Amphenol: Fundamental, In-Depth Review (APH)

May.11.06 | About: Amphenol Corporation (APH)

Telecom/cable components company Amphenol (NYSE:APH) beat earnings estimates by $0.04 in the first quarter, but $0.03 was due to the contribution of a recent acquisition (the company had guided for it to be slightly dilutive in the first half) and the remaining $0.01 was due to less conservative allowances for doubtful receivables.

While the stronger than anticipated performance of the acquisition is positive, the resulting earnings surprise should be viewed as one-time in nature since the underlying business did not exceed expectations. Still, organic sales growth of 12 per cent is quite strong. The company has been paying down debt since its IPO out of leveraged buyout firm KKR, and its credit rating may earn an upgrade if debt reductions continue.

Income statement analysis

Sales growth – 39 per cent year/year, with a 2 per cent currency drag. Organic growth of 12 per cent in dollars, 14 per cent in local currencies.

Earnings quality

· Capitalization of expenses – Company has $900 million of goodwill on the books, which is not amortized. If acquisitions are viewed as an alternative to capital expenditures, which would be depreciated, the goodwill portion represents a capitalized expense.

· Operating margins – operating margins declined from 18.9 per cent last year to 17.3 per cent in Q106. The decline resulted from higher freight costs, increased amortization due to an acquisition, and the requirement to expense stock options beginning in Q106.

· Net margins – declined from 11.2 per cent in Q105 to 10.0 per cent in Q106. The main cause of the decrease was lower operating margins. Higher interest expense also contributed, partially offset by a lower tax rate.

· Stock options reduced net income by $1.8 million in Q106, the first time they were expensed. The net impact was approximately $0.01 per share.

· Pensions – the recurring costs (service cost and interest cost) of the company’s pension and other post-retirement benefits are approximately $3 million per quarter higher than the cost recorded on the income statement, as the company is permitted to record an expected return on plan assets to offset a portion of the costs.

· Anomalous tax rates – tax rate fell to 33 per cent in Q106, from 34 per cent in Q105.

· Other – recent acquisition TCS had sales of approximately $94,000 and operating income margins of approximately 10% for the three months ended March 31, 2006. The Company incurred additional interest expense of approximately $5,400 during the period as a result of the incremental borrowings. As such, TCS contributed approximately $.03 to diluted earnings per share for the three months ended March 31, 2006. In the company’s fourth quarter press release they said “For the first quarter of 2006 we expect revenues and EPS in the range of $535 million to $545 million and $.57 and $.59, respectively. As previously announced, we expect the TCS acquisition to be accretive for the full year 2006, but slightly dilutive in the first half of 2006.

Balance sheet analysis

Debt load and maturity schedule - $741 million in Q1, down $25 million from year-end. The company uses a $1 billion revolving credit facility as its primary source of debt capital.

Value of unexercised options
– aggregate intrinsic value, which can be considered the minimum off-balance sheet liability, is $171 million.

Accruals

· Doubtful accounts – the accrual rate for doubtful accounts was lower than in Q42005. Had it been held constant, EPS would have been $0.01 lower in Q106.

· Environmental reserves – company is involved in several environmental site cleanups but its costs are reimbursed by Honeywell under an agreement dating to Amphenol’s days as an AlliedSignal subsidiary.

Receivables trends (DSO) – days sales outstanding declined modestly both sequentially and on a year/year basis.

SPEs and other off-balance sheet items – company securitizes and sells a portion of its accounts receivable. The amount securitized was $85 million in Q106, $5 million higher than in the same period last year. The $85 million is the maximum allowable under the plan. Receivables sold are not recorded on the balance sheet.

Cash flow analysis

Operating cash flow and net income trends – cash flow was $7.8 million less than net income in Q105 and improved to a $1.4 million shortfall in Q106. $1.8 million of the improvement was due to the stock option expense add-back, which reduced net income in 2006.

Growth indicators

Guidance - as given in the company’s first quarter press release (.pdf):

Assuming a continuation of the current economic climate and relatively stable currency exchange rates, we are raising our guidance for the full year 2006 to achieve revenues and EPS in the range of $2,300 million to $2,345 million and $2.64 to $2.72, respectively. This compares to the Company’s previous guidance of revenues and EPS in the range of $2,250 million to $2,300 million and $2.56 to $2.63, respectively. For the second quarter of 2006 we expect revenues and EPS in the range of $580 million to $590 million and $.66 and $.68, respectively. EPS guidance for the year and second quarter of 2006 includes approximately $9.8 million ($.07 per share) and $2.5 million ($.02 per share) relating to stock option expense as a result of the adoption of SFAS 123R. Pro forma 2005 EPS after option expense is $2.23 and $.56, for the full year and second quarter, respectively.

Consensus estimates are at the very upper end of the guidance range.

APH 1-yr chart: