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Morningstar | Near-Term Headwinds Emerge for Subsea-Free TE; Lowering FVE to $92

TE Connectivity’s full-year results topped our expectations on both revenue and adjusted earnings per share after normalizing between periods for the impact of the SubCom sale as the subsea business was expected to contribute roughly $700 million in sales for the fiscal year. The strong performance, however, was coupled with guidance that dampened our outlook for the upcoming quarter and fiscal year. We are lowering our fair value estimate to $92 from $97 to account for near-term headwinds but we reiterate our narrow-moat rating for TE Connectivity. Shares have traded down slightly and we believe this represents an attractive opportunity for long-term investors.

Sales in the quarter increased nearly 9% year over year to $3.51 billion. Revenue in the communications solutions segment increased by 11% year over year with sales into the data and devices market increasing by 15% over the same period. Similarly, adjusted operating margin for this segment expanded by 300 basis points to 16.8%, in part due to the absence of the previous ship business. Without SubCom, we anticipate the quarter-to-quarter performance of this segment will be much less lumpy. The industrial solutions segment continued to grow solidly at 6% year over year as strong growth in medical devices and aerospace offset slower sales in factory automation. As previously discussed, the firm has been in the process of rightsizing operations in the segment and we are pleased to see profitability improving as adjusted operating margins increased by 60 basis points sequentially to 15%.

Also, the transportation segment sales grew by 9% versus a year ago to $2.0 billion, which represented a slowdown from the double-digit sequential increases of the previous three quarters amid softening demand from Europe and China. This was also reflected in the segment’s adjusted operating margins declining by 120 basis points sequentially to 18.1%. The adjusted earnings grew by 19% year over year to $1.35 per share.

While several of TE’s end markets performed strongly in the quarter, management’s guidance indicates that leaner times are on the horizon as economic tailwinds turn to headwinds and industrial spending slides. Total revenue for the first quarter of fiscal 2019 is expected to grow by just 1% to $3.38 billion as management expects automotive sales to decline during the quarter. Adjusted earnings per share are expected to decline sequentially by 6% to $1.27 at the midpoint of management’s guidance with cost-cutting efforts expected throughout the year. With nearly 50% of total revenue coming from the automotive market, near-term dips in automotive output due to regulatory compliance and macroeconomic factors will undoubtedly have an impact. However, we reiterate our long-term view that increasing electronic content in the automotive and industrial markets will be a sustaining growth driver. On this point, management announced that during the past fiscal year, the firm generated $800 million in design wins from automotive sensors and we expect that dynamic will continue. We believe the firm’s forecast for low automotive revenue growth for the full year, in the face of end-market declines, reinforces our thesis that the continued electrification and connectivity content increases may also help insulate the firm from the worst of cyclical downturns.