Amphenol: A Bit Risky In Light Of Cooling Demand Environment

Amphenol Corporation (NYSE:APH) is well-known for its leading interconnect systems, sensors, and antennas which play a critical role in modern transportation, enabling data transfer and communication between various components and systems that are more cost effective. Amphenol's backlog report shows impressive growth, thanks to its strong global presence and competitive advantage in the market. However, it faces short-term risk as management forecasts slowing revenue outlook for FY'23. This is mainly due to softening of demand as shown in its slowing book to bill metric of 0.89:1 this Q4'22, down from its 1.08:1 recorded in Q4'21. Additionally, this has snowballed into a slowing earnings per share outlook, making it unattractive, especially considering today's macro uncertainties which may negatively impact sales volume further.

Company Overview

Despite a slower book to bill ratio this quarter, APH's total revenue was $12,623 million, up from $10,876.3 million recorded in FY'21. Thanks to its strong operating leverage and sustained sales volume, APH managed to expand its (Non-GAAP) operating margin to 20.7%, up from 20% recorded in FY'21.

The year-over-year increase in adjusted operating margin was driven by strong operating leverage on the higher sales volumes, as well as the benefit of ongoing pricing actions. Source: Q4'22 Earnings Call Transcript

One point of concern of APH is its exposure to the ongoing commodity price deflation, as majority of its raw material used are commodities such as copper and aluminum. Therefore, changes in commodity prices can lower its input cost, as well as the prices of its products. The commitment to fixed expenses, such as its growing human resource base of 91,000 may put pressure on its future profitability. This is especially true considering uncertainties regarding today's softening demand environment, which could snowball and affect the company's resilient pricing power, particularly in light of today's inventory buildup. In fact, management provided a weaker outlook on its top line for Q1'23 compared to its $2,951.9 million recorded in Q1'22 as quoted below.

For the first quarter, we expect sales in the range of $2.840 billion to $2.900 billion and adjusted diluted EPS in the range of $0.65 to $0.67. This would represent a sales decline of 2% to 4% and adjusted diluted EPS of flat to down 3%, compared to the first quarter of '22. Source: Q4'22 Earnings Call Transcript

This reflects today's moderation in demand environment especially on the communications related markets, according to management. However, APH has a diversified portfolio that caters to different high growth end markets, including automotive and IT data communication which will drive continued revenue growth, as can be seen in the image below.

Additionally, APH continues to expand through acquisitions and we might, in fact, see positive growth next quarter.

In addition, we're pleased to have signed an agreement for the acquisition of the North American hybrid and fiber optic cable and cable assembly, as well as the global infrastructure antenna business of RFS at the end of the fourth quarter. Based just down the street from us here in Meriden, Connecticut, RFS is a provider of Interconnect and Antenna products for the mobile networks market with expected sales of approximately $100 million in 2023. Source: Q4'22 Earnings Call Transcript

This made APH's long-term outlook attractive, particularly in light of its solid balance sheet and track record of share repurchases.

On A Logical Resistance Point

Amphenol is on the verge of breaking out. However, with its current weakness, I believe this potential bullish breakout will be unsustainable. Hence, waiting for a better price to purchase APH is a safer option. Waiting for a lower price would result in a higher risk/reward investment potential than at today's level. If APH were to experience a short-term pullback, I would monitor its key support levels at around $70 and $75 which, in my opinion, would likely provide an attractive entry point for investors. APH's MACD indicator appears to be struggling to maintain bullish momentum, as shown in the chart above. Consequently, a potential bearish crossover would act as a confluence to compel a correction in the coming trading weeks.

Relatively Expensive

APH suffers from a negative sentiment from analysts' forecast regarding its forward P/E of 26.69x and which trades higher than its respective 5-year average of 21.70x. This makes the company risky in light of multiples mean reversion. In fact, earnings per share outlook of management for Q1'23 is to be around $0.65 on an average basis, down from $0.68 recorded in Q1'22. APH also suffered from a slowing demand environment, as quoted below.

Looking ahead, we expect sales to decline in the low double-digits from these levels, due to seasonal adjustments from customers. Source: Q4'22 Earnings Call Transcript

This translates to an unattractive forward P/S of 3.85x which is relatively expensive than its 5-year average of 2.83x.

Sensata Technologies (ST), Aptiv PLC (APTV), TE Connectivity (TEL)

The forecasted slowdown in APH's top line and its premium valuation relative to its peers as shown in the image above makes the company unattractive at today's levels.

Conclusive Thoughts

Despite today's weakness, APH's balance sheet remains liquid with a declining total debt of $4,871.4 million, down from its $5,050.9 million recorded in FY'21. Cash level keeps improving to $1,434.2 million. Its debt to equity ratio improved to 0.69x, better than its 5-year average of 0.84x. Today, its free cash flow margin of 14.2% remains above its 5-year average of 12.7%. APH's low payout ratio of 27% and improving FCF margin hints us of potential continued dividend growth in the future, despite today's weakness. However, deteriorating working capital management heightens the risk of margin contraction, as shown by the higher inventory days of 86, up from 80 in FY'21; higher day sales outstanding of 73, up from 71; and lower days payable outstanding of 54 days from 56 in FY'21. APH's short-term future remains risky and makes it an unappealing breakout play as of this writing.

Thank you for reading and good luck everyone!