Like many other stocks, Amphenol Corporation (NYSE:APH) has seen its share of volatility in recent months. The coronavirus outbreak caused great fear and many stocks sold off as a result once it finally showed up in the U.S. But the prospect of COVID-19 being brought under control has helped many stocks recoup most of their losses. This includes a stock like Amphenol, which got hit hard with its heavy exposure to China. But the coronavirus may be hiding problems that go much deeper. The reason why will be covered next in further detail.
Amphenol gets some relief
Amphenol started 2020 with things looking up. The signing of the Phase One Trade Deal between the U.S. and China was scheduled on January 15th. An important development for Amphenol with its heavy presence in China, which includes as many as 50 manufacturing operations in the country.
The stock has been under pressure ever since the trade war erupted in 2018. So the signing of a trade deal and the perceived resolution to trade disputes was seen as bullish for Amphenol. It's probably no coincidence that Amphenol's stock peaked on January 16th, the day after the trade deal was made official. The hope was that with trade tensions out of the way, Amphenol would finally be able to reverse the recent slump in earnings.
Amphenol gets hit by the coronavirus
However, the removal of one headwind was quickly followed by the arrival of a second one. China reported the outbreak of a novel coronavirus, which would force it to shut down in order to contain the epidemic. This had major implications for Amphenol due to its significant presence in the country as mentioned previously.
Amphenol had to pull its quarterly guidance in February due to the uncertainty caused by the coronavirus. So when Amphenol released its Q1 2020 earnings results, some sort of negative impact from COVID-19 was already expected. Sales declined by 5% YoY to $1.86B and net income fell by 9% YoY to $242.1M. The table below shows the results for Q1 2020.
(GAAP) | Q1 2020 | Q1 2019 | YoY |
Net sales | $1,862.0M | $1,958.5M | (5%) |
Net income | $242.1M | $267.5M | (9%) |
EPS | $0.79 | $0.87 | (9%) |
Source: Amphenol
Q1 2020 earnings call
Management pinned the blame for the less than stellar results on the coronavirus outbreak. From the Q1 2020 earnings call:
"Our sales reached $1.862 billion, a reduction of 5% in U.S. dollars versus prior year and 9% organically. And that was driven by lower sales in the mobile devices, mobile networks, IT datacom, automotive and industrial markets. These declines largely related to the COVID-19 disruptions in China, including, in particular, the approximately three weeks shutdown of all of our manufacturing operations in that country."
A transcript of the Q1 2020 earnings call can be found here.
Amphenol expects to see more headwinds from the coronavirus. Accordingly, it's pulling its full-year guidance and expects Q2 to take an even bigger hit than Q1.
"Given the significant uncertainty related to the COVID-19 crisis, we believe it's prudent to withdraw our full year sales and EPS guidance at this time and we will not be providing a specific sales and EPS outlook for the coming quarter. With that said, we do expect sales and EPS in the second quarter to be lower than our first quarter level."
Furthermore, management leaves open the possibility that the after-effects of the pandemic could linger for quite some time. That could further hurt already weak demand.
"I mean unemployment is increasing in many countries, for example, very significantly. So, there is an end demand that is related in some way to this crisis, but not a direct part of the battle against COVID-19. When does that end demand come back depend on so many factors."
Quite a few people expect the economy to quickly bounce back with a V-shaped recovery. In theory, such a fast recovery could certainly help a turnaround at Amphenol when it comes to quarterly earnings. But management questions the validity of those forecasts. If the economy takes longer to recover, quarterly numbers will not improve so quickly.
"In the last 90 days, I haven't heard a single forecast that's been correct. So, I don't know what those macro forecasts are really going to be whether there will be an L-shape or V-shape or U-shape and S-shape"
Nevertheless, Amphenol sees opportunities arising as a result of the pandemic despite the hits it's now taking. They may not materialize in the near term, but further down the road.
"There are some things that need to have disappeared in terms of demand but there's so many opportunities for new things that are going to come out of this whole crisis. And ultimately, I think those things are going to be real positive in the long-term. Not a second half necessarily commentary, but I'm telling you, I think there's going to be a lot of good that's going to come out of it."
In a nutshell, the coronavirus is a major challenge for Amphenol. It's having a big impact and there's no way of knowing how long that will last.
Source: Wikimedia Commons
Investor takeaways
Amphenol's stock rallied in the fourth quarter of 2019 once it became clear that a trade deal between the U.S. and China was imminent. The stock reached its high for the year the day after the trade deal was signed. This strong correlation to news on the trade front should not come as a surprise. Amphenol has traded up or down depending on whether there is good or bad news on the trade front. This issue is covered in further detail in another article.
This correlation is based in large part on the assumption that trade issues were responsible for the weakness in demand as seen in prior quarterly reports. However, as mentioned in the previous article, management has cautioned against assuming that trade tensions are the only driver of declining demand. Other factors may also be at play. So the removal of trade tensions with the signing of a trade deal may not necessarily lead to a revival in demand.
In addition, there are signs that the Phase One Trade Deal is not living up to expectations. It's possible that trade tensions will flare up once again between the U.S. and China. There are rumors that the U.S. may cancel the agreement, which implies a resumption of the trade war. Such a development would not bode well for Amphenol if past history is any indication. The Phase One Trade Deal remains for now, but no one can be sure for how much longer.
But while trade issues may have taken a backseat in recent months, the coronavirus has not. The latter has now taken over from the former. Amphenol now seems to be taking its cue from the coronavirus. The stock took a beating in March when the virus hit the U.S. It has since recovered and at one point even managed to recoup almost all its losses. However, recent signs indicate that the pandemic is not yet over and may even get worse. The stock has responded accordingly.
The assumption is that once the pandemic is brought under control, Amphenol is in the clear. The less than stellar quarterly earnings will improve as soon as the headwinds from the coronavirus recede. But this assumption may not be correct. The weak demand that Amphenol is experiencing may remain even when the coronavirus goes away.
There's the perception out there that if it wasn't for the coronavirus, all would be fine. But the U.S. economy was showing clear signs of weakness even before the pandemic emerged. For instance, the manufacturing sector was already contracting in 2019 and the Fed was forced to ease monetary policy with interest rates cuts, repo operations and expansion of the balance sheet. The yield curve also inverted back in the summer of 2019, a sign that a recession was on the horizon. All this occurred before there was COVID-19. The coronavirus may get all the blame for the current recession, but the economy was already heading towards one, even in the absence of the coronavirus.
So even if the coronavirus goes away due to a vaccine or whatever, economic weakness could remain. The string of weak quarterly results at Amphenol could remain for far longer than expected if what we're now experiencing is more than weakness induced by the coronavirus. Amphenol itself expects the Q2 numbers to be worse than Q1. It also leaves open the possibility that the second half of 2020 may not see as strong a recovery as some people seem to expect.
Both trade issues and COVID-19 have been hogging the limelight. The price action certainly suggests that these two issues are the ones considered most important to Amphenol. The former has receded to a certain extent, but could re-emerge at any time. The latter seems to be getting worse after it appeared the pandemic had reached its peak.
Up until now, Amphenol has been forgiven for its weak quarterly numbers. Instead, external factors have been blamed. First, trade tensions and more recently, the coronavirus. But both of them could merely have been covering up for problems in the global economy that go much deeper and have yet to be addressed. With this in mind, I remain neutral on Amphenol.
