Sensirion
Sensirion Holding AG (SENS SW) is a €1.5 billion leading manufacturer of high-quality environmental and flow sensors for the measurement and control of humidity, gas flow, liquid flow and machine diagnostics.
Originally set up in 1998 as a spin-off from the Swiss Federal Institute of Technology (ETH Zurich), SENS is headquartered in Staefa (Switzerland) and employs over 1.200 people worldwide. This is a short video of its products:
The two co-founders (Moritz Lechner and Felix Mayer) are currently co-Chairmen of the Board and still hold a ~5.5% stake each in the company; management, board members and the “Anchor shareholders group” own an additional ~30%, while the rest is free float.
Sensirion at a glance
Sensirion is a pure-play sensor company: in addition to the Swiss headquarters, it operates 11 international offices in China, Germany, Hungary, Japan, Singapore, South Korea, Taiwan, the Netherlands and the United States.
Its digital microsensors and systems are commonly found in the medical, industrial and automotive sectors, analytical instruments, consumer goods and HVAC products, for a variety of demanding applications, including those in which the sensors perform mission-critical functions.
The increasing penetration of sensors in day-to-day life is driven by several secular megatrends:
Air and water quality
Energy from hydrogen
Energy metering
Digital health
Autonomous driving
“While we have been focused primarily on the software exposure of the automation companies as the fastest growing parts of the market, the core automation businesses remain focused on hardware. For process markets, hardware continues to account for some 56%, while in discrete industries hardware accounts for 44%. This mostly comprises valves, actuators, motors, flowmeters and other sensors as well as the hardware components of the various core automation components. (Merrill Lynch: “Capital Goods Global Primer: Digital Machinations III - Partnering up”)
“A key piece of the puzzle is incorporating sensors and smart nodes into various devices to “undumb” the hardware. Sensors can be divided into multiple categories including position, action, monitoring and others. Developments in micro-electro-mechanical systems (MEMS) technology has been instrumental, by enabling manufacturers to shrink sensors down by 10x over the last 20 years to allow them to be packaged into tiny semiconductor packages. (Merrill Lynch: “Energy Efficiency Primer”)”
“The AI renaissance of the last few years has been fuelled by new machine learning techniques, which require teaching computers what to do (training), and then having the computers apply that training to complete certain tasks (inference). Training is very compute-intensive and is typically done in a data centre. However, inference is often applied in the “edge” of the network, when a decision needs to be made based on data collected at the edge. For example, in the above example of the city parking lot, the video camera footage can be augmented by sensors that capture inputs such as noise, pressure, temperature, etc., which can be analysed with the use of AI models to infer whether there is a gunshot, fire, or other emergency. (Goldman Sachs: “The ‘Outsiders’ - Emerging Ecosystems”)”
Sensirion advantage is built on its expertise across all relevant fields of the technology value chain: from the development of design and processes to calibration and application expertise. Its customers are device manufacturers who use small but precise measurement sensors in their products, with industrial applications the largest end market.
Sensirion often provides significant design support because the accuracy is very sensitive to the placement of the sensor within the device and extensive calibration is required. By being closely involved at an early stage in the development of new products with its customers, the company has a good idea of the quantities of its chips that need to be delivered in the near future. The applications that clients come up with are often of essential importance to the end customers, which means that demand turns out to be very non-cyclical in economic downturns. While Sensirion develops its own sensors from scratch and manufactures most of its products in production facilities, it has outsourced chip production to major chip manufacturers such as TSMC, but part of the testing, calibration and packaging is carried out by the company itself in Switzerland and Hungary.
Strategy
As highlighted since the IPO in 2018, Sensirion’s strategy is three-fold:
Focus 1: drive market and cost leadership in core markets (flow sensors)
Focus 2: broaden the product offering towards a full range of environmental solutions
Focus 3: expand the global operational footprint and develop technologies for longer-term growth
Focus 1: Drive technology and leadership in historic core markets
Sensirion’s first strategic focus is its traditional core market of humidity and flow sensors, aiming to further expand and strengthen its already strong leading position with regards to technology, costs and long-standing, trusting customer relationships. Volumes are a necessity in order to leverage economies of scale in both development and manufacturing.
