Jabil Circuit: Inflection Point Ahead

| About: Jabil Circuit (JBL)

Summary

Full-year revenue guidance reduced again, now seen as $18.2 billion for FY 2016.

$400 million share repurchase announced and capital allocation framework explained.

Capital expenditures will be reduced going forward and acquired capabilities will be leveraged to produce profitable growth.

Today Jabil Circuit (NYSE:JBL) reported fiscal Q3 2016 earnings and revenues. The fiscal 2016 revenue guidance was reduced by mobility again. Now revenues for fiscal 2016 (ending on August 31st) are expected to be $18.2 billion versus prior expectations of $18.5 billion. Clearly this is disappointing and earnings for Q4 2016 and the full year will be well below what was previously expected.

GAAP diluted earnings per share (EPS) is now expected to be $1.20 for fiscal 2016 versus $1.48 estimated in the last earnings release. Core diluted EPS is now estimated at $1.85 versus $2.12 projected three months ago. I have posted the numbers from recent quarters including estimates from a spreadsheet below:

Jabil Quarterly Results:

Actual

Estimate

Estimate

Q1 2015

Q2 2015

Q3 2015

Q4 2015

Q1 2016

Q2 2016

Q3 2016

Q4 2016

FY 2016

Revenue

4,550

4,309

4,359

4,681

5,208

4,404

4,311

4,250

18,172

Cost of Revs

4,167

3,942

3,983

4,304

4,724

4,004

3,990

3,930

16,648

Gross Profit

383

368

376

377

484

399

321

320

1,524

SG&A Expense

214

210

228

209

252

225

240

220

936

R&D Expense

6

7

7

8

8

8

8

8

32

Amortization

6

6

6

7

8

9

10

11

37

Restructuring

12

20

(1)

1

1

3

4

5

13

Operating Income

145

125

135

150

215

155

60

76

505

Interest Expense

32

32

31

29

33

34

35

35

137

Income before Tax

113

93

104

121

182

121

24

41

368

Income Tax Exp.

40

35

32

30

50

42

18

25

136

GAAP Net Income

72

52

72

89

132

79

6

16

233

GAAP Diluted EPS

$0.37

$0.27

$0.37

$0.45

$0.68

$0.41

$0.03

$0.08

$1.21

Diluted Shares

195

195

196

196

193

193

193

193

193

Click to enlarge

I have estimated Q4 2016 GAAP EPS along with combining the four quarters of fiscal 2016 to come close to the $1.20 GAAP diluted EPS that management has projected. The last two quarters have seen GAAP net income sharply lower than what was previously reported and lower revenues from mobility is the stated cause.

Quote from CEO Mondello from Q3 2016 Conference Call:

I'll now offer thoughts as to what's driving our business, starting with DMS and our Jabil Green Point business. Ninety days ago our forecast suggests that a rebound of our handset business would occur in the June time frame. We now anticipate this to occur in August, based on the most recent near-term demand signals. Notwithstanding our team's exceptional execution, the large scale demand fluctuations will adversely impact our fourth quarter in a significant way. Please note that our Green Point team is aggressively managing cost. However, they're also navigating very complicated product ramps which are critical to our customer.

Jabil's fourth fiscal quarter typically exhibits deep investments and under-absorbed capacity within our Green Point business. This year is no different. However, the current decline in demand we've seen in existing products is more acute than in past years, thereby amplifying the negative impact to the earnings this quarter.

Catalysts for Growth

There are catalysts for growth and now that Jabil has invested aggressively over the last several years they will leverage these new capabilities to drive profitable growth. Jabil has made several acquisitions over the last several years, including Hanson (for DMS) and Plasticos (now part of Nypro) to broaden capabilities and address new customers.

Healthcare and packaging businesses are strong and the outlook is 8%-10% growth going forward. Another quote from the conference call from CEO Mondello:

Our healthcare business is accelerating. We continue to benefit from broad technology disruptions in the areas of pharmaceuticals, medical devices, and patient diagnostics. The hardware platforms and the ecosystems that support this space endeavor to be connected as well as optimize for cloud, data and analytics. This is all good news for Jabil.

Combining this with rapid advancements in wearable technologies and data science applications, we have a suite of catalysts for growth across products and services. Quite simply, our healthcare team continues to deliver on its mission of delighting customers while improving the way in which people live.

