailwind.

 

attached is a transcript w/Marth Sullivan from a recent presentation at citi

Citi-2018-Global-Technology-Conference-Transcript-9-2018.pdf

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The stock is under pressure because recently there have been negative comments about chips and semiconductor businesses which makes no difference to me even if it the comparison was accurate (which it wasn't)  and that there is a coming slowdown.  I have done some work on their adjustments and they are appropriate imo and yes there are some definite tailwinds. 

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"At the same time, we are very often the sole supplier of the mission-critical products that we provide our customers." From CEO of Sensata.  What is a little strange for me is that when your product is mission critical and a low cost relative to the product that your product is enhancing, that usually results in pricing power.  Combined with the fact that they are often the sole supplier.  However, like I mentioned earlier, the pricing of sensors goes down by a couple percent annually.  Anyone have any insights or knowledge that they would like to share as to why this may be the case?

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"At the same time, we are very often the sole supplier of the mission-critical products that we provide our customers." From CEO of Sensata.  What is a little strange for me is that when your product is mission critical and a low cost relative to the product that your product is enhancing, that usually results in pricing power.  Combined with the fact that they are often the sole supplier.  However, like I mentioned earlier, the pricing of sensors goes down by a couple percent annually.  Anyone have any insights or knowledge that they would like to share as to why this may be the case?

 

All electronic components go down in price over time. Sole supplier does not mean that there is a Deep moat, it’s just cheaper to use the same components to save costs. I am guessing that the agreements with the customers have a costdown scheme with increasing volume, as this is common in the car industry ( and anywhere else for that matter). I think low cost may be Sensata‘s moat to some extend. Most of their manufacturing is located in low cost countries (Bulgaria, China etc).

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Well I never said "deep moat" in my post but I do believe you are underestimating their sole source position.  I dont think thats what she meant (it just results in lower costs for customers) when she said it.  I believe she is trying to stress that their revenue is highly visible and earnings are durable.  My comment was around potential pricing power.  Volume discounts are obvious but pricing power would probably negate or offset that over time, it would not result in  loss of price annually.  And Yes electronic components do go down in price over time, but I feel like low priced, mission critical sole sourced components would hold up better than commodity type components. 

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It looks like things didn't go perfectly backing Quanergy.

 

https://www.bloomberg.com/news/features/2018-08-13/how-a-billion-dollar-autonomous-vehicle-startup-lost-its-way

Quanergy has stopped talking about an IPO and has been pursuing new investments in recent months. It has had talks about finding a buyer, according to people with knowledge of the situation. Quanergy backers Samsung Ventures and Sensata Technologies Holding Plc, an auto sensor maker, have expressed disillusionment with the startup, according to people familiar with those firms. Alexia Taxiarchos, a Sensata spokeswoman, said the company remained excited about Quanergy.

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It looks like things didn't go perfectly backing Quanergy.

 

https://www.bloomberg.com/news/features/2018-08-13/how-a-billion-dollar-autonomous-vehicle-startup-lost-its-way

Quanergy has stopped talking about an IPO and has been pursuing new investments in recent months. It has had talks about finding a buyer, according to people with knowledge of the situation. Quanergy backers Samsung Ventures and Sensata Technologies Holding Plc, an auto sensor maker, have expressed disillusionment with the startup, according to people familiar with those firms. Alexia Taxiarchos, a Sensata spokeswoman, said the company remained excited about Quanergy.

Not sure if the turn away from public markets is necessarily a negative.  Private markets could be more frothy than public markets--certainly deals getting done from 12x to 14x EBITDA. 

 

The reduced optimism on Quanergy might be more a problem with its management than its product?

 

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Negative pricing is not just a function of chip business, it is a function of the auto business and how OEMs require contract structuring.  I have talked to the company about this and it is "nature of the beast" when you want to sell to large global OEMs.  They absolutely don't have pricing power in the traditional sense, but they do price contracts to account for the annual deflation.  The upside is that Sensata product are relatively high-spec and are often co-engineered with OEM designers for a specific purpose.  The OEMs are relatively captive as Sensata engineers are often embedded within OEM design and engineering department.  Because of this dynamic, Sensata is highly likely to win repeat business on the next iteration of a vehicle (new body style etc).  Of course you have the broad growth of sensor content as a tailwind.  However, this business is definitely cyclically exposed to the auto cycle, despite attempts to diversify across geographies and non-auto end markets.  They were also over-levered after the CST deal (probably didn't need to do that one), which helped drive the stock heavily out of favor in 2016.  Management realized this and re-prioritized all FCF to debt paydown. 

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Great post Fisch.  I do realize they are close to their customers products and just assumed originally that they would have some pricing power.  Wondering also if same pricing dynamic is present with industrial end markets.  Also agree that they over levered but they are/will be a better business because of the last couple acquisitions and now that opens the door to lots of bolt on acquisitions in better end markets.  As you know thats not a small positive...small bolt-ons are much lower risk and there are potentially many to choose from.  I like their positioning

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