Earnings Call Transcript - ST Q2 2023

Operator, Operator

Good day and welcome to Sensata Technologies Q2 2023 Earnings Call. Please note, this event is being recorded. I now will turn the conference over to Mr. Jacob Sayer, Vice President of Finance. Please go ahead.

Jacob Sayer, Vice President of Finance

Thank you, Keith and good morning, everybody. I'd like to welcome you to Sensata's second quarter 2023 earnings conference call. Joining me on today's call are Jeff Cote, Sensata's CEO and President; and Paul Vasington, Sensata's Chief Financial Officer. In addition to the financial results press release we issued earlier today; we will be referencing a slide presentation during today's conference call. The PDF of this presentation can be downloaded from Sensata's Investor Relations website. This conference call is being recorded and we will post a replay webcast on our Investor Relations website shortly after the conclusion of today's call. As we begin, I'd like to reference Sensata's Safe Harbor statement on Slide 2. During this conference call, we will make forward-looking statements regarding future events or the financial performance of the company that involve risks and uncertainties. The company's actual results may differ materially from the projections described in such statements. Factors that might cause such differences include but are not limited to, those discussed in our Forms 10-Q and 10-K as well as other subsequent filings with the SEC. We encourage you to review our GAAP financial statements in addition to today's presentation. Most of the information that we will discuss during today's call will relate to non-GAAP financial measures. Our GAAP and non-GAAP financials, including reconciliations, are included in our earnings release and in the appendices of our presentation materials. The company provides details of its segment operating income on Slides 7 and 8 of the presentation which are the primary measures management uses to evaluate the performance of the business. Jeff will begin today with highlights of our business results during the second quarter. He will then provide a few updates on exciting electrification product launches. Paul will cover our detailed financials for the second quarter, updates on capital deployment and he will discuss our financial guidance for the third quarter of 2023. We'll then take your questions after our prepared remarks. Now, I'd like to turn the call over to Sensata's CEO and President, Jeff Cote.

Jeff Cote, CEO and President

Thank you, Jacob and welcome, everyone. I'll start with some summary thoughts on our robust performance during the second quarter, as outlined on Slide 3. During the second quarter, we produced a record $1,062 million in revenue, up 4.1% from the prior year period and above our guidance range despite a 140 basis point headwind from foreign currency. Adjusted operating income of $206 million was at the top end of our range. Adjusted operating income margins increased by 40 basis points from the prior year period or 110 basis points on a constant currency basis as we continue to focus on improving our margins. Adjusted net income moved higher by 15% to $149 million and adjusted earnings per share grew 17% from the prior period or 23% on a constant currency basis to a record $0.97. Our customers' supply chain shows meaningful signs of returning to normal. Consequently, we believe customers reduced channel inventory to better align material on hand with their production. We estimate this impact was approximately $20 million or 200 basis points across the company in the second quarter, concentrated in automotive and heavy vehicle