The flow sensor market is highly fragmented, with hundreds of small/medium sized firms offering a variety of products in a wide price range. Sensirion has a high market share in certain flow application (CPAP devices and engine control): for example, the company estimates that it supplies all major CPAP (sleep apnea) manufacturers, covering more than 90% of the market. But it has also increased its penetration and market share in additional applications, such as demand-controlled and medical ventilation, gas metering and photoresist dosing. The development of new flow applications aims to address new market trends and emerging needs: examples include miniaturised flow sensors for medical smart inhalers as well as biogas and H2 in “power to gas” applications. But there are also “more than flow” new applications, such as gas concentration analysis and determination of calorific value.
The increase in market share in this segment (from 52% in 2017 to 56% in 2022) was mostly based on enabling new applications and winning customer projects from other players, in addition to entering into partnerships with former competitors. For example, in 2022 STMicroelectronics decided to close its humidity sensors business and now adopts Sensirion’s solutions, and the same thing happened previously with two other Japanese competitors. This is a chip business and higher volumes are required in order to depreciate the very high upfront R&D investments. Economies of scales are crucial, and STMicroelectronics is big in microprocessors and telecom components, but not big enough in humidity. And the cooperation is good for both companies.
This is why despite the competition and fragmentation, gross margins at Sensirion have remained very stable thanks to productivity gains and the introduction of new generation products employed in premium applications (e.g. certified temperature sensors for logging during transport of pharmaceuticals and vaccines): part of the recent success was indeed due to “capturing” pandemic-driven short-term business.
Focus 2: Become a leader in the entire environmental market
Leveraging its strong market position in humidity and flow sensing, Sensirion aims to attain market leadership in the environmental sector as a whole: there is a growing awareness of the importance of good indoor air quality and energy optimisation in the automotive, industrial and consumer markets.
While at the time of the IPO the company derived 93% of revenues from flow sensing solutions, today around 33% is from environmental sensing solutions (gas analysers, carbon dioxide, automotive models, …).
The cornerstone for this strategy lays in the successful launches of numerous new product families in the fields of CO2, particulate matter, formaldehyde and VOCs over the past few years: thanks to its extensive experience in chip design, MEMS (micro-electro-mechanical systems) and packaging, the aim is to further miniaturise the existing products, in turn enabling additional applications that are currently off-limits due to the form factor and pricing structure.
An example of the strategy is the integration of Auto Industrial Co. Ltd. (AIC), a provider of automotive sensor modules acquired in 2017 to establish a tier 1 business.
Focus 3: Develop technologies for long-term growth
The third strategic focus is a mix of internal developments and targeted acquisitions (gas analysers and gas leakage detection) to lay the foundation for long-term growth in new areas.
There are both a desire and a regulatory push that force us to measure the quality of the air around that has only increased since the COVID pandemic. Air pollution is the new tobacco, responsible for 4.2 million early deaths every year at a cost estimated to be $5.7 trillion, ~5% of global GDP; water quality is also high on the agenda for many governments and international agencies:
“Climate change, increasing water scarcity, population growth and urbanisation will pose challenges for water supply systems. […] By 2025, half of the world’s population will be living in water-stressed areas” (World Health Organisation)
This can be seen in the field of industrial applications (where sensors are used in air purification, ventilation and gas meters), in medical applications (such as ventilators and sleep apnea devices) and in the automotive market (where sensors monitor fogged windows and cabin air quality). Governments have introduced regulations that set minimum standards for air quality and ventilation in public buildings. All this explains the increasing need for sensors to meet higher measurement requirements and to bring smart solutions and applications.
As part of this strategic pillar, Sensirion completed three acquisitions in 2021 (the amounts paid have not been disclosed for any of them, as they were not material):
Qmicro (Netherlands): an innovative OEM supplier of miniaturised gas-analysis technologies
IRSweep (Switzerland): a provider of optical sensing solutions
AiSight (Germany): a supplier of scalable easy-to-use machine diagnostics solutions for the rapidly growing segment of condition monitoring and predictive maintenance for industrial plants
The company has thus entered into complementary business areas in which the focus is increasingly on qualified and merged sensor data rather than on sensor hardware for OEM suppliers.
Management: innovation is in the company’s DNA
While no longer managing the day-to-day operations (the new CEO Marc von Waldkirch is in charge since 2016), the two co-founders are still active in the company has they were on day 1.
The compensation structure for the members of the Executive Committee consists of an annual base salary, benefits and a bonus awarded in the form of restricted shares and restricted share units.
