TE Connectivity Earnings: Harsh Environments a Boon for the Company

TE Connectivity (TEL 0.34%), the market leader in the connector industry, reported solid third-quarter earnings on July 23. Revenue growth was driven by the strong performance of the transportation and industrial segments, and both gross margin and operating margin rose year over year. Here's a deeper look into the company's results.

Earnings rundown

TE Connectivity's results were largely what analysts were expecting, with the company edging out EPS estimates and coming up slightly short of revenue expectations:

Gross margin rose 80 basis points year over year, while adjusted operating margin jumped 60 basis points. This improved profitability was driven by growth in the high-margin transportation and industrial segments.

 Source: TE Connectivity

TE Connectivity's guidance for the fourth quarter includes year-over-year revenue growth between 4%-7%, adjusted EPS growth of between 5%-10%, and continued strong growth in both the transportation and the industrial segments.

What worked and what didn't

The double-digit growth in TE Connectivity's transportation segment was driven by strong demand for automobiles. In 2013, global automobile sales reached a record 82.8 million units, and HIS automotive expects unit sales to reach 85 million this year and 100 million by 2018, driven by rising demand in emerging markets.

This strong growth, along with automobiles increasingly becoming computerized, with in-car displays and driver-assistance features, should lead to the market for TE Connectivity's automotive products to continue to grow rapidly going forward. Transportation is the most important part of TE Connectivity's business, both from a revenue and profitability perspective, and there's no sign that it's slowing down.

One weak spot for TE Connectivity was network solutions. The segment declined by 8% year over year, driven by declines in all four businesses within the segment, particularly a 50% decline in subsea communications. Telecom networks were weak in Asia, enterprise networks were weak in Europe, and data communications were weak in general.

Corning (GLW -0.54%), a company that competes with TE Connectivity in some areas of the network solutions segment, seems to be performing quite a bit better. During Corning's most recent quarter, the company's optical communications segment grew by 14% year over year, driven by strong demand for its fiber-based solutions. TE Connectivity also offers fiber-based products, but its results were very different.

Solid execution

TE Connectivity has been moving toward focusing more heavily on businesses that service harsh environments, where its products would be subjected to extreme temperatures or vibrations. Automotive is one example, and 70% of TE Connectivity's revenue is now derived from harsh environment markets.

These types of products are often customized for each customer and involve a high level of engineering, and this plays directly into TE Connectivity's strengths. Along with the transportation and industrial segments, which carry operating margins in excess of 20% and 15% respectively, TE Connectivity recently acquired two companies, SEACON Group and Measurement Specialties, which will further increase the company's focus on harsh environments. SEACON expands TE Connectivity's scale in the oil and gas markets, and Measurement Specialties increases the company's presence in the sensors business.

Key takeaway

While parts of TE Connectivity's business didn't perform all that well, the shift to harsh environment markets is playing out, and that should lead to continued revenue and margin growth going forward. The transportation and industrial segments, which collectively account for the bulk of operating profit, are both growing strongly, and acquisitions are allowing TE Connectivity to expand its presence in other markets. This will allow earnings growth to outpace revenue growth going forward, and that's good news for investors.