off-road. Taking that into account, market outgrowth for the last 12 months remained within our target range of approximately 535 basis points. As we've said, outgrowth can be lumpy in any quarter and the second quarter results continue to be impacted by electric vehicle launch schedules. We remain confident in our long-term outgrowth range given our business wins, new product development activities and future launch schedules. Outgrowth market since the beginning of 2020 has averaged 735 basis points. I'm also pleased that we remain on track to achieve our long-term goal of $2 billion in electrification revenue across the company by 2026, with that revenue growing strongly in the second quarter. In a moment, I will outline exciting new product launches that will help further propel that growth. At the beginning of 2023, we outlined a shift in our capital deployment strategy based upon our confidence in our capabilities to effectively intersect the electrification growth vector and deliver innovative solutions to our customers. We continue to execute that strategy during the second quarter, removing variable rate debt from our balance sheet and returning capital to shareholders in the form of debt repayments, the dividend and share repurchases. Considering current interest rate trends, that decision has made strong business sense. Our capital allocation strategy reduces risk in our capital structure, lowers interest expense, improves adjusted net income and earnings per share as well as return on invested capital. The end market Sensata serves is expected to experience significant change over the next 10 years as our customers transform their businesses and product portfolios to adjust to decarbonization trends. Electrification will impact all the end markets we serve. And as we have done repeatedly over our history, we've adapted to market trends. Sensata is focused on continually innovating to help customers solve their mission-critical, hard-to-do engineering challenges on this path toward electrification. As shown on Slide 4, I'd like to share some thoughts on new products that will help drive our electrification revenue going forward. In renewable power generation, solar energy developers and others are poised to benefit from global initiatives to decarbonize sources of energy, including last year's Inflation Reduction Act in the United States which provides significant long-term funding to this industry. To address a key need for this industry, we are launching a fifth-generation line of inverters that contain 3x the power density of its predecessor, creating a highly attractive value proposition for customers. These products which are launching this quarter are designed to enable new solar and other renewable energy installations to connect seamlessly to the electricity grid. Serving the needs of these installations represents a fast-growing $2.5 billion addressable market for Sensata. In addition, we have launched a new battery management system to help address the electrification needs of material handling, work truck, and bus OEMs. The BMS is an intelligent component of the battery pack, responsible for advanced monitoring and management of current. Think of it as the brain behind the battery. It plays a critical role in assessing the battery safety, performance, charge rates and longevity. Sensata's N3 battery management system is ASIL-C and ISO certified off-the-shelf and offers software flexibility, thus reducing development time and cost for customers. These battery management systems seamlessly manage the very high power requirements that OEMs face and represent a $350 million addressable market by 2028.