More important:
“As a result of Sensirion’s long-term business perspective based on sustainable innovation and resulting long investment cycles, common, mainly short-term-oriented, quantitative target metrics are considered inappropriate to determine the annual bonus of the members of the Executive Committee on a strictly mathematical basis. Sensirion believes that individual performance cannot be fully measured by key performance indicators only and that looking at quantitative targets only may create wrong incentives. Therefore, the major part of the compensation consists of a fixed base salary, and the variable bonus, which is based on performance criteria, only accounts for a small portion of the total compensation.” (Sensirion 2022 Annual Report)
In 2022, a record year for the company, the 6 top managers were only paid CHF 2.5 million ($2.5m) in total (and 87% was fixed compensation): definitely a very affordable amount for a company of this size, and way below remuneration for similar US companies.
Miniaturising different sensor techniques onto a single computer chip has been their big challenge from the beginning. Smaller chips are more economical to produce in large numbers (less silicon) and much easier to implement in increasingly smaller measuring equipment. SENS achieved the first success with humidity sensors: upon their introduction to the market, its sensors were often ten to fifteen times smaller than existing solutions.
Sensirion is therefore a real R&D organisation, and innovation is at the core of its past and future success: it owns more than 200 patent families, a quarter of employees (300) work in R&D and more than 20% of the total have a PhD, including at the highest level. Four out of the six board members (including the two founders) hold PhDs in Microelectronics, Physics and Theoretical Physics (and the other 2 members have Master Degrees in Microengineering and Business Administration). Also four of the six Executive Committee members have PhDs: the CEO in Electrical Engineering, the VP of Operations in Physics, the VP of Sales & Marketing in Microwave Electronics and the VP of Research & Development in Electrical Engineering.
Financial numbers
Although in activity for 20 years and already established, at the time of the IPO in 2018 Sensirion was still very much similar to many start-ups: very promising but not yet profitable, as strongly growing sales could not yet fully absorb the operating costs (in particular R&D, which very conservatively has always been charged directly to the P&L account).
Detailed financial statements are only available since the IPO, but thankfully the company provides more historical info on revenues and gross margins.
Sensirion has definitely benefited from the pandemic, which opened additional opportunities in the medical sector (ventilators) and the ramp-up of new product families (CO2, particulate matter PM2.5). This is evident in the following charts for growth, NOPAT and ROIC: 2022 has already seen the disappearance of some (but not all) of the one-off revenue from ventilators for COVID patients, so NOPAT and earnings were at the same levels as 2021.
Financially, the company is still managed conservatively. It has no debt (rather, CHF 123 million in net cash, even including leasing liabilities), development costs are taken directly as expenses in the income statement instead of being capitalised on the balance sheet, and free cash flow is largely reinvested in future growth: it doesn’t paid dividends and has only done very marginal buybacks.
The gross margin was mainly driven by additional capacity that SENS is installing in order to improve utilisation rates, not necessarily by raw materials price increases. On the contrary, the company declared that prices to customers were raised (and accepted) 3 times in 2022: these price increases could be reversed once the raw material prices come down again, this should not influence the gross margin.
A couple of years ago management said that they expect average sales growth of 15% per annum, but the humidity/temperature market segment has been more or less stagnant over the last few years due to the pandemic and geo-political tensions: growth is the near future is expected to resume but still limited to mid-single digit percent per year. And while the medical and industrial segments are still strong (+10%-15% expected underlying growth), the automotive and consumer sectors are more cyclical and have recently been weak (+3%-4% for the former and -1% for the latter). Overall, a more conservative CAGR in earnings for the medium term is probably around 10%.
“Since middle of 2022, we see also some slowdown in the market. So this is very hot space where all the customers were mainly concerned about the fact that they might get few products is old. Now the customers also started again to optimize their inventories. This is mainly seeable in the appliances and the consumer industries, not yet in automotive.” (Q4 earnings call)
Valuation
The sensor manufacturing industry is wide and includes a plethora of different players in different segments. Sensirion’s competitors range from the subsidiaries of large industrial multinationals (Honeywell International, Bosch, ABB, Schneider, Smits Group) to much smaller companies. TE Connectivity also offers a broad range of sensor solutions in the transportation, industrial applications, medical technology, energy, data communications, and the home sectors: it’s just 12% of its overall revenues, but still 3x Sensirion’s sales.
