Sensata Is a Moaty Electric Components Supplier Benefiting From the Mix Shift to Electric Vehicles

Analyst

William Kerwin

We think Sensata Technologies is a differentiated supplier of sensors and electrical protection, predominantly for the automotive market. The firm has oriented itself to benefit from secular trends toward electrification, efficiency, and connectivity. Despite the cyclical nature of the automotive and heavy vehicle markets, electric vehicles and stricter emissions regulations provide Sensata the opportunity to sell into new sockets, which has allowed the firm to outpace underlying vehicle production growth by about 4% historically. We think such outperformance is achievable over the next 10 years, given our expectations for a fleet mix shift toward EVs and Sensata’s growing addressable content in higher-voltage vehicles. 

In our view, Sensata’s ability to grow its dollar content in vehicles demonstrates intangible assets in sensor design, as it works closely with OEMs and Tier 1 suppliers to build its products into new sockets. We also think the mission-critical nature of the systems into which Sensata sells gives rise to switching costs at customers, leading to an average relationship length of roughly three decades with its top 10 customers. As a result of switching costs and intangible assets, we believe Sensata benefits from a narrow economic moat and will earn excess returns on invested capital for the next 10 years. 

Over the next decade, we expect Sensata to focus on organic growth in electric vehicles and increasingly electrified industrial applications. The firm has historically been an active acquirer but is focusing on organic investment, reduced leverage, and increased shareholder returns in the medium term, of which we approve. The firm’s ability to grow content in electric vehicles and outperform underlying global automotive production are the primary drivers of our investment thesis.

Business Strategy & Outlook

We assign Sensata a narrow economic moat rating, based on intangible assets and switching costs. These moat sources lead to excess returns on invested capital that we expect to endure, more likely than not, for the next 10 years.

We think switching costs are the primary moat source for advantaged components suppliers. Once a supplier's component is designed into an end application, it is likely to remain in for the product's entire lifecycle--ranging from five to seven years in cars, and more than 10 years in aerospace applications. It is highly unlikely a customer would rip out and replace a component once designed in.

Customer switching costs are tangible, and include the time and cost of system redesign, retraining to learn and integrate the intricacies of a competitor’s proprietary technology, the lead time and expense of designing and testing the new system, the potential for disruption during production, and the purchase or relocation of heavy equipment or manufacturing.

Sensata designs components into mission-critical systems like electric vehicle battery management systems, avionics systems, and power grids. These applications carry outsize costs to electrical failure, in our view. If there is an electronic part failure in a consumer device like a smartphone or gaming console, it results in customer inconvenience and a potential loss of future sales for the original equipment manufacturer, or OEM. If there’s a similar failure in a mission-critical system, the results can be catastrophic, such as driver or passenger injury (and in the worst cases, death), or widespread power outages with knock-on adverse effects. With these high costs to failure as a backdrop, OEMs for these applications are highly risk-averse and require components to work flawlessly, 100% of the time, no matter what the circumstance or context. As such, strong suppliers like Sensata build components to withstand harsh environments like heat, cold, water, snow, ice, sand, dirt, intense vibration, electromagnetic interference, and even explosions, depending on the application. In our view,

Sensata has earned the trust of risk-averse OEM customers across verticals with a flawless operating history, and its customers have a very high bar for switching away from a trusted incumbent supplier for mission-critical applications.

We believe an additional facet of switching costs is derived from highly integrated relationships between Sensata and its customers. Once Sensata wins a design, it takes on the role of a design partner, often moving a team of engineers onsite at a customer to build out the system in question.

This adds an incumbent advantage to Sensata. Both teams build relationships, share knowledge, and have experience from working on previous designs together. We contend these close relationships add an additional layer of stickiness to mission-critical products. We think that customers looking to build a new product iteration or model are more likely than not to choose incumbent Sensata and avoid the time, cost, and risk of using a new supplier.

Sensata also boasts robust design and engineering abilities, in our view, exhibiting intangible assets that supplement its moat. Nearly all Sensata’s sensors are custom or semi-custom, with each customer using its own proprietary designs and needing specific requirements for components to fit in. Sensata has an expansive array of individual sensors and electrical protection components at its disposal to design custom systems in collaboration with its customers.

In cutting-edge applications like new vehicles and industrial equipment, we posit that system requirements are constantly evolving, requiring new tweaks to electronic component content that incentivizes custom design. We think lower-value consumer applications are more standardized and less differentiated, but Sensata focuses on custom designs for cutting-edge applications that lead to pricing power in order to maintain strong gross margins and fend off lower-priced competition. Sensata’s research and development budget is focused on advancing new products that will enable new use cases at customers, like new high-voltage systems in an electric vehicle.

We think that Sensata’s ability to innovate allows it to win new sockets and staves off the threat of commoditization, while Sensata’s close design relationships and reliability in mission critical applications create sticky customer relationships. In tandem, these dynamics lead us to believe the firm will earn economic profits, more likely than not, over the next decade.

Narrow

Economic Moat

Sensata Technologies Hld

Sensata Technologies Holding Plc is a global industrial technology company, which engages in the development, designing, manufacturing, and marketing of electromechanical, electronic sensors, and controls. The firm operates through the following two segments: Performance Sensing and Sensing Solutions. The Performance Sensing segment serves the automotive and heavy vehicle and off-road (HVOR) industries through development and manufacturing of sensors, high-voltage contactors, and other solutions used in mission-critical systems and applications, such as those in subsystems of automobiles, on-road trucks, and off-road equipment. The Sensing Solutions segment is engaged in the industrial and aerospace industries through development and manufacturing of a portfolio of application-specific sensor and electrical protection products used in a diverse range of industrial markets, including the appliance, heating, ventilation, and air conditioning (HVAC), semiconductor, as well as the aerospace market. The company was founded by Rathbun Willard on April 24, 1916, and is headquartered in Attleboro, MA.

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Sensata Technologies Holding Plc is a global industrial technology company, which engages in the development, manufacture, and sale of sensors and sensor-rich solutions, electrical protection components and systems, and other products used in mission-critical systems and applications. The firm operates through the Performance Sensing and Sensing Solutions segments. The Performance Sensing segment serves the automotive and heavy vehicle and off-road (HVOR) industries through the development and manufacture of sensors, high-voltage solutions, and other solutions used in mission-critical systems and applications. The Sensing Solutions segment engages in the industrial and aerospace industries through the development and manufacture of a portfolio of application-specific sensor and electrical protection products used in industrial markets, including the appliance, heating, ventilation, and air conditioning (HVAC), water management, operator controls, charging infrastructure, renewable energy generation, green hydrogen production, and microgrid applications and markets, as well as the aerospace market, including commercial aircraft, defense, and aftermarket markets. The company was founded by Rathbun Willard in 1916 and is headquartered in Attleboro, MA.

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