TE Connectivity Earnings: Impressive Margins in Dynamic Market Environment Drive Up Our Fair Value

We increased our fair value estimate for TE Connectivity TEL to $128 per share from $125 after good fiscal third-quarter results led us to raise our short-term profitability assumptions. TE’s quarterly sales met guidance, but margins were above our expectations. The company has done well to improve its pricing to offset inflation; this is a testament to the sticky nature of its products, which also underpins our narrow moat rating. Transportation sales, the firm’s largest driver, showed continued strength and reflected TE’s strong position in electric vehicles. There are pockets of weakness, primarily due to industrial and data center customers digesting built-up inventory, but we think TE is executing nicely against that backdrop. We still see the shares as moderately overvalued, however, and would advise investors to wait for a pullback.

Third-quarter sales of $4.0 billion declined 2% year over year and 4% sequentially, primarily due to ongoing slow spending at data center customers. Auto sales were up 7% year over year, continuing to outperform car production thanks to an increasing mix of electric vehicles, in line with our long-term thesis. Industrial equipment sales declined 12% year over year, with management citing inventory digestion beginning there as well. Communications and industrial equipment relies more heavily on distributors, which leads to lumpier inventory adjustments.

Profitability impressed us, with non-GAAP operating margin up 130 basis points sequentially to 17.3%. TE’s pricing actions are now fully offsetting inflation, according to management. In our view, the strong margin expansion even against a sequential sales decline shows good execution. While margin was still down year over year, this reflects market challenges affecting volume.

Fiscal fourth-quarter guidance calls for sales and profits to be flat sequentially. We had been expecting higher sales; weaker industrial short-term demand explains the disconnect.