3 ‘Pick and Shovel’ Stocks for the Tech Industry

In America’s great Gold Rush in the 1800’s many prospectors went bust looking for gold while the real money was being made in outfitting them with picks, shovels and other equipment needed for the endeavor. In today’s world where technology changes quickly perhaps it’s time to be investing in the equivalent companies that supply to the ‘prospectors’ [read: tech manufacturers] rather than the innovators themselves.

Three large companies that distribute electronic and computer components and computer products worldwide are Ingram Micro (IM), Arrow Electronics (ARW) and Avnet, Inc. (AVT). Prices are 10:15 AM quotes from April 17, 2008.

In the calendar year just completed:

Ingram had 2007 sales of $35.05 billion.

Avnet had 2007 sales of $16.99 billion.

Arrow had 2007 revs of $15.99 billion.

All three posted all-time high revenue numbers.

Here are some key [per share] metrics* for each of these companies over the past 5 years:

Arrow Electronics:

Year …EPS [cont. ops]…. Sales…….. C.F……. B.V…….Avg. P/E

2007……...$3.28 ………. $130.14 …. $3.86…..$28.92 ……. 12.0x

2006……...$2.93 ……….$110.72 ….$3.32 ….$24.44 ……. 10.7x

2005……...$2.19 ………..$92.81 …..$2.61 ….$19.73 ……..12.7x

2004……...$1.97 ………..$91.54 …..$2.54 ….$18.87 ……..12.5x

2003 ……..$0.74 ………..$58.87 …..$1.40 ….$14.89 ……..23.6x

Avnet Inc. [FY ends June]

Year ….EPS [cont. ops]…. Sales…… C.F……. B.V…….Avg. P/E

2007 …….$2.76 …….....$104.66 ….$3.12 …..$22.70 ……10.5x

2006 …….$1.90 ………..$97.18 …. $2.32 …...$19.30 ……12.7x

2005 …….$1.39 ………..$91.64 …..$1.90 …...$17.36 ……13.3x

2004 …….$0.60 ………..$85.03 …..$1.14 …...$16.21 ……34.3x

2003 ……d.$0.39 ………$75.69 …..$0.36 …...$15.33 ……NMF

Ingram Micro.

Year ….EPS [cont. ops]…. Sales…… C.F……. B.V…….Avg. P/E

2007……$1.74 …………$202.65 …$1.89 …..$19.82 ……13.2x

2006 …...$1.55 …………$185.10 …$1.93 …..$17.24 ……12.2x

2005 …...$1.50 …………$177.43 …$1.91 …..$15.02 ……11.6x

2004 …...$1.01 …………$160.40 …$1.38 …..$14.12 ……16.2x

2003 …...$0.81 …………$148.81 …$1.33 …..$12.33 ……15.4x

You can note the general trend towards higher sales, cash flow, book values and earnings for each of these distributors. While this is a low margin business it has huge gross revenues that only figure to grow with the increased pace of electronics applications in everything from cars to home appliances.

Here are the consensus estimates for each of these three companies:

(Sources: Zacks’s, MSN Moneycentral, Value Line)

………………… CY 2008 ……………CY 2009 ……….. Projected P/E 2008

Arrow ……………$3.50 ……………….$3.77 ………………. 8.85x

Avnet …………….$3.20 ……………… $3.52 ……………… 8.71x

Ingram …………. .$1.81 ………………..$2.02 ………………. 8.97x

These companies are trading at big discounts to their typical multiples right now despite excellent historical results and expectations for record years.

Even 12 times estimates for this year leads to target prices for the three companies of:

Arrow………….12 X $3.50 = $42 target ---- up 35.5% from today’s quote

Avnet…………..12 X $3.20 = $38.40 target --- up 37.8% from today’s price

Ingram………….12 X $1.81 = $21.72 target --- up 33.7% from the current quote

Are these goals realistic?

ARW shares hit a high of $44.90 in 2007 when EPS were $3.28 [a P/E of 13.7]

AVT shares hit a high of $44.70 in 2007 when FY EPS were $2.76 [ a P/E of 16]

IM shares hit highs of $21 - $22.50 in each year 2004-2005-2006-2007 when EPS

ranged from $1.01 - $1.74 [average P/E equaled 13.3]

All three firms had strong value-oriented holders as of year-end 2007. Here are some of the bigger owners as of Dec. 31, 2007 and the year-end closing prices:

Arrow: Dec. 31, 2007 close: $39.28

FMR [Fidelity Funds] ………11.64%

AXA ………………………...10.70%

Wellington Mgt………………9.75%

J.P. Morgan Chase …………..5.39%

First Pacific Advisors ……….2.70%

Avnet: Dec. 31, 2007 close: $34.97

FMR…………………………9.62%

AXA ………………………..8.32%

Bank of NY Mellon…………4.84%

First Pacific Advisors……….4.17%

Ingram Micro: Dec. 31, 2007 close: $18.04

Wellington Mgt……………..7.23%

Lazard Asset Mgt…………...5.03%

FMR ………………………...4.50%

First Pacific Advisors is run by Guru Robert Rodriguez, one of the few people to correctly predict [and avoid] the current credit market debacle. He loves both ARW and AVT with 5.69% and 9.25% of the funds’ assets committed to these two stocks as of March 31, 2008.

These companies are the world leaders in an industry that seems destined to grow. They offer very nice year-ahead prospects at single-digit P/E that are well below their historical norms.

A return to even average valuation parameters in each of these should bring 30 – 40% returns over the next 12 months.

Disclosure: Author owns shares in all three companies discussed.