I have provided these quotes for those who do not end up listening to the conference call because I believe that Jabil has an exciting story to tell. They have also made acquisitions in the wearables space and these are some of the market segments that may see explosive growth in the years ahead. The Internet of Things (IoT) and the 20-50 billion devices that will be connected to the Internet by the year 2020. Jabil is telling that story on their website about the "Connected Future:"

The Internet of Things is revolutionizing the way in which products and services are developed and manufactured. In the consumer space, products ranging from washing machines to running shoes are racing toward connectivity at a breakneck pace. In the commercial space, millions of sensor-packed devices are already helping smart companies become more agile and efficient. With economic impact estimates in the trillions, it's hard to overstate the impact that IoT will have on our lives, our work and our economy.

Higher Margins Seen in the $11 Billion EMS Business

The Electronics Manufacturing Services (EMS) business is now seeing core operating margins above 3% on an $11 billion book of business. First half of fiscal 2017 should see margins of 3% - 4% with some growth. While DMS has seen rapid growth in some quarters and now sharp deceleration in the last few months, the EMS business is large and slowly growing and shows the value of Jabil's efforts to diversify. So while the DMS segment (including mobility) shows large fluctuations in demand and profitability the large EMS segment provides much needed stability.

CEO Mondello again from Conference Call:

Moving on to our $11 billion EMS business. The team has done a wonderful job of increasing core operating margins throughout this year. Taking our structural margin profile from what was 2.3% to 2.4%, five to six quarters ago, the core operating margins solidly above 3%. I firmly believe this new margin structure is sustainable throughout FY17 and beyond.

I believe this large scale business will grow 3% to 4% in terms of core earnings year-on-year when comparing the first half of FY '17 to the first half of FY '16. Our healthcare and packaging businesses remain strong. We anticipate their growth first half to first half to be in the range of 8% to 10% in terms of core earnings year-on-year.

Green Point Outlook

CEO Mondello again from Conference Call:

The financial results for the first half of FY 2017 will be dependent on the overall product demand in the mobility market. The Green Point team is outstanding and well positioned for the upcoming product ramps. Product ramps around new products. Our Green Point business exhibits a rare and valuable combination of capability, capacity and what I would call optimal readiness at scale. Moreover, I'll reemphasize that Jabil's market share with our largest customer remains very consistent.

The good news is as we sit today, new product ramps are going largely as planned. In combining this data point with the hyper operating leverage of the Green Point business and our unchanged market share position with the world's leading brand in the space, Jabil is well positioned for a snapback type recovery. We believe this recovery should begin in the next five to six weeks.

Capital Allocation Outlook Framework

Capital expenditures are now expected to drop in the next several years and more cash will be returned to shareholders in fiscal 2017 and 2018. This should definitely help the stock price.

Jabil's Board of Directors authorized a $400 million share repurchase program today. The capital allocation framework is designed to return approximately 40% of cash flows from operations through dividends and share repurchases over the next two years, not to exceed $1 billion in total. With the share price depressed, in my opinion, all the additional funds will go toward share buybacks.

Quote from today's earnings release from CFO Alexander:

"This framework announced today reflects our confidence in our ability to generate in excess of $2 billion of cash flows from operations over the next two fiscal years," said CFO Forbes Alexander. "Moving ahead, we remain confident in our ability to effectively leverage our asset base, maintain relationships with both new and existing customers and grow earnings per share," he added.

This new framework doubles the amounts of share repurchases from 20% of cash flow to 40% of operating cash flow and the dividend (roughly $62 million per year) will remain the same. This is a clear step, in my view, toward Jabil becoming more popular on Wall Street. Also Jabil is leveraging up by adding more debt at favorable rates (see below).

Jabil recently announced a private placement of $300 million of senior unsecured notes maturing on June 14, 2023, with an interest rate of 4.9%. The proceeds from the sale of the notes are anticipated to be used to repay Jabil's $312.0 million 7.75% Senior Notes due July 15, 2016.

Now that Property Plant and Equipment on the Balance Sheet has risen to $3.2 billion from $2.8 billion a year ago the additional debt will provide more financial flexibility to do buybacks. Shareholder's equity is now $2.5 billion and $1.8 billion of long-term debt is up from a year ago but still reasonable given Jabil's solid cash flows.

Conclusion

Analyst day will be Tuesday September 27th - this could be a positive catalyst to help them tell their story. They will drill down into business segments and highlight their competitive advantages. Coupled with the increased share buybacks scheduled for 2017 and 2018, it now appears that Jabil wants to create a more positive image of itself for investors.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.