On 3/24, electronic manufacturing service Jabil Circuit (NYSE:JBL) reported a lackluster 2Q 09, replete with charges, a GAAP loss of (.20), and conservative guidance based on limited visibility. The stock tanked briefly to as low as 3.73, but has since soared to close at 6.63 on Thursday last week. This outcome is not necessarily surprising, if one pays attention to the cash flow.
The company is a major player in the electronic manufacturing business, which is extremely competitive and cyclical. In recent years, restructuring has been ongoing, for Jabil and also for many competitors. Share prices have plummeted.
On the plus side, using a service like Jabil, as compared to building product in house, is attractive for a number of reasons. First, Jabil has plants in low cost areas, so U.S. or other high cost manufacturing operations can be off-shored without the delay and expense of setting up a new plant. Also, customers who have cyclical variations in volume can avoid the cost of temporarily idled manufacturing facilities. Finally, the company has considerable expertise and may be able to do a better job than their customers can do in house.
During economic slowdowns, outsourcing is attractive as a cost-cutting measure. Long term, this is a good business and should grow steadily as world consumption increases. Jabil has grown 13% per year over the past 5 years, with a slowdown this year. I think long term they can do 7% or better per year.
On the topic of a potential increase in outsourcing, or how Jabil will do as the economy recovers, here are some comments by CEO Tim Main from the last conference call:
Well, using the ‘91 recession and the 2001 and 2002 recession as guides – I know it is very hard, and I don't mean to be Pollyanna-ish about it, but we – it is hard to think – not to think in 90 day buckets. Let’s put it that way. These things take more than 90 days to transpire and have position made. So if you looked at the three to four year trend after each of the 2001, 2002 recession, and the ‘91 recession, the next three, four years were extremely robust periods of growth for the entire industry and pretty darn good periods of growth for Jabil as well. And for Jabil, that 2002 to 2006 time period was the most robust period of growth for Jabil and the industrial, instrumentation and medical sector, we opened up consumer electronics and enjoyed some great growth there. So our revenue in 2002 was 3.5 billion, by 2006 it had gone to 10.3 billion, so that is about 190% growth over that four year period, and EBITDA grew substantially as well by 73%.
What is really important for us is to make sure that we capitalize on the opportunities. And what we think of it is, we are the best funded and financially strong large-scale global players in the business and using that to our advantage in terms of building market share and opening up new opportunities for our company with the existing and new customers and even those who have not outsourced in the past.
Follow the cash
Before discovering Seeking Alpha's transcript service, I frequently listened to conference calls, bearing with the boredom in order to pick up some feeling for management attitudes and credibility. CFO Forbes Alexander, when explicating certain aspects of one quarter's financials, advised listeners to “follow the cash.” According to his on-line biography, his early employment and education were in Scotland; in any event, he had a musical way of saying it, somehow it made me think of follow the yellow brick road.
Like many tech companies, Jabil presents both GAAP and nonGAAP earnings. Their version is “core” earnings, which among other adjustments eliminates the cost of employee stock options. Just like the good old days. NonGAAP figures can be useful, but in this case it is more instructive to look at cash flow than to wade through periodic restructuring and non-cash charges. Some companies, Jabil among them, frequently report earnings that are a much smaller portion of cash flow than usual. From 2002-2008, Jabil's reported earnings averaged 32.3% of cash flow. Cash flow that is not identified as earnings is not taxed: instead it can be deployed for business purposes such as capex or acquisitions.
For the most recent quarter, Jabil reported cash flow of 343 million, ending with about 775 million of cash plus an unused revolver that does not renew until 2012. According to CEO Tim Main, Jabil generates cash as it shrinks its balance sheet during industry slowdowns, leaving it fit and lean to focus on opportunities as they develop. My guess would be that the sudden share price increase was caused by the good news on cash. Looking at the 2002-2008 period, cash flow per share averaged 1.67 per year. Comparing that to last week's 6.63 share price, up from as low as 3.19 on 3/11, suggests some of the attraction of the stock.
Ken Fisher has written two books - the earlier one, Super Stocks, suggests using P/S as a valuation metric, buying industrials at .40 and selling them at .80. Jabil has traded at a P/S ratio ranging from .07 to 1.07 during the past 5 years, bracketing either side of the proposed range. At a P/S of .60 on estimated 2009 revenues, the shares would trade at 33, a price they have frequently exceeded in the past.
Fisher himself has backed away from the use of P/S, noting that low ratios are typical of distributors with very thin margins or of companies saddled with excessive debt. Certainly the EMS sector has been extremely competitive, with thin margins for many players. However, Jabil is a strong competitor with a robust cash flow. Not that long ago, I saw a price target of 17 to 27. It's really embarrassing with the stock trading where it is, but that kind of target is still possible when the global economy recovers.
As the market tanked early last month, taking my portfolio with it, I started working along the lines of the Phoenix strategy after reading an article by Cam Hui. Basically, this involves buying lower price, beaten up, but “real” company stocks at market bottoms, under the theory that they will increase faster than the overall market. Jabil fits the outlines of this strategy fairly well. Chugging along adding shares during that difficult time, I got my average cost down to 4.77. I reduced my position recently, not because share prices were anywhere near my target of 17, but because taking profits has helped me almost every time I have done it for the past year.
I also have a position in YTJAA, JBL Jan10 5 Calls. From 2004 on, I have used a strategy of buying in the money LEAPS as a substitute for stock ownership. This worked well until 2008, when it became problematical. Leverage works both ways, and magnifies both good and bad results. Looking back after the hectic conditions of March and now April, I wonder now why I traded JBL in shares rather than adding to or closing the options position.
Jabil seems unlikely to go to zero. So the shares at 6.63 are potentially a two bagger or somewhat better, with little risk of a complete loss of principal. The options, trading at 2.40 mid bid/ask as of Thursday's close, are potentially a 5 bagger, but there is the risk of losing the entire investment. The choice is really one of risk tolerance, something each investor has to answer for himself.
Disclosure: Long JBL.