Paul Vasington, Chief Financial Officer

Thank you, Jeff. Key highlights for the second quarter, as shown on Slide 6, include: record revenue of $1,062 million, an increase of 4.1% from the second quarter of 2022. Revenue growth reflected market growth of approximately 2.5%, inventory contraction of approximately 2% and market outgrowth of approximately 2.9% as well as the net impact of acquisitions and divestitures in the quarter, partially offset by foreign currency headwinds. Adjusted operating income was $206 million, an increase of 6.2% compared to the second quarter of 2022. This increase was primarily due to higher volume, pricing, and productivity improvements, partially offset by the impact from acquisitions and divestitures last year and the unfavorable movements in foreign currencies. Adjusted operating margins improved 110 basis points from the prior year period on a constant currency basis due to operational improvements within the business. This represents very strong 39% incremental margins on a constant currency basis and over 80% incremental margins organically. Record adjusted earnings per share of $0.97 in the second quarter grew 17% from the prior year quarter, faster than adjusted operating income due to lower interest expense, a lower cash tax rate and a lower share count. On a constant currency basis, adjusted earnings per share would have been $1.02, representing 23% growth from the prior year period. Now, I'd like to comment on the performance of our 2 business segments in the second quarter of 2023, starting with Performance Sensing on Slide 7. Our Performance Sensing business reported revenues of $757.4 million, an increase of 3.5% compared to the same quarter last year. Automotive revenue increased due to market growth, content launches and higher pricing, partially offset by the unfavorable revenue mix, inventory destocking, slow new product launch ramps, and foreign currency. Growth in heavy vehicle off-road revenue reflects market and content growth, partially offset by inventory destocking and unfavorable foreign currency. Performance Sensing operating income was $191.1 million, with operating margins of 25.2%. Segment operating margins increased year-over-year, largely due to improved pricing, higher volumes, and productivity, partially offset by unfavorable foreign currency. Excluding the foreign currency impact, Performance Sensing operating margin would have been 26%. At the start of the quarter, Sensata moved the reporting of certain material handling products from heavy vehicle off-road in performance sensing to industrial and sensing solutions to reflect changes in our reporting structure. Prior periods have been restated to reflect this change. As shown on Slide 8, Sensing Solutions reported revenues of $304.7 million in the second quarter, an increase of 5.5% as compared to the same quarter last year. Industrial revenue increased due to strong acquired revenue growth in electrification, offset somewhat by weaker markets especially in HVAC and appliance and unfavorable foreign currency. Aerospace revenue increased strongly in the quarter due to market, pricing, and content growth. Sensing Solutions operating income was $84.2 million with operating margins of 27.6%. The decrease in segment operating margin was primarily due to the net margin impact of acquisitions and divestitures of 400 basis points. Excluding the foreign currency impact, Sensing Solutions operating margins would have remained the same at 27.6%. On Slide 9, corporate and other operating expenses not included in segment operating income were $81.5 million in the second quarter of 2023. Adjusted for charges excluded from our non-GAAP results, corporate and other costs were $68.1 million, a decrease from the prior year quarter primarily reflecting cost controls and lower incentive compensation. We expect to invest $60 million to $70 million in Megatrend-related research and development this year to design and develop differentiated solutions to address trends impacting our customers' businesses. New business wins are a leading indicator of future outgrowth to market. Given the long cycle nature of our business, new business wins are tied to trends in our end markets and our best view on a multiyear basis. We expect to sign approximately $600 million to $800 million of new business wins this year, representing a 3-year average of nearly $800 million, a substantial increase from prior period averages. Moving to Slide 10, our capital deployment strategy and steadily improving returns to shareholders. As indicated by our improving return on investment capital of 9.8%, up 50 basis points from the end of 2022. We generated $68 million in free cash flow during the second quarter, up substantially from the prior year period and $371 million in free cash flow over the last 12 months, representing 65% conversion of adjusted net income. For the full year 2023, we expect free cash flow conversion to be approximately 75% of adjusted net income, consistent with Sensata's long-term average. Capital expenditures are expected to be in the range of $170 million to $180 million for 2023. We paid down the balance of our outstanding variable rate term loan during the second quarter. Our net leverage ratio was 3.2x at the end of June 2023 and we expect this to decline to below 2.5x by the end of 2025, primarily through strong free cash flow generation. During the quarter, we returned $25 million to shareholders in the form of share repurchases. In addition, we recently announced our Q3 quarterly dividend of $0.12 per share that is expected to be paid on August 23 to shareholders of record on August 9. We are providing financial guidance for the third quarter of 2023, as shown on Slide 11. Our expectations are based upon the end market growth outlook shown on the right side of this page. We are aligned with IHS estimates for automotive production on a Sensata revenue-weighted basis. Foreign exchange represents an expected $6 million headwind to revenue, a 90 basis point headwind to adjusted operating margin and a $0.03 headwind to adjusted EPS in the third quarter. Excluding the impact of FX, adjusted operating income margin expectations for the third quarter represents a 60 basis point improvement from the prior year period. Our current fill rate is approximately 90% of the revenue guidance midpoint for the third quarter. This is consistent with fill levels we experienced pre-pandemic and represent a return to normalcy of customers' supply chain dynamics. Looking to the full year 2023, we now expect foreign exchange to be a $49 million headwind to revenue and a $0.20 headwind to adjusted earnings per share given term exchange rates.

