Unfortunately for Jabil (NYSE:JBL), there's really nothing that this manufacturing specialist can do about the uninspiring demand conditions in so many of its end-markets today. Key markets like consumer electronics, IT hardware, and healthcare are all pretty stagnant right now, and that is working its way back to this otherwise well-run company. Although Jabil still looks undervalued on a long-term basis, the same problems remain – weak free cash flow margins, inconsistent (and often quite mediocre) returns on capital, and ample volatility in demand, which places a premium on timing the stock buys and sells carefully.
A So-So Fiscal Third Quarter, With Sluggish Guidance
None of Jabil's best-known customers, companies like Apple (Nasdaq:AAPL), Cisco (Nasdaq:CSCO), or General Electric (NYSE:GE), are reporting exceptional end-user demand, and that seems to be translating into pretty mediocre operating conditions for Jabil.
Revenue rose 5% this quarter, and 1% on a sequential basis. The company's large DMS segment saw revenue decline 4%, though E&I was up 4%, and HVS was up a very strong 23%.
Margins weren't great, due in part to the revenue mix. Gross margin ticked up slightly on a sequential basis, but fell about a half-point from the year-ago level. Operating results were a little more convoluted – adjusted GAAP operating income (after adding back restructuring and impairment charges) rose just 1%, while the company's non-GAAP measure (which also excludes stock compensation) rose 7% and 4%, respectively. Margins were down on a year-on-year basis in both HVS and DMS, but improved very slightly in E&I.
SEE: A Look At Corporate Profit Margins
It didn't help matters that the company's guidance wasn't great. The midpoint of revenue guidance looked about 2% or 3% shy of prior expectations, suggesting that there isn't going to be a big near-term rebound in consumer or enterprise IT markets.
Nypro Is A New Adventure
Earlier this year, Jabil announced the acquisition of Nypro – a large manufacturer of precision plastic products. Jabil isn't an especially active acquirer, and this deal is relatively large – about $1 billion in revenue, for which Jabil is paying $665 million.
While the size of the deal would offer up its own risk factors, this deal also represents an expansion for Jabil into multiple new markets. Although beefing up its capabilities in precision plastic molding makes a great deal of sense for Jabil (it will now be the largest company there, and it is a meaningful part of what they do for Apple), the products and markets that Nypro serves will be new in many cases.
Almost half of Nypro's sales come from healthcare, and the company has 12 FDA-registered facilities. Growing the healthcare business has been a priority of Jabil for a while now, and this deal now brings them deeper into consumables, disposables, and accessories. The deal also brings them into the packaging business (about 25% of Nypro sales), and that could offer some integration and execution risks.
All told, though, I'm keeping an open mind and an optimistic tilt on this deal – over the long term, it should improve the company's margins and reduce revenue volatility, while very definitely diversifying its addressable markets.
The Bottom Line
I wouldn't dismiss the possibility that Jabil could have a meaningful role in the production of a cheaper iPhone, and that that could add some meaningful revenue and earnings to the next fiscal year. On the other hand, the company is also having to deal with a weaker IT hardware industry and will now not only be trying to integrate Nypro, but also execute a corporate restructuring that will likely see employee firings and production shifts between facilities.
I've been passive-aggressively positive on Jabil for a while, and that's still the case today. I do believe that Jabil is a relatively well-run outsourced manufacturing services company, but it's a brutal and generally unattractive industry. I do believe there's a chance for Jabil to deliver free cash flow growth in the teens if management can drive sustained margin improvements, but that's historically been extremely challenging. It's probably early to buy these shares, but I do believe they will see a good run at some point over the next six to 18 months.