TE Connectivity Is the Largest Automotive Connector Supplier and Merits a Narrow Moat

Analyst

William Kerwin

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Transportation Solutions

Industrial Solutions

Communications Solutions

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TE Connectivity designs and manufactures connectors and sensors, supplying custom and semicustom solutions to a bevy of end markets in the transportation, industrial, and communications industries. TE has maintained a leading share of the global connector market for the last decade, specifically dominating the automotive connector market, from which it derives almost half of its revenue. 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 for TE to sell into new vehicle sockets, like an onboard charger or advanced driver-assist system.

TE’s products offer high performance and reliability for mission-critical applications in harsh environments. As such, its customer relationships tend to be very sticky, with customers facing high financial and opportunity costs from switching to another component supplier, as well as the risk of component failure in new products. TE’s customers also rely on the firm supplying cutting-edge products to power new capabilities in end applications. As older products become commoditized, the firm is able to maintain high prices with new innovations. As a result of these switching costs and pricing power, we believe TE possesses a narrow economic moat.

In the future, we think TE will focus on increasing its dollar content in end applications across its end markets. TE’s products pave the way for greater electrification and connectivity in vehicles, planes, and factories, which allows the firm to occupy a greater portion of these end products’ electrical architectures. We also think TE will remain a serial acquirer, bolting on smaller components players to expand its geographic and technological reach. We expect TE to continue expanding its midcycle gross and operating margins via footprint consolidation, as it streamlines the fixed-asset portfolio it has gained over a decade of acquisitions.

Business Strategy & Outlook

We assign TE Connectivity 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 one to two years in data centers, 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. 

TE designs components into mission-critical systems like electric vehicle battery management systems, advanced driver-assistance systems, avionics systems, and power grids. These applications carry outsize costs to electrical failure, in our view. If there’s 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. 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 TE Connectivity 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, TE 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 TE and its customers. Once TE Connectivity 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. 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 TE Connectivity and avoid the time, cost, and risk of using a new supplier. 

TE Connectivity boasts strong design and engineering abilities, in our view, exhibiting intangible assets that supplement its moat. Nearly all electronic components are custom or semi-custom, with each customer using its own proprietary designs and needing specific requirements for components to fit in. TE has an expansive array of individual connectors and sensors at its disposal to design custom systems in collaboration with its customers. In cutting-edge applications like new vehicles and communications 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 TE 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. TE Connectivity’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, or higher-speed data transfer in a data center or mobile network base station. 

We believe TE’s technological portfolio would be difficult to replicate by a new entrant or an existing smaller competitor. Furthermore, its parts are hard to rip out once embedded with a customer, especially for mission-critical applications. This combination leads to strong returns on invested capital and our narrow economic moat rating.

Narrow

Economic Moat

TE Connectivity

TE Connectivity Ltd. engages in the design and manufacture of connectivity and sensor solutions. It operates through the following segments: Transportation, Industrial, and Communications Solutions. The Transportation Solutions segment offers products that are used in the automotive, commercial transportation, and sensors markets. The Industrial Solutions segment provides products that connect and distribute power, data, and signal. The Communications Solutions segment supplies electronic components for the data and devices and appliances markets. The company was founded in 2000 and is headquartered in Schaffhausen, Switzerland.

Earnings data Q3 2021

Earnings data Q4 2021

Earnings data Q1 2022

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Earnings data Q4 2022

Earnings data Q1 2023

Earnings data Q2 2023

Earnings data Q3 2023

Earnings data Q4 2023

Earnings data Q1 2024

Earnings data Q2 2024

Earnings data Q3 2024

TE Connectivity reports strong Q2 performance, focuses on margin expansion

TE Connectivity's Q2 2023 performance showcased strong sales growth and margin expansion efforts. While facing challenges in the Communications and Industrial segments, the company is focused on driving long-term growth and value creation for stakeholders. Opportunities lie in the electric vehicle market, AI-driven growth, and margin improvement initiatives.

TE Connectivity reports strong Q3 performance, highlights AI opportunities

TE Connectivity's Q3 2023 earnings call showcased strong performance and disciplined capital strategy, with growth in Transportation and Industrial segments offsetting declines in the Communications segment. The company highlighted corporate responsibility achievements and discussed opportunities in AI and various business segments, while addressing challenges in the communications segment and the impact of AI on future growth.

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TE Connectivity reports resilient Q4 performance, eyes auto industry opportunities

TE Connectivity's Q4 2023 performance reflected resilience in a challenging economic environment, with notable strengths in orders and sustainability. However, challenges persist in certain business units and pricing dynamics. The company is poised to capitalize on opportunities in the auto industry and AI-related content, while focusing on improving profitability and cash-on-cash return from the Schaffner acquisition.

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TE Connectivity Ltd. engages in the design and manufacture of connectivity and sensor solutions. It operates through the following segments: Transportation Solutions, Industrial Solutions, and Communications Solutions. The Transportation Solutions segment offers products that are used in the automotive, commercial transportation, and sensors markets. The Industrial Solutions segment provides products that connect and distribute power, data, and signal. The Communications Solutions segment supplies electronic components for the data and devices and appliances markets. The company was founded in 1941 and is headquartered in Schaffhausen, Switzerland.

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