Jeff Cote, CEO and President

Thank you, Paul. Let me wrap up with a few key messages as outlined on Slide 12. Sensata's business, organizational model and growth strategy are strong, resilient and validated as we deliver mission-critical, highly engineered solutions required by our customers. While end markets are expected to remain volatile due to inflation, higher interest rates, the risk of recession in various geographies, and geopolitical events, Sensata's strong management team provides proven experience in navigating choppy markets. We continue to execute on our growth initiatives as we transform the business to focus on rapid growth opportunities across all the end markets we serve. We are making excellent progress in electrification as demonstrated by strong new business wins and significant revenue growth. Our success in driving this transformation allows us to focus now on strengthening our financial returns through improved margins, stronger free cash flow, and higher returns on invested capital. As shown by the examples I discussed today, we continue to innovate for our customers, solving their difficult engineering challenges in providing differentiated solutions to a widening array of customers, while specifically leveraging our expanding electrification product set. Solving mission-critical challenges enable Sensata to earn long-term customer trust as demonstrated by our expected $600 million to $800 million in new business wins this year and by delivering industry-leading margins for our shareholders. I'm pleased with our progress in delivering on Sensata's long-standing vision to help create a cleaner, safer, more electrified and connected world, not just for our customers' products but also through our own operations, we strive to meaningfully contribute to a better world. We are making good progress on achieving our ESG targets and I encourage you to read our latest sustainability report which describes the long-term sustainability and success of the company for all of its stakeholders. And finally, I'm very excited about sharing our innovation path and strategy and an investor event in New York City on September 27. You can find more details on our website regarding that event. Now, I'll turn the call back over to Jacob.

Jacob Sayer, Vice President of Finance

Thank you, Jeff. We'll now move to Q&A. Keith, would you please introduce the first question?

Operator, Operator

And this morning's first question comes from Wamsi Mohan with Bank of America.

Wamsi Mohan, Analyst

Jeff, your outgrowth in the first half is well below your long-term outgrowth. As you look over the next 12 months, can you talk about some of the puts and takes? And do you expect if inventory will still continue to be an overhang as it was 200 basis points in this quarter? And what are maybe some of the drivers that you think could possibly reverse over the next 12 months, particularly on outgrowth? And if I could, one for Paul as well. On the margin front, you had very, very strong incremental margins in the quarter that you noted. How should we think about the sustainability of these very strong incremental margins?

Jeff Cote, CEO and President

Great. Thanks, Wamsi. So we discussed last quarter the expectation regarding outgrowth in the first half of this year given some well-publicized delays around some electrification platforms that we're on. But again, we want to emphasize outgrowth and new business opportunities for that matter as indicators of long-term success. So we have no concerns regarding our long-term growth. We're very comfortable with the 400 to 600 range of outgrowth. The last year, last 12 months, it's been 535 basis points. The last 3 years, a little more than 3 years, it's been 735 basis points. So I would encourage all to look at that as a long-term measure, not to look at an individual quarter in terms of the outgrowth. There are puts and takes regarding the launches mix of business and so forth that will impact that on our short-term measures. So I don't want it to confuse the view around secular long-term growth that we're very confident in and we're sharing with investors the indicators around new business wins that will support that long term. Regarding the inventory question, the couple of end markets where we're able to understand what inventory is or at least we have a model that we believe gives us a view into inventories around the automotive market during the second quarter, about $20 million that would lead us to believe there's still about $20 million. But it's getting to the point, Wamsi, where it's not a meaningful portion of inventory. We do really feel as though the order patterns from our customers and their inventory planning process is getting back to normal. I would credit that to not only changing market dynamics but also how Sensata has served that market. If we are successful in delivering to our customers when they ask it, they'll get back to more normal order patterns and they won't carry extra inventory. So we're seeing that for sure and I wouldn't expect it to be meaningful but we'll continue to call out if we see inventory takeout in the system that we believe is happening or build in the system just to provide that level of transparency. But again, it's not a meaningful impact.

Paul Vasington, Chief Financial Officer

Wamsi, it's Paul. So as we said, our cost structure as it stands today has the capacity to serve more volume. And so you're seeing that in the incremental margins this quarter where we were getting some better volumes. We're able to convert that at a higher contribution rate. And for the foreseeable future, that's the kind of leverage I would expect until we get to a point where we need to start adding capacity to support incremental growth. But that would be the expectation, at least for the foreseeable future in terms of what we should convert incremental volume at in that 35% to 40% range.

Operator, Operator

And the next question comes from Mark Delaney with Goldman Sachs.

