Ingram Micro: Historical Stability At An Attractive Valuation

| About: Ingram Micro (IM)

Ingram Micro (IM) operates as a distributor in four main product groups: IT Peripherals, Systems, Software and Networks. IT peripherals make up 35-40% of the company's revenue and includes products such as printers, monitors, digital signage, consumer electronics, video surveillance and computer componentry such as motherboards. Systems represent 30-35% of the total business and comprises servers and desktop computers.

Software makes up 15-20% of the company's revenue and consists the full range of software products offered in the market. The Networking portion of the business, representing 10-15% of sales, comprises networking equipment such as switches, routers and interface cards and communications products such as VoIP phones. The company's largest supplier is HP with about a 20% share.

Ingram operates in four regions with North America carrying the most importance in terms of revenue, profit and margin. EMEA is the second most important region in terms of revenue and profit, while carrying good margins as well. Margins in Asia Pacific are low currently, a situation the company is addressing, but the region is important in terms of revenue and profit dollars. Finally, Latin America carries good margins, but is a relatively small business, at present.

One of the company's main areas of focus at present is implementing SAP's ERP program. While the early stages of the implementation went well, the company ran into some difficulty in Australia with the system contributing to poor profitability in Asia Pacific. Ingram is working to improve margin over the long-term in the region through more customer focused initiatives to regain market share while somewhat delaying the continued roll-out of SAP in order to improve certain aspects of the implementation.

The company is also widening the base of products it distributes to include non-computing electronic products which it believes will drive demand for existing products as well. Ingram's fee-for-service logistics business is another area of strategic focus due to lower working capital requirement compared to its traditional business.

From 2006 to 2011 revenue has grown at a compound rate of 3% while EBITDA has grown more slowly, at a 1.1% rate. The growth in EBITDA has been impacted by weak performance in 2011 due primarily to low margins in Asia Pacific. On the investment side, capital expenditures have grown at a very fast pace, but the overall dollar amounts are relatively small.

The company has not been an active acquirer since 2006, but previously the company has carried out quite a few acquisitions. In 2008, the company wrote off the entirety of its goodwill or close to $750 million. As a distribution business, working capital is extremely important and Ingram has managed to keep this line item well under control over the historical period.

Analysts expect EBITDA of $561 million in 2012, a somewhat dramatic increase from 2011 which would be one of the best growth performances in years. Capital expenditures are expected to come down somewhat.

Because forward earnings estimates look somewhat aggressive, the model has been calibrated with a blend of 2011 and 2012 earnings, yielding a projected level of gross income of $503 million. This figure is consistent with EBITDA of $520 million and EPS of $1.86. Based on this level of earnings, the company is currently producing returns on capital of about 8.3% on an IRR basis and after adjusting for the reinvestment rate a MIRR of 7.7%.

Given an inflation-adjusted cost of capital of 5.8%, the company is currently generating returns about 1.3x above cost, hardly a stellar performance, but still creating value for shareholders. If the current earnings were the norm, then the fair value of equity would be about $29 per share.

The market seems to implying a lower level of ongoing earnings however because the share price is quite a bit lower than $29. In my view, the market is implying cycle-adjusted earnings of $1.00 per share or $373 million of gross income. On an EPS basis this is some 45% lower than current earnings while 25% lower on a gross income basis. If we look at the average of the last six years of EBITDA, which should serve as a good proxy for changes in gross income, the company's current level is roughly the same as the average, both well above what the market is discounting.

It appears then that the market may be discounting some sort of idiosyncratic decline in Ingram's prospects over the long-term. There are certainly some headwinds in long-term; for example, the company generates significant revenue from software, which is increasingly moving to an internet based delivery platform. In addition, since HP is the biggest supplier, Ingram is somewhat tied to the long-term performance of that company's products. Since HP has suffered difficulties recently, this may be holding the stock back .

From a short-term perspective, one of the company's closest competitors, Synnex (SNX), guided toward weaker results than expected on its most recent conference call. Since Synnex derives 35% of its revenue from HP, the two companies have a large revenue stream in common. This may portend some difficulties in Ingram making analyst estimates although it should be noted that Synnex's shares had run ahead of themselves in terms of valuation before the fall, a situation not evident in Ingram's shares.

While I am long Ingram's shares, the weak performance of Synnex is some cause for concern, especially in light of the large drop in its shares, following the announcement, of some 15%. Although I remain comfortable with the long-term value proposition, it seems prudent to be cautious and I may exit the shares in the coming weeks. The company reports earnings April 26th, according to Wall Street Horizons (unconfirmed), at which time the analyst community may have to confront a lower level of future earning than it expects.

Disclosure: I am long IM.