Amphenol Corporation: Peak Margins and Peak Valuation

One short-term strategy that I like to employ personally is shorting a stock on December 31st that I believe everyone else will sell on January 2^nd. I wrote in late December about the potential for deferred gains realization in several stocks that had enjoyed meteoric rises. In the course of thinking about it further, it hit me that Amphenol (APH) (43, $2.7 billion), a member of my watchlist and a company that I have followed and owned at times for quite some time, was a perfect candidate, so I shorted it at 46+ on 12/31. I was very fortunate that an analyst downgraded it on Wednesday, but I didn’t cover, as I expect that the stock could drop to the mid-30s over the next few months. The stock has moved to 48 from 1 fifteen years ago and a 2002 low of 7.50:

As you can see in the chart above (click to enlarge), valuation is near an all-time high and margins have never been higher. Analysts are forecasting even a bit more margin expansion next year, with EPS growth expected close to 17% on low double-digit revenue growth.

For those not familiar with the company, it primarily sells connectors, competing with Tyco (TEL) and Molex (MOLX) as well as many small manufacturers that make up about ½ the rest of the market. They are broadly diversified in terms of end markets. I am the first to admit that it is a great company, as I have admired their accomplishments for years (as an owner at times). Bulls rightly point to the high amount of defense business that should be immune from any slowdown. Still, though, they cater to IT (increasingly since a fantastic acquisition of Teradyne Connection Systems two years ago), cell phones, automobiles and general industrials, so the company is exposed to the broad economy.

Beyond the potential for the company to finally not beat earnings as they have done consistently, there has been an increased pace of insider selling recently; Tyco (TEL) is now independent and could become a more formidable competitor and deals could be scarce for this historically acquisitive company (especially ones that can move the needle). Perhaps most alarming to me, though, is the high level of inventory growth and AR growth over the past year relative to sales (though inventory growth has moderated lately). The stock is expensive relative to its history, to its growth potential and to its peers. I believe that further weakness will draw in more sellers after the big run over the past several years. 15X 2009 EPS (based upon 10% growth in 2008 and 2009) would yield a year-end target of 35, a decline of almost 20%. I can get there on the charts as well.

Disclosure: Author has a short position in APH