Mark Delaney, Analyst

Your revenue guidance assumes the auto end market is down 5% year-on-year in 3Q. I believe you said you're assuming something similar to IHS. But maybe you could elaborate a bit more on what you're seeing by end market from by region from your customers? And are you specifically trying to incorporate a strike in North America later in 3Q as part of your outlook?

Jeff Cote, CEO and President

Thank you for your question, Mark. You made some valid points. The guidance of $1 billion at our midpoint suggests a decrease of about 5.5% to 5.8% from Q2 2023. This reflects a return to more typical seasonality for our business. Looking back at 2018 and 2019, we experienced a 4% to 6% decline from Q2 to Q3, which was consistent with normal seasonal trends. Therefore, I see this decline as a sign of a return to normalcy, especially since the past few years have been quite atypical. Additionally, we anticipate a 2% decrease compared to Q3 of last year, largely attributed to market conditions. Overall, our market estimates indicate a 5.5% drop from Q3 last year to this year. There's also about a 60 basis point negative impact due to foreign exchange rates, which explains the expectation for a year-over-year revenue decrease on a quarterly basis. As for individual markets, we are currently aligned with IHS regarding production levels, which predicts a 4% decline in the auto sector. Our numbers reflect a 5% drop after factoring in the impact and mix of our business, which is consistent with their forecast. Year-over-year, we see HVOR recovering a few hundred basis points, suggesting an increase of 4% or 5%. On the other hand, the industrial sector is seeing significant declines. Key indicators here are the PMI metrics globally, and we have a notable presence in HVAC, major home appliances, and lighting, all of which have shown continuous decline, similar to what we witnessed in Q2. I hope this gives you a clearer picture.

Mark Delaney, Analyst

Yes, that's helpful. I mean and then just specifically around the potential UAW strike in North America, I mean is that something you try to incorporate at all within the range of guidance? Or just any more color on how you're thinking about that potential headwind in 3Q, if that does, in fact, come to fruition?

Jeff Cote, CEO and President

Thank you for your question. We are closely monitoring the situation. Our customers indicate that there may be an impact in late Q3 or early Q4. However, we haven't observed any order patterns suggesting that anyone is preparing for this potential issue, although it is being watched closely. This situation is not factored into our guidance. If there is a near-term impact, it will affect our revenue in line with overall production levels influenced by this development. We are hopeful for a positive resolution, but we are keeping a close eye on it, and it is not included in our $1 billion midpoint guidance range.

Jacob Sayer, Vice President of Finance

Thanks, Mark, for the question.

Operator, Operator

And the next question comes from Matt Sheerin with Stifel.

Matt Sheerin, Analyst

Yes. I'm hoping you can update us on pricing trends. It looks like it's been a tailwind for the last couple of quarters less so in the coming quarter. So what's happening there in terms of pricing, particularly in the auto market?

Paul Vasington, Chief Financial Officer

So we continue to get positive pricing. It continues to more than offset the inflationary conditions around material prices that we've been experiencing for the last couple of years. So it continues to be a positive to revenue and profitability. Now we are now going to start comparing to more difficult comps. So the absolute increase quarter-over-quarter will be more challenging but we're still positive on the pricing side.

Matt Sheerin, Analyst

Okay, great. And Jeff, could you update us on insights, the telematics business? I know you made a lot of investments there. Could you give us an update on the business and the traction you're seeing?

Jeff Cote, CEO and President

Yes, absolutely. So remember that the premise here is that the telematics ecosystem broadly, logistics and supply chains benefit from more information. It makes their systems and their processes more efficient and safe. And we have a lot of sensors that can bring data to that. Our acquisitions have been around collecting that sensor data, equipping it to the cloud in some instances, analyzing it, and feeding it to customer fleet management systems. Continued positive trends in terms of what we see in terms of the opportunity there. But the reality is it's a $180 million business. It's going to grow very nicely but it's become increasingly clear as a company that our future is electrification. We'll continue to focus on insights as we will continue to focus on safe and efficient applications in other powertrains but the future in terms of the trend and the acceleration of the trend associated with electrification is the area that we really need to be investing. Our Megatrend investments have been disproportionately in the electrification area for some time now and we'll continue to invest in insights as a growth vector but electrification is the future of the company given where our customers are going.

