I don't know whether Jabil (NYSE:JBL) is really going to succeed in differentiating itself over the long term from the broader electronics manufacturing service (EMS) industry. What I do know, though, is that this is a tough stretch for the global economy and for key end markets like handsets, medical equipment, and communications/networking hardware. Jabil's stock does look undervalued, though, and while I think it may be too soon to make a major commitment here, I can see how this stock could appeal to more aggressive value hounds.
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Q4 Comes in OK
Jabil's fiscal fourth quarter was broadly in line with expectations, with core EPS coming in at 54 cents, which was slightly below estimates 58 cents, which isn't a bad result considering all of the turmoil in consumer electronics and enterprise IT hardware end markets.
Revenue squeaked out a 1% improvement from last year, as the company's Diversified Manufacturing (DMS) segment saw 14% growth and the other segments (High Velocity and Enterprise & Infrastructure) fell 10% and 5%, respectively.
While it looks like business tied to the Apple (Nasdaq:AAPL) iPhone 5 boosted DMS revenue, it did have a more negative impact on margins as the company works through some yield and operating leverage growing pains, evidenced by the 27% decline in net income during the quarter. Company-wide GAAP gross margin fell about 40 basis points (to 7.3%), while GAAP operating income fell 13%. Even non-GAAP adjustments don't help all that much, as adjusted core operating income was still down about 6%.
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Negative Guidance Reflects Some Macro Caution
The bigger news for Jabil coming out of this report is going to be that management pushed guidance down for the fiscal first quarter by about 3% on the top line. Handsets continue to be weak (at least those not made by Apple or Samsung), and companies like Cisco (Nasdaq:CSCO) and NetApp (Nasdaq:NTAP) have seen analysts get more cautious about their sales outlooks for the second half of this year.
Given the weakness at companies like Research In Motion (Nasdaq:RIMM) and Hewlett-Packard (NYSE:HPQ) (traditionally large customers for Jabil), it's hard to call this revision a major surprise. Likewise, while the company may be seeing some success in attracting customers in industries that don't traditionally outsource to EMS providers (like healthcare and renewable/clean energy), those end markets aren't exactly in robust health either at the moment.
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Can Jabil Establish Real Differentiation?
As I alluded to in the opening paragraph, Jabil is trying to carve a different path for itself in the EMS space. The company has built up its capabilities in more complex processes (largely in the DMS segment), and can mass-produce a variety of moldings and detailed metal tooling (which is what I believe it does for Apple). That, and the company's commitment to automation, sets it apart from the lower-margin assembly work done by the likes of Hon Hai (OTC:HNHPF).
Likewise, the company has put a lot of resources into establishing its capabilities in healthcare, and has succeeded in attracting well-known clients such as Philips (NYSE:PHG) and Boston Scientific (NYSE:BSX).
The question I have is whether these investments are going to allow the company to really differentiate itself from others in the EMS space. If a competitor like Flextronics (Nasdaq:FLEX) sees Jabil getting a leg up, will they (and others) match those capabilities in time and once again compress the margin potential?
SEE: Competitive Advantage Counts
The Bottom Line
I'm not sure this is a great time to invest in the EMS space, as numerous end markets still look pretty shaky and order trends are choppy across several markets. Said differently, it seems like the evidence points to more downward revisions than upward across the sector for the next quarter or two.
On the other hand, value investors know that you get the best prices when things look dicey, and Jabil's shares do look interesting on valuation. If you believe Jabil can grow its revenue at a mid-single digit rate and lift its free cash flow margin back into the mid-2% area, these shares could be significantly undervalued. Likewise, I think the company can grow its EBITDA at more than 5% a year over the next couple of years while the EV/EBTIDA ratio sits around 5%.
This is a brutal business with razor-thin margins and ample competition. It's also worth noting that Jabil has seldom managed to put together two straight years of strong free cash flow. That said, if investors believe in the new path that Jabil is following, or simply that current valuations are too depressed, these shares could have real appeal at this price.
At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.
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