He wrote this morning:
Stein writes that his best ideas in the group are to buy Flextronics (FLEX), which he says should show accelerating revenue and improved operating margins driven by expanding relationships with Sun (SUNW), Juniper (JNPR) and Cisco (CSCO), and to short Solectron (SLR), which he expects to “disappoint on margins (and perhaps sales, too).”
The EMS [electronics manufacturing services] industry is burdened with over-capacity in high-cost manufacturing regions. Utilization rates of approximately 60% in high-cost regions drive hyper competition, affording these companies no pricing power. The result has been anemic margins and returns consistently below the cost of capital. We expect the situation to improve, but we do not expect returns to match the cost of capital in the near term. Moreover, we estimate the long-term earnings growth rate of the group to be 12%, markedly lower than the groups [next 12 months] P/E multiple of 18 times. We look to other areas of technology, even within hardware, for better value.
Here’s a rundown on his position on the seven stocks he started covering today:
Flextronics: Rating: Outperform; target, $14. The key to improvements in Flextronics’s fundamentals came with the new CEO Mike McNamara, who shifted the company from a geographic structure to an end-market management structure. Jabil (JBL): Rating: Neutral; target, $21. We believe the option investigation that started last year distracted management, resulting in…execution and margin problems. Meanwhile, Jabil is currently losing a significant amount of its Nokia (NOK) handset business, denting revenue growth. Solectron: Rating: Underperform; target, $3. We believe some of Solectron’s key customers, most notably ALU, ERIC and MOT, will pursue a consolidation of their EMS suppliers over the coming two years, introducing a risk of revenue dislocation for Solectron. Sanmina-SCI (SANM): Rating: Neutral; price target, $3.50. Sanmina continually offers investors lofty expectations for a return to revenue growth and expanding margins, periodically attracting new investors, but almost always disappointing them. Celestica (CLS): Rating: Underperform, price target, $5. We remain skeptical about the company’s ability to grow out of its profitability problems in Europe…expectations for Celestica to improve its operations and financial metrics are too high. Benchmark Electronics (BHE): Rating: Neutral, price target, $22. Sun’s second-sourcing all of its product lines, plus its inventory reduction plans are hurting visibility at Benchmark’s biggest customer. We believe similar shifts may be occurring at another of the company’s customers, as well. Plexus (PLXS): Rating: Neutral, price target, $23. For some time, Plexus has had the highest gross margins, and recently developed the higher operating margins in the industry, a situation that may not be sustainable…Juniper, a 20% customer, has been diverting some of its electronic assembly business to competitor Flextronics, potentially zapping future demand at Plexus.
In today’s trading:
Flextronics is up 17 cents at $11.50. Jabil is down 6 cents at $23.09. Solectron is down 7 cents at $3.39. Sanmina is up 4 cents at $3.61. Celestica is down 3 cents at $6.73. Benchmark is down 8 cents at $20.94. Plexus is up 5 cents at $21.09.