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Amphenol: Another Constellation Software?

- By New Moon


Amphenol Corp. (APH) makes things that are almost never at the back of your mind until they are broken. These are the connectors, antennas and sensors that go into your cell phones, your computers, your cars, your smart speakers and thermostats. They look like the following: this... this... and that... many kinds of them.

Amphenol is divided into two business segments, interconnect products (95% of sales with 22% operating margin) and cable products and solutions (5% of revenue with 10% margin). Interconnect products include connectors, which when attached to an electrical, electronic or fiber optic cable, a printed circuit board or other device, facilitate transmission of power or signals. The Cable Products and Solutions segment primarily designs, manufactures and markets cable, value-add products and components for use primarily in the broadband communications and information technology markets as well as certain applications in other markets.

Amphenol's products are used in a variety of industries, the biggest ones being industrials, information technology and data communications, automobile, and mobile devices. Mobile devices appear to the be the most volatile and unpredictable part of the business. Apple, the company's biggest customer, accounted for about 10% total sales.

Amphenol was founded in 1932 as American Phenolic Corp. Its first product was a radio tube socket and has since established its leading position in interconnect technologies.

Amphenol's CEO Adam Norwitt is an Amphenol veteran. He took the reigns in 2009 and is 48 years old. He holds bachelor's degree from Georgetown and an MBA from INSEAD. He was a corporate lawyer prior to joining Amphenol.

Fidelity, Vanguard and Blackrock own 14%, 11% and 7% of Amphenol.

Why buy the stock?

Amphenol looks very much like Constellation Software. The two companies focus on their core competencies but run as a collection of small companies with small headquarters. They have lead positions in many of the things they do. But the real strength is the managers' ability to buy companies in their highly competitive industries and still maintain the culture and high returns.

Amphenol has clear strategies. Besides pursuing diversification, product development, global expansion, and cost control, the company also focuses on "strategic acquisitions and investments" and "forester collaborative, entrepreneurial management." That is very much the strategy at Constellation Software and Berkshire Hathaway. On Amphenol's conference calls, the management says "our ability to identify and execute upon acquisition opportunities and then to successfully bring these new companies into the Amphenol family remains a core competitive advantage for Amphenol" and "the Company's entrepreneurial management team, which continues to foster a high-performance, action-oriented culture, which each individual operating unit is able to appropriately adjust to market conditions and, thereby, maximize both growth and profitability in a dynamic market environment."

For a long-term investor, Amphenol has these desirable characteristics:

  • Position in a growing industry.

Amphenol's products are used to connect parts in electronics. As things in our life are increasingly electrified and connected, they require more connectors, antennas and sensors.

  • It's good at what it does.

Connectors made by Amphenol has been used in Boeing 707, the space and lunar Apollo missions, and the world's first cellular phone and every new generation of new mobile device thereafter. It is an Apple supplier. It has "industry leading profit margin" of 20%.

  • It has a diversified product base with exposures to many industries.

No single industry accounts for more than 20% of Amphenol's sales. Except for its exposure to Apple (10% of sales), Amphenol does not have high concentration in any industry or customers.

  • It has high and consistent returns.

Amphenol's ROIC has been consistently at 15-20% (except in 2017 when the tax rate was abnormal due to the U.S. tax reform).

  • Rising and recession-resistant profit margin.

  • Good asset allocation.

In the last 10 years, Amphenols' invested capital more than tripled and still maintained at ROIC almost 20%. It started to pay out dividend in 2011 and currently has a payout ratio of 20%. From 2011 to 2018, it bought back $4 billion worth of stocks and reduced number of shares outstanding by close to 15%.

  • Reasonable price

Amphenol stock has a forward price-earnings ratio of 24x. It is at premium compared to its competitors. But many of its competitors are more cyclical as they are heavily exposed to certain sectors such as automobile and mobile devices.

Amphenol is a value accretive acquirer with high returns. Stocks with similar characteristics are at premiums. Compared to them, Amphenol is priced attractively. If you believe in the quality of Amphenol, it is cheap in the current market.

Amphenol is also priced attractive reasonably against history, especially considering the whole market is at a premium.

This article first appeared on GuruFocus.