Operator, Operator

The next question comes from Christopher Glynn with Oppenheimer.

Christopher Glynn, Analyst

Any comments or expectations, aspirations around the market capture you see Sensata able to harness for the Compact Power 5?

Jeff Cote, CEO and President

So on the inverter side, is that what you're referring to, Chris?

Christopher Glynn, Analyst

Yes, Jeff.

Jeff Cote, CEO and President

Yes. So recall last July, we acquired Dynapower which was an industrial-grade inverter converter business serving that market. The business has performed very well and we're really excited about the opportunity here associated with these new product launches that will really play well in terms of the overall market. It is a large market. There are some very niche areas that Dynapower is focused on associated with defense-related applications but also hydrogen and other applications where we have targeted as being meaningful opportunities for us. And I think if you follow sort of the trends associated with renewable energy, those are areas that will continue to see very strong investment from governments around the world. So we feel great about that and we're going to continue to make sure that we execute on market to bring that. This is part of our electrification strategy. I think that most tend to think of Sensata as a component play with OEMs, this is building on our view that with the electrification of all this equipment, there will need to be significant and considerable investment around grid hardening associated with the global infrastructure and Dynapower as well as, if you recall, lithium balance around battery management and other applications, that's our play in that area. And so we're feeling really positive about it.

Operator, Operator

And the next question comes from Luke Junk with Baird.

Luke Junk, Analyst

I just want to circle back on auto trends. And if you could just maybe help us understand the magnitude, at least on a relative basis of the auto headwinds you saw this quarter. So I'm thinking channel inventory destocking, you called that out as 200 bps overall. And maybe if you could comment on auto specifically plus the adverse mix and launch delays. Are those latter to similar? Or is there 1 of those factors that's having a more meaningful impact? And then as we look to 3Q and beyond, just how sticky each of those might or might not be?

Jeff Cote, CEO and President

Yes, absolutely. So we're not anticipating more channel destocking in our guide right now. So it's largely driven by the overall market. IHS forecast production to be down 4% in the third quarter versus third quarter of last year. That's going to come largely in China. So China is expected to be the 1 that's down the most. And so we're pretty much mirroring the impact associated with that. So that's the big driver in terms of really auto decline year-over-year and quarter-over-quarter but also the company, given the fact that 50% of our business is automotive. So that's where we're seeing the largest impact on that book.

Luke Junk, Analyst

Just if I could clarify the adverse mix and the launch delays, to what extent are those reflected or not reflected in the third quarter outlook, Jeff?

Jeff Cote, CEO and President

They are definitely accounted for in the guidance. We feel confident in maintaining the 400 to 600 range over the past year, although we acknowledge that some of that mix will continue to negatively affect the overall growth in the current quarter. However, keep in mind that when those product launches return, it will create an opportunity for growth. If something shifts out of a quarter or the first half of the year, our customers will eventually need to address that, creating overlap with other opportunities we are expecting. Therefore, it's not a loss of revenue, but rather deferred revenue that we need to consider in our overall guidance. We expect it to start increasing in the second half of the year, similar to the transition from the first quarter to the second quarter. However, we do continue to see some delays on that front.

Operator, Operator

And the next question comes from Evercore.

Unidentified Analyst, Analyst

I would like to inquire about the path to achieving 21% margins. I understand this is a long-term goal, but I want to know what the key factors will be to move from the current 19%. You mentioned volume previously, but any additional insights would be appreciated. I also want to ask if you are noticing any relief from commodity and flat costs decreasing, which could serve as a positive factor.

