AGB 2023.9 - Amphenol Corp (APH)
Benefiting from Electrification of Everything
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Amphenol
“Now the underpinning of that strategy is really what I like to call the electronics revolution and what that means by revolution is electronics, creating new functionalities, creating new capabilities, new applications across really every aspect of society and around the world. In earthmoving equipment, in mining equipment, in data centers, in more devices that we hold in our hands and wear on our wrists, you have revolutions every day. And what revolution entails is unpredictable. You don't know when that next new design is going to come, that next new application, that next big hit that may come about. And so it's up to us to remain poised to capitalize on that regardless of where that revolution comes and you see here whether that's getting more efficient and cleaner, whether that's being more mobile, connected higher speeds, there's so many aspects of that electronics revolution and it's our job to enable it and we do that really across the broadest and most balanced array of markets in our industry.” – Chief Executive Officer, Richard Norwitt, at the 2019 Baird Global Industrial Conference
Amphenol is one of the leading designers and manufacturers of electronic connectors and sensors. The company started as a manufacturer of sockets for cathode ray tubes used in radios in the 1930s. Since then, the company has expanded to make connectors and components for many different types of applications across most industrial, auto, technology, communications, aerospace and military end markets. No industry vertical is greater than 25% of revenues and this diversification allows the company to gain expertise across different technologies and experience less volatility from the various market cycles.
Similar to a Roper, Amphenol operates a decentralized organizational structure. The company has 130 business units, each led by a general manager who has autonomy over almost every aspect of the business including R&D, engineering, sales, marketing, quality control, manufacturing, sourcing, and back-office functions like HR, finance and IT. Each of these business units even operate their own ERP system, which could be viewed as inefficient. But it works for Amphenol because these general managers have accountability for each of those decisions. This autonomy also allows the general managers to adjust quickly during sudden demand shifts in their end markets.
The company recently changed its reporting segments into three groups - Harsh Environment (25% of revenues), Communications Solutions (45%), and Interconnect and Sensor Systems (30%). With that change, Amphenol promoted three division presidents that each oversee a group of business units. The division presidents report to the CEO. The company jokes that the CEO and division presidents mainly act as an intermediary between the general managers that are doing the real work and shareholders.
The interconnect and sensor market was estimated to be $235B in 2022, implying Amphenol’s share at just 5.4%. Each industry vertical is different but in general most are fragmented. The top 20 companies can account for as much as 88% of a market such as automotive, but as little as 58% in aerospace & defense. Amphenol’s highest market share is in aerospace & defense at 34% but the company only commands 2% of the consumer and automotive verticals. A lot of this has to do with customer concentration, regulatory requirements, and industry wide competition. Certain verticals also require certification and once a company is considered a qualified supplier, they tend to stay as a supplier.
Looking at data from 2020, Amphenol leads across the industrial, aerospace & defense and telecom verticals. The company competes with public competitors like Aptiv, TE Connectivity and Luxshare Precision as well as private competitors like Molex, Yazaki and others.
Customers choose Amphenol vs. the competition because of its technology innovation, product quality and price. The company tries to work with customers to design value added products which require much more customization and longer lead times. Amphenol especially shows its value when customers need to make last minutes re-designs, which also require a new interconnect system. The company makes adjustments quickly (the company gave an example of a 5 day turn around on its 2Q 2021 earnings call) to accommodate the new designs.
Amphenol’s growth engine is fueled by both organic reinvestment and acquisitions. Over the past 10 years, organic revenue growth has averaged +7.1% and acquisitions have contributed +4.5%. This implies roughly a 60%/40% split. The company aims to achieve a 67%/33% split, so the last decade was relatively close to internal targets. We have to remember that organic revenue growth calculations can be overstated because starting in the 2nd year, growth of acquired companies is counted as organic. Given that Amphenol generally acquires much smaller companies, its superior distribution and manufacturing capabilities should naturally increase production and selling capabilities for many of the acquired assets. This is all to say that Amphenol’s organic revenue growth number is benefitted by its acquisition strategy.
Of Amphenol’s eight verticals, automotive has been one of its main growth areas over the past 10 years. A lot of Amphenol’s growth in this area can be attributed to the electrification and increased complexity of passenger and commercial vehicles. Over the years, luxury car manufacturers have increasingly loaded their cars with more options, which tend to have higher connector content. And lower-end car manufacturers have also adopted more of these features. The automotive vertical accounted for just 5% of revenues in 2008. This has increased to 21% in 2022.
Amphenol manages the company to operating margins targets because each business unit has a different gross margin profile and capital investment requirement. Acquisitions sometimes have a dilutive impact to margins and the company is mindful of that when setting targets, especially since the general managers make capital allocation decisions at the business unit level. The incremental margin target is 25% for organic revenue growth.