For a couple of quarters now, I've thought that Jabil Circuit (NYSE:JBL) looked undervalued on a long-term basis, but that the trends in the electronic manufacturing services (EMS) industry were likely to keep the stock stuck. To that end, the shares are down about 1% for the year, even though the company's business with Apple (Nasdaq:AAPL) seems to be ramping up well. I continue to believe that Jabil's current price understates its long-term value, but I also believe that getting the timing right on when to buy this stock could be tricky given the ongoing malaise across so much of consumer and tech hardware.
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A Good Start to the Fiscal Year
Jabil has started fiscal 2013 off to a good start with a quarter that was solidly ahead of analyst expectations on both the top and bottom lines, though management's guidance for the next quarter was not quite as robust.
Revenue rose 5% this quarter, though with a lot of moving parts. Diversified manufacturing service (DMS) revenue rose 20%, with specialized services up 51% while healthcare dropped 22% and industrial/clean-tech was down 9%. Unfortunately, the company doesn't give (or isn't able to give) much customer-specific data, so it's hard to say how much Apple had to do with this result. Looking at the other businesses, enterprise/infrastructure was up 17%, while high velocity (which includes a lot of handset business) was down another 20%.
Margins were iffy; not so bad relative to expectations but not great on their own. Gross margin picked up slightly from the fiscal fourth quarter, but declined about 30 basis points from last year. Operating income fell 1% on an adjusted, and the company saw some margin erosion at the operating line. Although margin in DMS improved significantly on a sequential basis (due, I believe, to the company ramping up that Apple business), high velocity margins declined by a matching amount.
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Still a Ways from "All Clear"
While I have my doubts that Jabil will succeed over the long-term in differentiating itself from the likes of Flextronics (Nasdaq:FLEX), Benchmark Electronics (NYSE:BHE) or Plexus (Nasdaq:PLXS) and posting significantly better margins, that's not the issue today.
The issue today concerns the outlook for demand for the things Jabil builds/assembles for others. While Cisco (Nasdaq:CSCO) was relatively optimistic on its last call and Apple continues to see solid demand, the PC and consumer electronics markets are still pretty soft. Likewise, enterprise hardware demand is looking soft, as many OEMs have expressed caution on demand in networking, storage, and other segments.
Sooner or later the rebound will come. Companies like IBM (NYSE:IBM) aren't talking about a multi-year trough, but rather just a few difficult quarters. Likewise, carrier spending has to improve at some point, even if it's just to roll out 100G products. When that comes, I expect Jabil (and the EMS sector) will be in good shape to thrive from both a revenue and margin perspective.
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The Bottom Line
Long-term cash flow modeling for Jabil is tricky, given that the company has never been able to post consistent free cash flow margins. Likewise, pinpointing a good time to buy is tricky as the market is likely going to buy the stock ahead of confirmation of better orders and sales at its OEM customers.
That said, I do believe Jabil can support a fair value in the mid-$20s on the basis of its revenue and free cash flow prospects. That's enough undervaluation to make this stock worth further exploration today, though I will again caution investors that this stock could be pretty much dead money for a few quarters (or more) if that recovery in consumer electronics and enterprise hardware takes longer to materialize.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.