With the communications sector undergoing almost month-to-month innovation, the secular trends are strong for suppliers. Communications and electronic equipment providers are in a good position to also capitalize off of greater consumer expenditures in technology. In this article, I will run you through my DCF model on TE Connectivity (TEL) and then triangulate the result with an exit multiple calculation and a review of the fundamentals compared to Corning (GLW) and Qualcomm (QCOM). I find that Corning and TE represent significant value plays right now.
First, let's begin with an assumption about the top-line. TE finished FY2011 with $14.3B in revenue, which represented a 18.6% gain off of the preceding year. I model 10.9% per annum growth over the next half decade or so. This is a figure that I feel is slightly optimistic but solidly within the boundaries of reason.
Moving onto the cost-side of the equation, there are several items to consider: operating expenses, capital expenditures, and taxes. I model cost of goods sold as 70% of revenue versus 12.9% for SG&A, 5% for R&D, and 3.7% for capex. Taxes are estimated at 30% of adjusted EBIT (ie. excluding non-cash depreciation charges to keep this a pure operating model.)
We then need to subtract out net increases in working capital. I expect this figure to hover around -1.5% of revenue over the explicitly projected time period.
Taking a perpetual growth rate of 2.5% and discounting backwards by a WACC of 10.5% yields a fair value figure of $45.70, implying 30.3% upside. The market seems to be factoring in a discount rate of 12.55%, which is too conservative despite that beta of 2. The dividend yield of 2.1% in an industry with strong barriers to entry reduce the risk.
From a multiples perspective, TE is also attractive. It trades at just a respective 12.5x and 9.9x past and forward earnings versus 21.8x and 14.9x for Qualcomm and 7.5x and 8.9x for Corning. Assuming a multiple of 13x and a conservative 2013 EPS of $3.51, the stock would hit $45.63 - virtually in-line with my DCF result.
All of this falls within the context of safer and more well-known brands, like Qualcomm, which has delivered impressive momentum:
"We are pleased to report another quarter of record revenues and earnings per share driven by strong demand for 3G and 3G/4G multimode-enabled devices across both developed and emerging regions.
Consistent with this performance in March, we announced the 16% increase in our dividend and a new $4 billion share repurchase authorization".
Qualcomm, however, already has much of its projected growth accounted for. It would take a multiple of 19.5x at a conservative EPS for Qualcomm to have the same upside that TE has at only a multiple of 13x.
Corning is a riskier play than TE, but the upside is more attractive. Gorilla Glass continues to be underappreciated, and the company is well positioned to boost free cash flow - even to just normalized levels. A multiple of 13x at a conservative 2013 EPS of $1.45 would send the stock soaring to $1.45. The downside to holding Corning has already been fully accounted for. Value investors willing to think like a contrarian would thus do well backing this glass-maker.