Buy Rogers Corp.: Arms Dealer To Megatrends In 5G, ADAS, And HEVs/EVs

Summary

• Rogers is a key supplier to communications infrastructure - 5G a large catalyst.
• Rogers is a key supplier into other strong growth markets in auto safety (ADAS), hybrid and electric vehicles and the electronics that power the IoT.
• Path to $10 in EPS in the medium term.

Rogers Corporation (NYSE:ROG) is something that is hard to find - a small cap arms dealer to 5G infrastructure and electric vehicle (EV) megatrends that already earns mid-teens operating margins, targets 7-10% organic growth and has the strength and optionality afforded by a net cash position. While the company’s 2020 goals are behind schedule, the business can still deliver on an impressive combination of growth and margin expansion to generate $10 earnings per share by 2022. Stocks with this set of drivers routinely command a multiple in the low-to-mid 20x range affording the stock material upside (50%+) from today’s $130 share price.

ROG is a value add manufacturer of high performance materials and components. While the company manufactures electronics products in three categories, it is easier to think about their two primary end markets - Advanced Connectivity and Advanced Mobility. These two markets are the fast growing pieces of the company and currently account for half of sales. The drivers in Advanced Connectivity are 5G wireless infrastructure and the Internet of Things while the growth of EV and advanced driver assist systems (ADAS) support Advanced Mobility. These are two of the most compelling structural growth trends in the markets today with both poised to accelerate in 2020 and beyond.

Source: Rogers Corporation

Roger’s goal for 2020 is $1.2BN in revenues and a 20% operating margin. As 2019 has developed, this goal looks aggressive. The primary example of this is in the 5G market. ROG is a supplier into the Huawei suppliers and the current state of the trade dispute with China has slowed 5G deployments and disrupted the supply chain. Since Huawei has been the leader in 5G base station deployments and other suppliers been slower to get to market[1], this has put pressure on ROG’s near-term growth rate. Similarly, the EV market has been weaker from lower subsidies in China while the major Western OEMs transition to electric is more of a 2021 growth driver. Further, the general industrial markets that comprise around 25% of ROG’s sales have suffered from the same headwinds that we see across the industrial and electronics landscape due to general malaise in Europe and the US/China trade conflict. Lastly, ROG assumed contributions from M&A to reach their revenue targets and the pace of deals has been slow.

Despite such near-term revenue challenges, the company has remained committed to its 20% margin target. The nuance is that it is now a target return for the end of 2020 – specifically the fourth quarter. Taking into account the lower revenue run rate in 2019 puts revenues just below $1BN in ’19 and then accelerate in the ensuing years. This should drive earnings in 2020-2022 of $6.50 $8.00 and $10.00 over the next 3 years. As the calendar turns to 2020, investors looking out 2 years for a 12-month price target will consider fiscal 2021 earnings. Using a reasonable 20x multiple affords approximately 25% upside to our $8 eps estimate. Assuming it is then a matter of time until ROG is able to capitalize on the strong industry trends and add in some acquisitions, the $10+ in EPS would then be back in sight implying a $200+ stock (>50% return).

Source: Rogers Corporation

Circling back to the drivers at ROG and starting with Advanced Connectivity, the company’s enthusiasm for the 5G wireless infrastructure buildout takes on several forms. First, the company has 80%+ market share in all major 5G infrastructure equipment companies. This is an impressive number for any business to achieve and acts as a commercial endorsement that their materials meaningfully outperform their competitors. Further, the ROG bill of goods is only ~3% of the total infrastructure cost, making this area less of a focus for cost reduction while still being critical to performance, most importantly in efficient heat management.[2] The dollar content per 5G base station is 3-5x that of a 4G base station, so even as their 4G business starts to decline, the ramp in 5G growth should more than make up the difference. Third, the build out of 5G itself will require a denser network and thereby more units adding to the size of the addressable market. With low shipments to date and more than 500 thousand base stations expected to ship annually for years to come, the opportunity is significant for ROG. Further, the forecasted growth for 5G is now running ahead of earlier estimates with Ericsson writing, “5G subscription uptake is expected to be significantly faster than that of LTE.”[3] Lastly, the growth is not fully dependent on 5G. High speed data networks will enable elements of the 4^th industrial revolution, as ROG has described it, “the internet of things, which will be enabled by 5G networks (will facilitate) communication in vehicle-to-vehicle, machine-to-machine … and then to low earth broadband which is bringing Wi-Fi to remove parts of the world … we see this again utilizing Rogers’ high frequency circuit materials.”[4]