Other companies that do not offer the same exact products but could be considered similar to Sensirion are:
Landis & Gyr (non-smart and smart gas meters; heat and water meters and solutions)
Ams-OSRAM (LED, optical and image sensor solutions for automotive, consumer, and industrial end markets)
Currently, Sensirion is trading at:
P/E (2022): 23x
P/E (5Y): 45x
EV/sales (2022): 4,2x
EV/EBIT (2022): 18x
Normalised FCF yield: ~2%
Dividend yield: 0%
In 2022 organic growth was +12%, mostly driven by new products in the environmental sensing area. And while it is still benefitting from strong post-pandemic demand in its medical division, the company expects the one-time additional business in the CPAP market to normalise in the course of 2023, and therefore no further significant contributions to sales are likely.
Free cash flows were markedly down in 2022, from CHF 60 million the previous year to around CHF 20 million. This was due to two factors:
Investments in working capital: the company wanted to proactively manage its inventory of raw materials and semi-finished products just to assure service levels to customers over the next 12 months in case of shortages of supply or energy. One of the USP that the company touts is its ability to deliver seamlessly during the pandemic, and for that premium it had to invest in inventories and partially in receivables.
Investments in capex: linked to the point above, over the last 18 months Sensirion had to run its fabs in Switzerland and Hungary at an utilisation level well above 100%, which is not healthy in the long term. As they would like to come back to normal utilisation to support the next growth steps, they double capex from CHF 15 million to CHF 30 million. Going forward, capex is likely to be within 6% and 8% of sales, vs. 10% in 2022.
With around CHF 28 million coming from a one-off special demand in the CPAP medical segment, management expects 2023 revenues to be between CHF 300 million and CHF 340 million (vs. CHF 322 million in 2022), for a growth between -7% and +6% (or +2% to +16% in the core business, excluding the one-offs).
Despite the economic uncertainties, it continues to invest in growth opportunities by expanding the Sales and R&D divisions: these additional costs are not yet fully reflected in the current financial statement and the first significant revenues from new initiatives (including the recently acquired companies) will not be registered for a few years. Therefore, it expects the gross margin to normalise in the mid-50s and the core profit margin to come closer to the medium-term guidance of 17% in the coming reporting periods (both lower than 2022 numbers).
“And looking back in 2022, we won additional designs for European car manufacturers. These are not yet influencing the top line because it takes typically 2 years in order to be ready with auto production.” (Q4 earnings call)
Assuming the mid-range of the revenue guidance (CHF 320 million) and the “normalised organic” profit margin (17%), this gives core earnings (2023e) of CHF 55 million (vs CHF 64 million in 2022 but higher than the CHF 44 million in 2020), which would put the company on a forward P/E of 27x.
So I asked ChatGPT for its recommendation…
No, of course I didn’t. But let’s see how AI might have answered (these are my own conclusions, whether intelligent or not).
Does Sensirion have a strong moat? Not in the traditional interpretation, as the market is very fragmented, there are many competitors with different price ranges and the company is not the largest of the bunch. But innovation (R&D is 20% of sales) does ensures some sort of protection vs cheap copies, and Sensirion is the global market leader in its niche flow sensing solutions with a growing presence in the environmental sensing solutions.
Can it maintain the recent excellent ROIC? As this was in part due to being a Covid-beneficiary, the management has clearly acknowledged that margins, profitability and absolute profits/cash flows will normalise to lower levels in the next few periods, but still within long-term guidance.
Will earnings/cash flows be higher in 5-10 years? Most likely yes, although growth will be neither linear (=guaranteed) nor parabolic. As explained above, the costs for the new growth initiatives are going into the annual numbers immediately, but the benefits are not going to materialise for a few more periods (if they ever will, of course).
So the question is how much we are paying today for those profits and how much could the market value them in 5-10 years. It's not a value play, I’d rather classify it as a Growth at a Reasonable Price story, although its PEG ratio will not appear on top in a pure GARP screening.
The boost from Covid is receding (but not disappearing) and some end markets are slowing down, but Sensirion is not a “one-hit-wonder” that is likely to fade. It’s not extremely expensive and any “extra” (higher revenue/earnings from the growth initiatives) would be the icing on the cake.
Very good write-up. Liked the ChatGPT joke at the very end. :-)
Vey good write up... Remember in circa 2005 buying mems gyro from Honeywell... Were leader in mems at the time ... Not sure now how sensirion is positioned vs Honeywell or Bosh