Paul Vasington, Chief Financial Officer

Let me test the second part of that.

Jeff Cote, CEO and President

Commodity prices.

Paul Vasington, Chief Financial Officer

So I guess there's 2 things. One, we've been very prescriptive about the impact that currency is having year-over-year for benchmarking ourselves to a 21% margin that we've demonstrated in the past. If you adjust for currency, with 110 basis points headwind in the second quarter. And then just to be consistent with what we've done in the past, volume will be the largest driver of our margin increase over time. We're I think executing well on the pricing inflation dynamic. We're managing our cost structure very efficiently as the volumes start to come back, particularly in businesses like our industrial business, we'll see very, very significant incremental margins, as I mentioned earlier, that would be the thing that would drive us towards 21%.

Jeff Cote, CEO and President

Yes. Just to add to what Paul mentioned, I want to stress that our third quarter guidance is expected to be in the 20s on a constant currency basis. While volume is the largest factor impacting margins, foreign exchange also significantly affects our margin profile, which is beyond our control. On the supply chain front, we're beginning to see supply chain challenges ease considerably, and this is quite broad-based. However, we have long-term relationships with our customers, which means we also have a long-term structure with our supply chain. Therefore, even when supply chains normalize, we won't see an immediate effect on pricing from the supply side, but this is an area where we excel. We have shown over decades that once we reach a more normalized operating environment, we can deliver significant productivity in our overall cost structure, positively influencing the business's margin profile. For the past three years, our productivity has been significantly challenged by year-over-year inflation. In 2023, we expect continued inflation in our cost of goods sold. However, we hope to start reducing that cost curve moving into 2024 and 2025, aiming to return to a more regular business model of productivity both quarter-over-quarter and year-over-year. Thank you for the question.

Operator, Operator

And the last question comes from Shreyas Patil with Wolfe Research.

Shreyas Patil, Analyst

Yes, maybe just following up on 1 of the other questions earlier. So Q3, you're guiding to 20% margin ex currency. We are seeing auto production improving some of the industrial end market headwinds that you're experiencing at the moment are potentially going to moderate as we look out to next year. And so clearly, the volume should be a tailwind as you get back to 21% margin. But just maybe on this topic of supply chain, how do we think about when that starts to benefit the business? And are there any other puts and takes to think about as we look towards that 21% margin level?

Jeff Cote, CEO and President

Yes. I'll give it a go and Paul can add or correct me if I'm off. We're seeing improvements in our cost structure related to inflation and productivity. Looking back at 2021 and 2022, we faced significant negative productivity impacts, but that's decreasing in 2023. As I mentioned before, we expect this trend to continue into 2024. The volume in the third quarter is notably down, and from a margin perspective, constant currency will hit 20%, indicating improvement despite facing foreign exchange challenges and a drop in overall volume affecting margins. We are still striving toward our profitability targets, but the ongoing factors, including the decline in volume from the second to the third quarter and the margin pressures tied to foreign exchange, are making it take longer to reach our goals.

Operator, Operator

And the last question comes from Joe Giordano with TD Cowen.

Joe Giordano, Analyst

Can you talk about China specifically in the quarter? I know last quarter, like the mix was unfavorable given where the production was coming from. And I know this quarter, Tesla had a big production in China. So can you talk about how that looked and what you guys did? And maybe comment about the structural dynamics in China and like how you see that playing out, like who's going to take share and like what the opportunity is for you at those players?

