Description

Munger: "Over the long term, it's hard for a stock to earn a much better return than the business which underlies it earns. If the business earns 6% on capital over 40 years and you hold it for that 40 years, you're not going to make much different than a 6% return—even if you originally buy it at a huge discount. Conversely, if a business earns 18% on capital over 20 or 30 years, even if you pay an expensive looking price, you'll end up with a fine result."

Let us start by saying that we are not setting the world on fire here valuation wise.  But we would suggest that most companies that still sport a buffett-type valuation have serious flaws or impairments that make them difficult as investments.  We know, we know; those are the exact opportunities we should be drawn to.  But the truth is that with both the stock and bond markets at all-time highs there isn’t a lot to pick from in the bargain basement, and with plenty of eyes on value plays, we believe it akin to getting blood from a stone. 

Rather, we believe it is more interesting to turn our attention away from Buffett-style valuation plays in favor of Munger-style compounders.  We think these are worth highlighting for a few reasons. 

1)      For those of you who need to be invested, we think this will do well over longer time horizons.   

2)      It is very cash generative and liquid enough for the majority of us. 

3)      For those concentrated on “best” ideas; we believe this should be on your radar if the market, as a whole, resets. 

4)      It has never been posted to vic before

There is a light macro tailwind to this play but not quite comparative to where we usually are on that spectrum.  Sensata is a “leading franchise in the fast growing automotive sensor market”, and is “as close as you can get to a pure play on increasing electronic content in autos” (think emission control, fuel efficiency, airbags, etc.). 

Why is the sensor market interesting?

-        Since 2007, which obviously includes The Great Recession, the sensor market has not had a single year of negative growth.

-        Coming CAFÉ standards in US, Euro6 in Europe, China4/5 in China all provide tailwinds to the sensors market

Global Fuel efficiency and emission control standards

Source: Company Data, Morgan Stanley Research

-        Growth in sensors is expected to cagr at 8% to $122bn by 2020. 

Sensata is becoming a sensor rollup for automobiles, with 60% of revenues today coming from light autos and another 10% coming from heavy vehicles.  Sensata has all those great traits you look for in a roll-up…

-        #1 position in most of its markets

-        High switching costs; sensata will often have engineers onsite with customers

-        Bringing in a new sensor supplier can take up to 3 years for certification

-        Sensor operations are critical operating components yet make up a tiny fraction of production costs (generally $5-10 range)

-        Major automotive companies are consolidating their suppliers

-        A wide sensor platform that makes acquisitions very accretive, as the sales and marketing expense for smaller players in the space hurts profitability

-        Post-acquisition they can cross-sell to new customers in addition to acquiring new revenue and technology

And why is Sensata a compounder?

-        Extremely cash generative with some 3% of revenues devoted to capex

-        M&A is very accretive and even better, it’s simple to model

-        Sensors are very important to the functioning of equipment; they require a high degree of reliability and precession which allow higher margins

-        ST management recently reiterated +20% adjusted net income target

-        Has converted 90% of ANI to cash

-        36.2%gm vs 14.8% median for auto suppliers

-        24.2%om vs 6.9% for auto suppliers

-        No near term capital allocation risk as they plan to pay off debt; but acquisitions have been accretive (most recent was for less than 10x ebitda, before synergies). 

-        ST’s publicly traded peers are also in connectors which are a more commodity-like product; they experienced negative growth in the great recession and have lower forecasted growth through 2016

-        Insiders own multiples of their cash compensation in stock

Opportunity

-        As mentioned above, valuation leaves a bit to be desired as it stands today. 

-        Having said that, much of the street is favoring its two closest publicly traded competitors on valuation, but we believe that is a nearsighted view.  These companies have lower returns on assets/capital/equity, as well as lower gross margins, operating margins, and lower segment growth forecasts. 

-        We don’t believe rolling down into a cheaper valuation/smaller moat is the way to play this theme.    

-        Management believes they can double revenue from 2012-2017

-        MS is guiding to $3.40/eps in 2016 and we see nothing to disagree with.  That also includes $1b of cash building on the balance sheet, that can be highly accretive as m&a or with buybacks.  We believe that deploying that capital into either of those options can get them close to $4 in 2017, conservatively.  We also believe a 20x is appropriate.  Finding 3 year liquid doubles is not easy in the current environment and thus have circled the name. 

Risks

-        Fx risk, 38% of company is US

-        Managing high debt load, although interest payments relative to ebitda/revenue/operating income/etc. is very reasonable, especially for a company in a market that hasn’t experienced negative growth in quite some time.

-        M&A execution

-        Auto sales

-        Increased competition can change m&a dynamics

Catalyst