Within the Advanced Mobility end market, the driver has been the increased penetration of ADAS and the share gains that are coming from HEV and EV vehicles. The global automotive market is large running at 95-100M vehicles per year over the next few years.[5] The clear safety benefits are driving increased penetration rates of ADAS.[6] Combining the increased adoption and increasing sophistication of the systems benefit ROG. ROG materials and components are used in multiple levels of driver assist from automatic emergency braking, to spatial awareness and all the way up to the autonomous driving systems. The number of radar sensors going into cars is increasing as the safety application adoption increases. These units result in ~$1.00 per unit and the average vehicle with basic ADAS features has 3 units. Fully autonomous vehicles that are in development today can utilize 10 or more units, further increasing the addressable market. The trends for increased adoption of safety features is quite compelling and act as a content per unit opportunity that will continue to grow in the years ahead.[7]

Source: CCC Infoservices, “Crash Course 2019”

As for HEV and EV vehicles, ROG also sells into that ecosystem including materials that make batteries and charging more efficient, which is a key priority for the global auto OEMs. In June, the company stated:

On the EV/ HEV side the power modules, the silicon nitride for silicon carbide chip mounting, and power modules for all electric vehicles, a lot of work going on in Germany right now… essentially following what we’ve seen here in the US from Tesla and Model 3, and Rogers materials are right in the midst of that.[8]

For the company, the content range per vehicle starts around $5 for mild hybrids and increases all the way to $25 for a fully electric vehicle. The market share of BEV, PHEVs and hybrids is approximately 10% today and will triple over the next 5 years.[9] We can see the trends clearly. In Europe, emissions regulations have caused both VW[10] and Daimler[11] to move aggressively. But the trend is not limited to Europe. With a splash, Ford recently announced their Mustang Mach-E fully electric vehicle which is broadening out the offerings and making electric more mainstream, with good signs thus far based on customer orders. The start-up Rivian has gained attention with their pending pickup truck launch, including orders from Amazon for fleet vehicles.[12] And most recently, Hyundai announced a dramatic pivot toward electric vehicles with spending at a similarly large magnitude to the German OEMs.[13] The narrative may very well pivot towards the uptake on EVs for their performance attributes. In all these cases, ROG is right in the middle supplying the market.

Source: IHS Markit, “Automotive Industry Outlook,” February 2019

Looking at the balance of the business, a quarter of what ROG sells is put into the general industrial bucket. This area has been a challenge in recent quarters. A global industrial slowdown started earlier in 2019 and has affected all companies selling into the broad industrial complex. More recently, data points from China, Europe and the US have shown stability and even suggested a recovery could be taking shape.[14] Regardless of the short-term outcome, comparisons in this end market will ease as we move through 2020 and provide a better set up for ROG. The remainder of ROG’s revenues come from end markets such as aerospace and defense, rail and renewable energy. In general, these have been good markets for ROG with the aerospace and defense markets growing well in 2019. The broad theme that crosses through the end markets for ROG is the proliferation of electronics across an increasing amount of end points that all require higher performance features to use energy efficiently and without disrupting other key functions of a chip or system.

Source: WSJ, “Manufacturing Shows Stability in U.S., Asia,” January 2, 2020

ROG certainly bears risks. The trade dispute with China is forcing US and Chinese companies to rethink the risks of a global supply chain.[15] While ROG is supplying to suppliers of Huawei for communication infrastructure, it is notable that Huawei shipped a handset without the direct use of US suppliers.[16] While the EV market has incredible growth in the pipeline, the Chinese market has been weak due to a reduction in subsidies on July 2019. While the macro backdrop has been shifting rather rapidly in recent periods, ROG’s other end markets have seen the impact from slower global industrial production and the tentative recovery could falter. Lastly, after posting several quarters that have disappointed the market in some shape or form in 2019, it will be harder for ROG to argue for a higher multiple until the cadence turns favorable. Note, the estimates referenced here assume ROG grows sales and profits at a healthier pace than is discounted by published analyst estimates.

To conclude, ROG supplies high performance materials and components into two of the more compelling growth trends in the global economy. First, 5G wireless deployment is underway and is a meaningful revenue opportunity for the company. Second, the electrification of transportation which includes safety features and the massive share gains from EV and HEVs benefit Rogers’ business and there have even been a couple recent positive data points from China including less EV subsidy cuts[17] and the opening of Tesla’s factory[18]. These drivers are in place for 2020 and beyond while a mild cyclical recovery is underway in the global economy. Lastly, there has been some progress on the trade front with an initial trade deal[19] signed. Combined, these factors are likely to help Rogers regain a strong earnings growth cadence in the years ahead. With margin expansion leveraging revenue growth over the next several years, Rogers can again aim towards its profit goals which imply $10+ in EPS, and in turn a $200+ share price (+50%).

