An Auto Parts Winner in a Greener Future

Automobiles, Tech

The global auto industry is in an all-out drive toward a cleaner and greener future.However, for some suppliers to the auto industry, it has not been a pleasurable joyride.

Instead, current conditions are more like driving on a icy, treacherous mountain road in the middle of a blizzard. Only the most skilled drivers will make it to the bottom of the metaphorical mountain intact.

View of cars lined up at a car dealership from the perspective of the trunks.]

Tough Sledding for Auto Suppliers

Most auto suppliers are already feeling a squeeze due to rising energy prices and rampant inflation in other parts of the supply chain. They have little choice but to shoulder most of the extra costs of making their components sustainable to help the automakers meet their environmental targets.

And make no mistake: the carmakers are pushing their suppliers hard. For example, Reuters reports that BMW expects all of its battery and many of its steel and aluminum providers to produce materials made using renewable energy, while Volvo Car is targeting 25% recyclable plastic in its cars by 2025.

Consequently, many suppliers to the automobile industry are making large investments to “green” their companies, doing everything from developing recyclable parts to using renewable energy.

Simultaneously, many of these same firms have little leeway to raise the prices they’re charging automakers, which are themselves focused on reducing costs. Automakers are spending tens of billions of dollars to shift their focus to producing electric vehicles.

This difficult situation faced by the auto parts industry was summed up nicely by Joe McCabe, CEO of the research firm AutoForecast Solutions, who told Reuters: “We use the term disruptive all the time, but it’s much more than just disruptive. We’re going to see a real big shakeout the next five, 10 years in the auto supply chain.”

In other words, the auto industry’s move to a greener future, alongside the supply-chain problems that began during the pandemic and soaring costs, has killed the profit margins for auto parts suppliers and created a perfect storm for the industry.

It is likely that only the strongest and shrewdest companies will survive this extinction event in the sector. The rest will go the way of the dinosaur.

One company that I believe will survive is TE Connectivity (TEL). It is able to pass along price increases to its customers, and it pays a dividend, too.

TE Connectivity

TE Connectivity is an American-Swiss technology company that designs and manufactures connectors and sensors able to withstand harsh environments for a number of industries. These industries include automotive, industrial equipment, communications, aerospace and defense, medical, energy, and consumer electronics.

Going green is costly for even the biggest suppliers, and TE Connectivity certainly isn’t immune. But it is a bit ahead of the curve, having launched its own sustainability drive in 2020. The company is presently working on recyclable products with automakers including Volkswagen, Volvo and BMW.

Of course, TE Connectivity continues to face supply chain challenges—but it seems to be navigating the headwinds well, as indicated by its continued price increases to customers that aid the company in offsetting inflationary pressures.

And the long-term thesis of growth that stems from increased vehicle electrification is holding up well, as management reaffirmed in its latest quarterly earnings results. Management expects electric vehicle production to be up more than 30% for the year, while the total automotive production environment is expected to remain flat.

The company’s third-quarter sales grew 7% year over year, and 2% sequentially, to $4.1 billion. Organic growth could be seen across all business segments.

Some of TE Connectivity’s other businesses, outside of automotive, did extremely well. Two of the largest growth areas were in the industrial equipment and data and devices end markets. Both grew at 27% on a year-over-year basis.

The industrial equipment segment saw continued benefits from increased factory automation applications, while the data and devices segment achieved its outperformance thanks to market share gains in artificial intelligence applications and high-speed cloud content growth.

TE Connects to the Future

The company’s balance sheet is sound, with very low net debt to EBITDA. That allows it to return an appropriate amount of capital to shareholders.

Management’s goal is to return two-thirds of free cash flow to shareholders, of which one third will fund the firm’s dividend (current yield is 2%) and the other third will be used for opportunistic share repurchases. However, this goal is often exceeded when management doesn’t find value-accretive deals for its cash.

TE Connectivity has raised its cash dividend every year since 2010. Over the past five years, the company has returned an average of more than 80% of its free cash flow to shareholders.

TE Connectivity has maintained a leading share of the global connector market for the last decade,

thanks to its dominance in the automotive connector market, from which it derives nearly 50% of its revenue. I do not expect the company to lose its dominant position. Morningstar reports: “While the firm’s entire business benefits from trends toward efficiency and connectivity, these are especially notable in cars, where shifts toward electric and autonomous vehicles provide lucrative opportunities.”

Just like other tech-related stocks this year, current market conditions have hit TE Connectivity, with a drop of 29%. It is a buy anywhere up to $120 per share.

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