CTS Corp.: A Cyclical Recovery Play With Secular Upside Potential
Summary
- CTS appears to be on track for a cyclical recovery amid positive near-term trends in transportation.
- The cautious guidance numbers also leave room for an upside surprise in the upcoming quarters.
- Longer term, CTS's components portfolio should allow it to benefit from secular tailwinds, along with accretive M&A.
- Following the recent correction, shares are very reasonably priced relative to the growth potential.
Buoyed by near-term transportation tailwinds, CTS Corp. (NYSE:CTS) appears poised for upside into the upcoming quarters. Not only was the magnitude of the recent quarterly beat greater than anticipated by consensus, but the conservative fiscal 2021 guidance also leaves room for an upside surprise. With longer-term trends also positive, plenty of M&A-related opportunities ahead, and the multiple de-rating to c. 10x EV/EBITDA (a discount to historical levels), I am positive about the CTS story.
Positive Transportation End-Market Dynamics
CTS's recent end-market performance may have been mixed, but the outperformance of transportation is a key bright spot. To recap, quarterly revenue increased 7% Y/Y, mainly on the back of transportation revenue growth of +12% Y/Y, with non-transportation revenue growth flat Y/Y. The strength in CTS's transportation business serves as a testament to the ongoing post-Covid-19 economic recovery, with its facilities currently running at a peak capacity of 85-100%.
Perhaps more importantly, the company also added four new customers in the recent quarter, including three global OEMs and one North American electric truck OEM. Furthermore, with an implied c. 20% of total new transportation business wins dedicated to fast-growing EV applications, there is plenty of growth potential here. My base-case scenario calls for more near-term strength, in-line with management expectations for global production to improve Y/Y in the US, Europe, and Asia as Covid-19 restrictions are lifted and operating conditions normalize.
Source: CTS Investor Presentation Slides (Feb 2021)
A Recovering North American Auto Cycle Boosts the Near-Term Outlook
The latest North American order data indicates that monthly Class 8 truck orders have been outperforming into year-end, with November orders already reaching pre-pandemic levels. Looking ahead, the recovery looks set to pick up, with current ACT Research forecasts calling for US Class 8 retail sales to rise further in the upcoming year. This seems reasonable to me, considering both the vaccine rollout and recent strength in the freight market. Similar to the positive trend seen in the commercial truck market, January 2021 data also indicates considerable Y/Y growth in trailer orders.
Source: Fleet Equipment Magazine
This strength looks likely to extend into the light vehicle market as well – the demand environment in H2 '20 has been on the recovery, with US SAAR now back in the c. 15-16 million range. This compares favorably to pre-pandemic levels around the 17 million level. On the back of auto demand trends that appear to be sustainable heading into fiscal 2021, CTS looks set to be a key beneficiary as a transportation supplier with exposure across most end-markets.
Cautious Guidance Embeds Some Healthy Conservatism
Notably, CTS's guidance numbers for the overall business fell slightly short in March, with revenue in fiscal 2021 projected at $460 million at the midpoint (short of consensus top-line estimates of c. $480 million). EPS was, however, in line at c. $1.40/share. Nonetheless, I think the guidance numbers could prove conservative assuming demand trends in transportation remain strong through the year. While the lack of bookings disclosure this quarter makes it slightly more difficult to gauge the shape of the near-term auto trajectory, industry trends (as highlighted in the previous paragraph) seem to confirm management's positive commentary around growing commercial vehicle bookings and e-commerce-led demand tailwinds for vehicle sales.
Source: CTS Investor Presentation Slides (Feb 2021)
Beyond growth, however, there will likely be some reversal of temporary COVID-19 cost measures, which could impact the P&L. Nonetheless, the key driver remains the pace of the volume ramp-up, with profitability improvement also likely on the back of the implementation of the restructuring program (announced last year). With the restructuring on track, the targeted c. 22-26c in gross EPS benefit remains intact and should support profitable growth in the near term, building on the EPS improvement generated in fiscal 2020.
M&A-Led Structural Improvements to Drive Buildout of the Sensor Portfolio
Thinking longer-term, CTS is especially well-positioned to benefit from electrification and passive safety tailwinds within key end-markets like the automotive and industrial fields. Much of the credit goes to management for this – over the last few years, CTS has actively divested non-core businesses to significantly improve its operating margin profile. In addition, key capital allocation decisions like reinvesting in tech IP and the acquisition of complementary assets like strategic sensors and ceramic piezoelectric components have paid off.
Source: CTS Investor Presentation Slides (Feb 2021)
As such, I expect any organic growth initiatives to be accompanied by accretive M&A, underpinning CTS's longer-term revenue target of c. 10%. The focus will likely be on building out the sensor portfolio, which has most recently benefited from the acquisition of Sensor Scientific last year and QTI in fiscal 2019, both of which broaden its reach in the medical and industrial fields. These new additions should allow CTS to outgrow the broader component market with double-digit % gains likely going forward.
Final Take
Overall, I think CTS's rich portfolio across sensors, actuators, and piezoelectric components leaves the company positioned to benefit from growth in the industrial Internet-of-Things and intelligent products areas going forward. With the company levered to some of the fastest-growing product segments and secular trends in the space, my longer-term view remains bullish.
Near term, the outlook looks positive as well, with cyclical tailwinds and conservative guidance likely to drive an upside surprise in the upcoming quarters. With current valuations reasonable relative to historical levels and plenty of M&A opportunities considering the robust acquisition pipeline and net cash position, I am bullish.
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