Stay with TE Connectivity, Stage Is Set for a Solid 2013

Today we revisit our buy recommendation from early April on TE Connectivity (TEL) (33.69). Overall business developments have been moving in the right direction, but the company has faced the difficult headwind of a European recession and a slowing China.

The stock is modestly lower than when we discussed it, while the overall market is up over 5% over the same period.

Our sense is that the stock is overly cheap, management is unhappy with weak stock price and is focused on enhancing shareholder value, and the company's recent negative and macro-dominated trends should be moving in a better direction into 2013. We expect the stock to be a timely investment, and a winner in 2013.

Since our recommendation, TEL reported mixed results in the second quarter. While sales were $50 million lighter than expected, operating margins were at the upper end of expectations at 14%, which allowed TEL to meet expected earnings of 79 cents.

There were whisper concerns the company might not meet earnings because of macro-concerns, so meeting expectations for the quarter and maintaining the 2012 guidance at $2.85 was welcomed.

Even so, earnings will have declined year-over-year because of the weak global economy.  Investors seem to be looking through this transient earnings outlook.

Nearer-term, demand has been mixed but management has done a good job at winning new business and reducing costs. And the core trends are on the mend at TEL.

This progress should be very visible in 2013 as the company gains market share thanks to improved automotive platform penetration, continued gains in North American auto production, and a rebound in telecommunications spending (as more providers upgrade their systems for mobile and broadband data.)

For the upcoming quarter we look for mixed results and an outlook which should be generally in line with expectations.

A bit further down the road, however, the picture brightens. TEL should see a nice recovery in earnings in 2013 as the company's end markets start to recover from still relatively depressed levels. The company will also fully participate in the rapid growth of the emerging markets of Asia, Latin America, Africa, Eastern Europe and the Middle East.

At a recent price of $33.69 TEL trades at just 11.8 times 2012's EPS estimate of $2.85 and 10 times 2013's EPS estimate of $3.35. By comparison, electronic component peers Amphenol (APH) and Molex (MOLX) each typically trade at 16 to 18 times earnings every year.

TEL also pays a respectable 2.5% dividend yield. Over the next five years, most of the analysts expect the company to grow its revenue 5% to 6% per year, its earnings 9% to 10% per year, and its dividend 8% to 10% annually.

We like a number of industrials here, including TEL, and believe that investors would be well-served to build positions now during the tail end of this period of uncertainty. We strongly believe that by the time the investment community is feeling more comfortable with a bottoming Europe and a reaccelerating China, these stocks will already have had a significant move higher.

However, in light of a handful of recent earnings disappointments in the last few days, and a number of companies talking about additional slowing in Europe in September, we would start to buy some TEL now, and would wait to buy the balance after earnings on Nov. 5.

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