There are plenty of valid reasons to take one look at an EMS provider like Jabil Circuit (NYSE:JBL), Flextronics (Nasdaq:FLEX) or Celestica (NYSE:CLS) and not bother again. After all, this is a highly cyclical market where the companies have minimal control over their own revenue, narrow margins and returns on capital that arguably do not cover their cost of capital.
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And yet, savvy investors realize that there may be a time and place for almost any stock. With the tech market in the doldrums and several major customers gasping, Jabil should be in rough shape. Oddly enough, the company is doing relatively well and may in fact be worth a look from investors who understand that this would not be a permanent engagement.
Decent Third-Quarter Performance
Third-quarter results at Jabil were not too bad, particularly given the weakness at customers like Research In Motion (Nasdaq:RIMM) and Cisco (Nasdaq:CSCO). Revenue rose 22% from the year-ago level, and 8% from the prior quarter, surpassing the consensus estimate by almost $100 million. Growth was strong in the Enterprise and Infrastructure and Diversified Manufacturing Services units, and those offset weakness in High Velocity Systems.
Profitability looked okay at first blush, but the company arguably should have done better on the bottom line, given its top-line performance. Gross margin was basically flat (and still below 8%), while operating income jumped about 58% and the operating margin improved by 80 basis points (a middling-sounding performance until you realize that is almost a 30% improvement). Still, even with that revenue outperformance and a big assist from a lower tax rate, Jabil came in only a penny above target (on a non-GAAP basis, which is what analysts use).
Balancing the Bad With the Good
There is no question that Research In Motion, a customer that is responsible for more than 10% of the company's revenue, is presently a major factor in Jabil's performance and below-consensus guidance. Right now, RIM just cannot seem to get its act together and take advantage of the shortcomings of other rivals like Nokia (NYSE:NOK). At the same time, Jabil's exposure to other weak sisters of tech like Cisco and the aforementioned Nokia isn't doing the company any favors.
On the other side of the ledger, the company seems to be doing more business with Apple (Nasdaq:AAPL), and that is a very good thing. Moreover, Jabil has a solid history with both sides of Motorola (Motorola Mobility (NYSE:MMI) and Motorola Solutions (NYSE:MSI)). Couple that with good growth in wireless infrastructure from companies like Ericsson (Nasdaq:ERIC) and good exposure to the strong data storage market through NetApp (Nasdaq:NTAP) and EMC (NYSE:EMC), and Jabil has balanced off the weakness in some of these major customers.
How Much do You Believe?
Margins and cash flow generation appear to be tracking below plan for many of the analysts who cover Jabil, but most are gamely supporting the stock and suggesting that things will get better. What is a bit troubling about that is that many of these analysts are projecting a level and consistency of cash flow production that Jabil has never before achieved. That seems like a big leap of faith, particularly in a cut-throat business like this, and could be setting unrealistic expectations.
Investors looking at Jabil should consider other names like Amphenol (NYSE:APH) or Tyco Electronics (NYSE:TEL) before jumping in; not because they are especially close comparables (they are not), but because they are good companies in a broadly similar sector. Turning back to Jabil, though, the question seems to be whether or not the company can regain margins similar to what it enjoyed in the middle of the last decade, as well as whether the company can show a nice jump in revenue next year and solid mid-single-digit growth thereafter.
The Bottom Line
Investors who believe those are attainable targets are looking at a stock that is undervalued by at least 20%, and possibly quite a bit more. Investors who believe Jabil won't be able to hit those demanding standards, or who simply don't want to invest in a brutal, low-margin, cyclical industry, should look elsewhere for investment candidates. (For more, see Use Breakup Value To Find Undervalued Companies.)
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