Jeff Cote, CEO and President

Yes, certainly. We recently made a trip to China in May, which was our first visit as a management team in three years. China has always been a fast-moving market, and that pace accelerated during COVID. Maintaining our presence there is crucial, and it's essential that we continue to enhance our engagement with customers like BYD, which has shifted its focus from succeeding in the Chinese market to competing globally. We have experienced good success in China, and our business growth there has been notable. However, it's important to mention that the overall market is not showing dramatic growth at the moment, which is a departure from the robust growth we've seen over the past decade. The government is trying to transition the economy from one driven by government stimulus to a consumer-driven economy, but challenges remain as consumers are spending on travel instead of durable goods, which affects our product categories. Additionally, we previously discussed the shift in the automotive market from local to multinational companies, which has stabilized around a 47% market share for multinationals. Last year, they held 51%, and in the first quarter, it was 54%. While there has been erosion, we believe it will remain stable around this level. Consumers are increasingly opting for electric vehicles because it’s easier to obtain a license plate for them in China compared to traditional combustion engines. As a result, there’s a growing selection of electric vehicles available from local brands versus multinationals. I hope this provides some useful insights.

Operator, Operator

And the next question comes from Samik Chatterjee with JPMorgan.

Unidentified Analyst, Analyst

This is Adrian McMillan on behalf of Samik Chatterjee. So I just wanted to touch on electrification a little bit more. Can you talk about how Sensata is thinking of investing in electrification opportunities in nonautomotive end markets? To the extent will this $2 billion of electrification revenue target be associated with electrification opportunities in these pieces?

Jeff Cote, CEO and President

Thank you for the question, as it addresses a common misunderstanding. We view electrification in a comprehensive manner. Only about half of our $2 billion target for 2026 will originate from the light vehicle automotive market. We are also focused on other areas where we are experiencing significant success in both new business wins and overall growth. When considering electrification, it’s important to include the broader heavy vehicle market, charging infrastructure for electric vehicles, and industrial applications, as well as the inverter market related to Dynapower. This shift towards electrification necessitates upgrading the grid. It's not environmentally beneficial to switch to electrification if we produce electricity through gas or other greenhouse gas-emitting methods. Therefore, investing in renewable energy is a key area where we expect the other half of the $1 billion to emerge from across various markets beyond light vehicles. We made notable progress last year, with 70% of our $1 billion in new business wins being connected to electrification, and we are observing a similar trend in the mix of new business wins this year compared to last year. This reflects our successful market performance linked to the capabilities we have developed.

Operator, Operator

And the next question comes from Chris Snyder with UBS.

Chris Snyder, Analyst

I understand the impact of foreign exchange. However, are the margins in the underlying business facing more challenges than you anticipated a year ago? When we look at the Q3 guidance and consider the high end, even after accounting for the FX impact, it seems there isn't much improvement in year-on-year margins for the underlying operations, despite all the efforts in the past year to increase these margins.

Paul Vasington, Chief Financial Officer

I would say that the improvement in the margin is largely derived from the core operations of the business. There are some enhancements as we move from Q2 to Q3, especially within our Clean Energy segment. However, the main factors contributing to improved margins include effectively managing pricing in relation to inflationary costs, controlling our expenses, enhancing throughput at our manufacturing sites, and addressing inflationary pressures on labor through increased automation. These fundamental efforts to reduce costs are essential to our progress. As the volumes begin to rise, we expect to see substantial incremental margins. Additionally, I want to highlight that our Industrial business, which is among our most profitable, has significantly declined year-over-year due to weak end markets. The deteriorating PMI is causing contraction in that market, but when it rebounds, we anticipate notable improvements in both volume and margins.

Operator, Operator

And this does conclude our question and ask session. I would like to turn the floor now to Jacob Sayer for any closing comments.

Jacob Sayer, Vice President of Finance

Thank you, Keith. I'd like to thank everyone for joining us this morning. Sensata will be participating in the Goldman Sachs Technology Investor Conference on September 5 out in San Francisco. As Jeff mentioned, we'll also be hosting an investor event the morning of September 27 in New York City. This will be held both in person and virtually. Registration for that event is now open and the link can be found on our Investor Relations website under Events. We look forward to seeing you at one of those events or on our third quarter earnings call at the end of October. Thanks for joining us this morning and for your interest in Sensata. Keith, you can now end the call.

Operator, Operator

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.