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Friday, October 20, 2006

Amphenol on a Roll

By William Trent, CFA of Stock Market Beat

Shares of electronic component producer Amphenol (APH) soared yesterday after the company reported solid results. After reviewing the company’s earnings release and conference call, we had the following observations.

On their conference call, management noted that profits had improved in their cable business:
From a segment standpoint, in the cable segment margins increased to 12.4%, up 70 basis points from last year and 50 basis point sequentially from 2Q. Margins in this segment have been under a significant pressure as a result of increases in material and trade related costs driven by higher commodity and energy prices. The company has implemented multiple price increases in both 2005 and 2006 that have collectively begun to bring up margins in this segment.

The company had been implementing price hikes along the way as copper and energy prices soared (both are crucial inputs for the cable segment.) However, there is a lag between when the company sees rising costs and when they can be fully passed along to customers. Margins were hurting during that lag time. Given the recent decline in energy prices and stabilization of copper prices, the company’s price increases appear to be catching up with costs. However, it is worth noting that costs could quickly swing the other way again. Given our beliefs on the direction of future commodity prices, we view these margin gains as temporary.

Operationally, however, the company continues to manage things well. The company came public following a leveraged buyout, and has diligently reduced its debt load since then. If they can continue to do so even while making additional acquisitions it is quite possible they will receive upgraded credit ratings in the near future.

Here is management’s breakdown of this quarter’s sources and uses of cash flow:
The cash flow from operations along with 6 million of proceeds from the exercise of stock options were used to fund 24 million in capital expenditures, 13 million of stock buyback, 2.7 million in dividend payments, a debt reduction of 19 million, and an increase in cash on hand of approximately $17 million.

Finally, Amphenol also doesn’t seem to be experiencing the same degree of slowdown in their wireless end markets as have been seen by some other firms.

In response to a question about this, management said:
We just feel that there are still tremendous opportunities out there. I always say that there is about half of the world connect to market available to us because it’s essentially covered by many small companies that do not have our global presence, small companies that do not have our leading product and manufacturing technology. They do not have the cost levels that are required to compete on a global basis. So there is tremendous opportunity still to gain, and therefore we will certainly be undertaking – undergo any fluctuations that are there in the demand. But we can obviously continue to mitigate those fluctuations with our own undertakings to gain positions in emerging markets, in new segments of the business and so forth, and that is clearly our intent.

The author may hold a position in the securities discussed. A current list of the author's holdings is available here.

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