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Morningstar | Sensata Registers Another Solid Quarter; Increasing FVE to $56

Sensata Technologies announced second-quarter results which tracked well with our previous estimates, reaching the high end of management's guidance for revenue and adjusted earnings per share, while management also provided an updated outlook for the year. We remain positive on the long-term secular trends driving top-line growth and in management's ability to improve profitability along the way. We are increasing our fair value estimate to $56 from $53 as we incorporate the updated outlook and the time value of money. Shares traded up slightly on today's positive news and we believe they are currently fully valued. Investors would likely benefit from waiting for a wider margin of safety for the narrow-moat sensor company.

Second-quarter revenue grew 9% year over year, with high-single-digit growth in both operating segments, Performance Sensing and Sensing Solutions. We are encouraged by the evidence that Sensata is benefiting from the secular trends for electrification and efficiency across each of its major end markets: industrial, automotive, and heavy-vehicle and off-road, or HVOR. Automotive sales grew nearly 7% year over year, while flat sequentially, due to strong demand in China. While sales from the automotive end market continue to dominate, accounting for 60% during the quarter, the sizable growth in the other end markets, particularly HVOR, are helping to slowly diversify the mix. HVOR sales grew 17% versus the prior year period and 8% sequentially. Management expects end-market growth of roughly 8% for the year, ahead of prior forecasts. With strong end market growth and increased content growth for efficiency and automation--including a recent design win for "steer-by-wire" technology--we expect segment sales to remain robust. Gross margins in the second quarter increased sequentially by 200 basis points to 36.3% while adjusted operating margin expanded 80 basis points to 23%.

As we have previously noted, the firm's future prospects are very dependent on China, where broad-based modernization and efficiency regulations have enabled Sensata to grow across all end-markets. While management expects some negative near-term impact from the recently enacted U.S. tariffs against China, they expect it will not be material beyond 2018, after having adjusted supply-chains to mitigate the effects. That said, we expect that further saber-rattling between the two countries may require the company to make additional contingency plans.

Management detailed the plan to repurchases $400 million in shares after successfully redomiciling to the U.K. in May, anticipating the completion of that buyback program over the next six months. Revenue guidance for the third quarter is slightly higher than we anticipated previously, with management forecasting $863 million at the midpoint. This would imply a sequential decline of roughly 6% but a year-over-year increase of at least 5%. Management expects adjusted earnings per share to be $0.90 at the midpoint after incorporating the divestiture of the company's valve business and the near-term impact of tariffs. Earnings at this level would represent a slight decline sequentially but an 11% increase over the prior-year period.