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[1] See as an example, “Nokia Made a Bad Call for 5G Chips, Scrambles to Rectify Situation,” Fierce Wireless, October 31, 2019

[2] See the transcript from May 15^th, 2019 at the B. Riley Conference

[3] See, “Ericsson Mobility Report; 5G Subscriptions to Top 2.6 billion by End of 2025,” November 25, 2019

[4] See the transcript from the June 4, 2019 Baird Conference

[5] See, “Automotive Industry Outlook,” IHS Markit, February 2019 https://www.cargroup.org/wp-content/uploads/2019/02/Wall.pdf

[6] See, “A Roadmap to Safer Driving Through Advanced Driver Assistance Systems, MEMA & BCG, https://www.mema.org/sites/default/files/MEMA%20BCG%20ADAS%20Report.pdf

[7] See, “Crash Course 2019,” CCC Information Services https://www.cccis.com/wp-content/uploads/2019/03/2019_Crash_Course.pdf

[8] See the transcript from the June 6, 2019 DB Conference. Also see “How 5G and the Internet of Things Can Create a Winning Business,” Ericsson Blog, January 14, 2020

[9] See, “Driving into 2025: The Future of Electric Vehicles,” JP Morgan, October 10, 2018, Driving into 2025: The Future of Electric Vehicles | J.P. Morgan and the “Electric Vehicle Outlook 2019,” Bloomberg New Energy Finance, Electric Vehicle Outlook 2019 | BloombergNEF

[10] See “Volkswagen Increases Investment in electric vehicles,” FT November 15, 2019 citing EUR 33BN spending on electric mobility in the next 4 year and EUR 27BN on hybrid and digitization. The article also notes the regulatory pressure, “The commitments put the German carmaker in a strong positive to meet stringent EU emissions targets which will be phased in from 2020. Failure to meet those standards could lead to billions of euros in fines.

[11] See “Daimler’s New CEO Warns Electric-Car Shift Will Be Painful,” Bloomberg November 13, 2019 noting the plan to introduce 20 EVs & plug-in hybrids by 2022

[12] See, “Amazon’s Order of 100,000 Rivian Vans Signals the Automaker is ‘For Real”, LA Times, September 19, 2019

[13] See, “Hyundai Motors Unveils, ‘Strategy 2025’ Roadmap to Transition into ‘Smart Mobility Solutions Provider,’ December 4, 2019

[14] One discussion of this seen here, “Morgan Stanley Sees a Global Economic Recovery in Early 2020,” Bloomberg November 17, 2019

[15] Rogers put out a press release on May 21, 2019 on this topic and made specific comments on this in detail on their November 1, 2019 conference call which can be referenced here. They highlighted the macro / cyclical headwinds from ‘industrial and conventional automotive demand and noted ‘recent data pointing to declining factory activity, lower industrial output and falling auto sales.’ Specific to the situation with China and Huawei they said, “the geopolitical tensions between China and the US which have resulted in trade restrictions on sales to Huawei are impacting 5G demand. While Rogers is able to continue sales to our direct fabricator customers, there is uncertainty around Huawei’s ability to maintain 5G deployments without certain U.S. components and whether they performance of its alternative base station design will be acceptable… A byproduct of these trade restriction has led Huawei to consider local sources of supply for high-frequency circuit materials, even though these alternative materials have performance limitations as compared to Rogers’ products. Although these challenges are impacting our near-term results, we continue to see very compelling market opportunities ahead.’

[16] See, WSJ, “Huawei Manages to Make Smartphones Without American Chips,” December 1, 2019

[17] See, “Electric Car Stock Jump as China Signals Lull in Subsidy Cuts,” Bloomberg 1/12/2020

[18] “Tesla Delivers First China-made Model 3 Sedans in Just Under a Year,” Reuters, December 29, 2019

[19] Here is a summary from the NY Times on the trade deal, titled, “What’s in (and Not in) the U.S.-China Trade Deal,” January 15, 2020. At the same time, the rhetoric towards Huawei has not improved with the U.S. considering a more aggressive stance, see, “Specter of More U.S. Restriction Weighs on Huawei,” Bloomberg January 15, 2020

Disclosure: I am/we are long ROG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.