Jabil Circuit - Diverse, High Growth, Low Expectations, And Great Value

Nov.21.12 | About: Jabil Circuit (JBL)

Jabil Circuit (NYSE:JBL) is the world's third-largest producer of electronics components in the world. It currently employs 121,000 employees and operates on the ground in 24 countries. Founded in 1966, and having gone public in 1993, Jabil has seen revenues grow from the low 100s of millions in the early 1990s to approximately 16.5 billion in FY 2012. It currently has a market cap of $3.62 billion. Key people at Jabil include Timothy Main, current CEO, and Mark Mondello, current COO. Main was named CEO in 2002 after holding several previous management positions since 1987, and is also scheduled to transition from being CEO to chairman of the board in March 2013. He will be replaced by Mondello, who has been COO since 2002. Forbes Alexander is the acting CFO, and has been in the role since 2004.

Business Model

Jabil is in the industry of electronics manufacturing services (EMS), in which it creates outsourcing partnerships with large technology companies in a variety of industries. Jabil classifies its business operations in three sections: High Velocity Systems (HVS), Enterprise and Infrastructure (E&I), and Diversified Manufacturing Services (DMS). HVS focuses mostly on electronic consumer goods, while E&I is focused on development, design, and repair of computing and networking technology, and DMS can be further divided into the areas Clean Tech, Industrial, and Medical Device services.

Internal Analysis

Economic Moat: Jabil Circuit employs a business-within-a-business structure: Big customers of Jabil's are given their own business unit, with its own manufacturing line and support staff. With this structure, Jabil is able to offer its largest customers, a smooth supply chain and specialized services. While this forces the company to expend a higher percentage of revenues on selling and administrative expenses, it allows the company to produce and more profitable bottom line. Jabil's current position proves hard to copy: A full adjustment by other companies to imitate its expense strategy would be a costly and painful, and Jabil's great relationships with key customers -- built up expensively and over time -- are difficult to duplicate. One of Jabil's greatest assets is also its customer and sector diversification. Through FY 2012 Jabil had only three customers who were responsible for 10%-plus of revenues, and management has predicted this will drop to only one customer in FY 2013. In addition, Jabil is also very diverse in terms of geography, currently operating in 24 countries and continuing to grow internationally -- mitigating the risk of natural disaster and adverse political action in one country.

External Analysis

Growth Prospects: The EMS industry is expected to grow at an annual rate of 7.6% (source: Ploner Research). While computers and consumer devices currently are the bulk of the industry, unorthodox sectors such as industrials and medical have a low outsourcing penetration of only 5%. Growth in these unorthodox sectors is expected to be the fastest in the industry and is reflected in Jabil's projected revenue growth by sector, with revenues from DMS expected to grow 5x as fast as E&I and HV at 15% year over year. The keynote here is that Jabil is penetrating these industries and capitalizing on it while its competitors are not. The following are IDC estimates:

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Competitors: Competitors of Jabil include electronic manufacturing companies such as Foxxcon, Plexus, and Hon Hai. As noted above, Jabil's competitors tend to derive most of their business from one of the traditional sectors, and only Plexus contains a similar yet still subpar composition of business as Jabil from the fast growing industrial and medical sectors. A comparison of these revenue breakdowns can be seen below:


DCF (shown below): A terminal multiple approach was chosen for the discounted cash flows analysis. The WACC and all assumptions were created with public information only. Assumed revenue CAGR for the next five years (2014-2018) was 8%. We felt that due to cyclical market conditions, an accurate projected revenue growth needed to account for volatility and uncertainty. Revenue growth has proved a highly volatile number -- as demonstrated by 23.2% growth in 2011, and 3.8% in 2012. Therefore, such volatility was smoothed out to an 8% growth rate over the next five years.

An assumed EBITDA CAGR for the next five years of 4.8% was derived from historical data. CAGR of 2010-13 was 18.9%. Once again, we expect volatility in the markets and adjusted for turbulence in operating expenses with SG&A and COGS in particular.

The WACC figure was created with most of the inputs coming from the MD&A and also Jabil's annual 10-K filings. The cost of equity was derived using a CAPM model; market risk premiums and the risk free rate were both calculated from public information (treasury bills and yields, etc.). The cost of debt was assumed from a deep analysis of Jabil's debt structure and its different long-term obligations. An average of 8.3% was combined with the most recent effective tax rate to create the cost of debt. The company's capital structure is a target structure. Jabil's management says that debt remains conservative since most of Jabil's long-term notes mature in late 2016. Therefore, our target capital structure has a little less debt than today's ratio to account for debt paid off over time. It is also important to note that the WACC figure was very sensitive to the high beta and not the cost of debt. The exit multiple was 3.3x, derived from EV/EBITDA multiples.

Sources: Latest conference call, 2012 10-K Filing, and Treasury Yields.

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Comparable Analysis (shown below): In our comparable analysis, P/E and EV/EBITDA were taken as benchmarks to find Jabil's fair value. EV/Revenue is shown, but not considered as a valuation metric due to Jabil being an established company, making free cash flows and earnings more important than sales. All final implied prices were considered, but weighting was heaviest for 2014 estimated multiples since forward multiples are generally used in comparable analyses. Moreover, due to the volatility of the industry, EV/EBITDA carried slightly more weight than P/E since net earnings and EPS may be an unreliable indicator of financial value. It is also important to note, given the size of the industry, picking comparable companies with similar market capitalizations was difficult. However, all of the comparable companies chosen have very similar operations and revenue sources as Jabil, which helps offset the difference in size. Every metric in every time frame shows an upside for the share price.

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Source: ThomsonBanker -- Reuters.

Precedent Transactions Analysis: A precedent model was not applicable for this valuation.

Price Target (shown below): Our football field analysis shows our valuation conclusion; the red line represents the current share price of $17.63 and the black line represents our final target price of $25.31. Our target price is a weighted combination of all the different valuation models and metrics. It resulted in an implied upside of 49.9%.

Risks and Catalysts

Catalysts: In the short term, analysts are expecting a very low EPS figure of $0.40 for the holiday quarter because this quarter's performance was subpar. Relative to the past, this figure is easily beatable ($0.52 in 2011, $0.47 in 2010). We believe analysts are not considering the fact that there is easily enough production pressure due to the holidays to post an earnings figure of higher than $0.40 per share. Moreover, as of a result of current social and economic trends, Jabil's diversified industries are growing at a tremendous pace. For example, the demand for clean-tech products is phenomenal. Also, trends such as the aging demographics increase demand for health care equipment and medical supplies, all of which Jabil is involved with. Lastly, there is significant competition in the technology sector, and the competition is becoming more heated every day. This is a good trend for EMS companies since there will be a pressure to innovate and well as produce and it will drive revenue.

Risks: Jabil faces some risks in the financial markets. As a volatile sector, Jabil's share price is impacted more by fluctuations in the general economy. Therefore, a double-dip recession could be detrimental to Jabil's price. Furthermore, companies like RIM can be a potential burden for Jabil's revenue. Since RIM is a large customer for Jabil, its collapse or diminishing revenue could result in less production on Jabil's end. We have yet to see this happen, but in general, Jabil's larger customers pose some risk to revenue. The EMS industry also faces low earnings margins, which provides little safety nets in case of recession. Finally, Jabil's international presence exposes it to currency fluctuations risk.

Source: Jabil statistics and latest press release.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JBL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.