CTS Corporation (CTS) designs, manufactures, assembles, and sells a broad line of electronic components and sensors. The firm also provides electronics manufacturing services primarily to original equipment manufacturers (OEMs), for the automotive, computer, communications, medical, industrial, and defense and aerospace markets. The firm was established in 1896 as a provider of high-quality telephone products and was incorporated as an Indiana corporation in February 1929. Along the way CTS had a hand in numerous technologies; from the radio to the space shuttle Columbia.
CTS has two reportable segments: Electronics Manufacturing Services (EMS) and Components and Sensors. Investors should take notice of how the firm has diversified its EMS segment and how the Components and Sensors segment is benefiting from tailwinds such as
Entering new markets for existing products.
Double digit growth in wireless communications.
Double digit growth in fuel economy and reduced emissions.
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The slower growing EMS segment has been exceptionally diversified since 2004 into medical and industrial markets where margins are higher and cost to enter the market is significant. This will likely produce higher margins and more reliable revenue in what is CTS' largest segment. EMS Firms with strong footholds in Medical, Defense, and Industrial will outperform firms with more concentration in computer and communications. CTS aims to find customers with complex needs in niche sectors such as defense, aerospace, medical and industrial. This ensures less competition and higher margins.
Components and Sensors
Components and Sensors are products which perform specific electronic functions for a given product family and are intended for use in customer assemblies. Components and Sensors consist principally of automotive sensors and actuators used in commercial or consumer vehicles; electronic components used in communications infrastructure and computer markets; components used in computer and other high-speed applications, switches, resistor networks, and potentiometers used to serve multiple markets; and fabricated piezoelectric materials and substrates used primarily in medical, industrial and defense and aerospace markets.
Sensors and Actuators
Sensors and Actuators ((32% of sales)) should see double- digit sales growth over 3-5 years. Green programs and fuel efficiency should provide a tail-wind. Products in this segment include Smart Actuator, Position Sensors, and Accelerator Pedal Modules.
CTS has sensor technology and strongly desires to diversify its base, the firm has been going beyond the traditional pedal-modules of position sensors and has endeavored to convince its customers that they should be looking at a broader array of sensors from the company. In short, the firm has found new customers and industries for its products.
The firm penetrated two of the largest diesel manufacturers with smart actuators for trucks and industrial engines. There have been four wins in all. This takes CTS into on-and-off highway diesel engines and trucks. This introduces the firm to commercial applications like construction, mining, and agriculture.
On April 13, 2011 CTS announced that CTS Automotive Products was awarded three new production programs with Chinese vehicle manufacturers for its Electronic Throttle Control (ETC) Accelerator Pedal Modules plus a new Transmission Sensor program for a North American platform. All four awards represent new business and will result in an increase in CTS' global market share. The pedal modules for the Chinese vehicles will be manufactured in CTS' facility in Zhongshan, China. The transmission sensors will come out of CTS' facility in Matamoros, Mexico and will be used in a new luxury all-electric vehicle. This is CTS' second business award for transmission sensors. Shipments have already begun for some of the programs. The remaining programs will launch over the next 18 months. Revenues from these four awards are expected to reach approximately $15 million over the anticipated five-year lives of the program. While these programs are small they represent new business area for the firm.
On March 22, 2011, the firm announced that CTS Automotive Products has launched its first smart actuator production program for use on heavy-duty industrial engines that are produced by a major heavy equipment manufacturer. This low volume, highly-engineered smart actuator was launched after extensive testing for use on a series of heavy-duty industrial engines for pumps and power generation. This program was awarded two years ago and is the first brushless DC smart actuator for the commercial market to go to production. CTS' diversification into new markets and customers will be further enhanced when production of the high-volume smart actuator programs for light and medium-duty trucks are launched in late 2012.
The total commercial market looks to be between $750 million to $1 billion. CTS target market share is 10%. Management sees projected sales at $90 million through 2015 with the first year of significant sales in 2013 ($20 million).
Electronic components (19% of sales) should see double-digit sales growth over 3-5 years. Social networks in developed countries and strong communications growth in emerging markets should provide a tailwind. Communications infrastructure and Piezo Electronics are two CTS products in this segment.
This segment has been increasing market share and winning new customers. Looking closer at the segment, fabricated piezoelectric materials and substrates are used primarily in medical, industrial and defense and aerospace markets. The firm's focus has been on specific solutions for customers requirements. For many customers, CTS remains their sole source. Piezo-elements are used in many applications, such as:
Medical Ultrasound Imaging Transducers
Material has the ability to be precisely machined into very tall, narrow structures which exhibit superior mechanical strength.
Piezo Ink Jet Heads
High density formulations offer a significant advantage to customers in building these types of structures.
Piezo-transducers that are used to receive acoustic signals underwater. These transducers are used to detect underwater oil reserves. CTS material is used because of its high sensitivity and the ability to provide high volume products.
Miniature compressors, pumps and synthetic jet products.
CTS is in the process of ramping the new piezoceramic component for the next generation of high density, hard disk drive application. A 10,000 square foot plus 1K level clean room has been commissioned in Tianjin, China. The facility has the capacity to support $15 million in annual sales of this new Piezoceramic component. This could translate to incremental annualized Piezoceramic sales of approximately $10 million and $3 million to $4 million in additional gross margin contributions in 2012; for the electronic components business, from a new product and new customer standpoint.
First quarter 2012 Electronic component sales benefited from the company's new piezoceramic HDD product launch and incremental sales from the Valpey-Fisher acquisition while automotive sensor and actuator sales profited from the introduction of a new global pedal module.
According to the P/B, the P/S, and P/E CTS appears undervalued compared to industry. According to the enterprise multiple, the firm looks overvalued. Recall that CTS Corporation's 2011 fiscal year was biblical, as the firm dealt with the adverse effects of earthquakes, fires and floods. As the firm rebuilds this business and receives insurance payments, this metric will likely come down.
P/E 2012 (E)
Here is how I view the valuation of CTS. (Background for valuation models)
Two Stage Free Cash Flow to Equity Model
FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment
- The firm is expected to grow at a higher growth rate in the first period.
- The growth rate will drop at the end of the first period to the stable growth rate.
Rationale for using the Model
As new products are introduced to new customers, we expect the firm to grow at a higher overall rate than the industry. As these products mature and the firm faces more competition, we expect the growth rate to level off.
Weakness of the Model
As you add more layers to the model it is more sensitive to the assumptions you make. The growth may look more "lumpy" than we have it in the model.
We used the following inputs:
We value the company based on the average of our P/E multiple (18.0x 2012 estimated EPS) and our two stage intrinsic model. The semiconductor/Electronic group average P/E is between 14x-20x and EMS firms tend to be lower. We feel CTS should trade at a premium to its peers, given the fact that the company has the potential to build growth in new markets.
- An 8-year period with an earnings growth rate of 10.0% (average forecast) and a discount rate of 12.6%.
- A continuing period assumed to go on forever, with earnings growing at 5% and a discount rate of 11.23%.
With these inputs we arrive at a target price of $14.00.