The Right Stuff

IBD profiles Amphenol (APH):

Ah, the joys of a well-executed roll-up strategy in a growing but fragmented market.
That has been the winning formula for Amphenol, (APH) a maker of connectors for electronic and fiber-optic systems that has combined internal growth with growth through acquisition to triple sales since 2002.
A skilled hand at boosting margins at acquired firms, Amphenol has grown earnings even more swiftly. The firm recently raised earnings estimates for this year to $2.34-$2.38 a share. That’s over five times the 46 cents it earned in 2002.
Amphenol’s connectors, which allow the mating of different elements within a broad range of electronic products, have been in demand. With strong sales to military, commercial aerospace and mobile device customers leading the way, Amphenol posted record sales and profits in the June quarter, exceeding analysts’ guidance.
Along with raising earnings guidance, the company also hiked revenue guidance for all of 2008, predicting sales of about $3 billion, a better than 15% gain vs. ’07. With robust cash flow and almost $200 million of cash and short-term investments on the balance sheet, Amphenol is well-positioned for further performance-boosting buyouts.
“They are the consolidators in an extremely fragmented marketplace,” said Amit Daryanani, equity analyst with RBC Capital Markets. The 10 largest connector firms — including Amphenol and its two biggest rivals, Tyco Electronics (TEL) and Molex (MOLX) — hold 55% of the global market. More than 2,000 smaller companies share the remaining 45%, Longbow Research analyst Shawn Harrison says.
Amphenol typically acquires firms with niche products and then broadens sales through its vast global distribution network, Harrison says.
Amphenol has a history of identifying good acquisition targets running 10% operating margins and then bringing those margins up to the stellar corporatewide standard, now approaching 20%, according to Daryanani.
In 2005, Amphenol purchased Teradyne’s connector business, then running at mid-single-digit margins. By mid-2007, the business was running at 19% operating margins. Among the efficiencies Amphenol brings to new buys: savings in volume procurement, efficient inventory management and “good management controls,” according to Daryanani.
Amphenol acquisitions contributed 4% to the company’s 2007 revenue growth. But other things also have been going well for the connector kingpin, whose products form the seams in items ranging from cell phones and computers to complex military electronics.
Organic growth in existing businesses contributed 8.5% to last year’s overall growth, with favorable currency movement kicking in an additional 2.7%, Daryanani said.
In the second quarter, sales to military, commercial aviation and mobile-device customers all grew smartly. With wars in Afghanistan and Iraq and strength in commercial aviation sales, combined military and commercial aerospace sales grew by 24% year over year. That represents one-fifth of Amphenol’s revenue, Chief Executive Officer Martin Loeffler said during a July 17 earnings call.
The company did not respond to requests for interviews with top executives.
Growing still faster, but from a smaller base, were products used in mobile devices, up 50% year over year and now representing 11% of total revenue. Interconnect offerings for wireless infrastructure including cellular base stations also did well, tacking on 36% growth and now representing 13% of total sales, Loeffler reported.
Amphenol benefited from the buildout of a cellular infrastructure in India, Citigroup analyst Jim Suva says. (Citi has provided investment banking services for Amphenol.)
“They’re in the right end markets,” Harrison said.
Amphenol also has won share in those markets. Harrison cites mobile handsets, cellular infrastructure, defense and automotive as connector customer sectors where Amphenol has amassed share.
But there is risk in some of these sectors. Mobile handset sales, for example, are expected to be down significantly in 2008, Harrison says. A Barack Obama presidential victory that brings expedited withdrawal from Iraq could pinch the military business. Sales to commercial aviation customers like Boeing and Airbus could suffer, too, if the airlines, hit with altitudinous fuel costs, delay delivery of ordered planes.
Amphenol President and Chief Operating Officer Adam Norwitt told analysts that even in the event of a change in war strategy, Amphenol’s military business would continue to flourish. He said engagement in two wars has slowed several other defense programs, including the Joint Strike fighter, and these programs could pick up, providing new sources of revenue if war operations are cut back.
“We do see strength and the potential for demand into these larger programs that have been delayed,” said Norwitt, who will become chief executive officer in early 2009.
Citi’s Suva believes Amphenol actually could see some benefit from an early withdrawal, as much military equipment there, in use longer than expected, will need to be refurbished.
One potential kicker to earnings could be commercial deployment of the Boeing 787 Dreamliner, now expected to begin in the second half of next year.
Analysts have not yet included revenue from Amphenol’s contribution to these planes, Citi’s Suva says. He believes Amphenol could realize an additional $12.5 million in 2009 revenue, translating into 2 cents a share and $30 million in 2010, adding a nickel to EPS.
Suva says Amphenol, along with Research In Motion, (RIMM) is his top pick among the 20 electronics companies he follows.
At RBC Capital, analyst Daryanani thinks Amphenol could surprise to the upside on future earnings, but that its market multiple — already dear — is unlikely to expand. Amphenol stock, around 49, is selling at more than 18 times Daryanani’s 2009 estimate of 2.70. “You are paying a premium for Amphenol,” Daryanani said.

Posted by Eddy Elfenbein on July 28th, 2008 at 10:19 am

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