I have been following Flextronics (NASDAQ:FLEX) since before the Solectron merger in October 2007. I thought it was interesting that this is the company that makes products well-known companies like Hewlett-Packard (NYSE:HPQ) (NYSE:HPE) and Cisco Systems (NASDAQ:CSCO) use, but is largely invisible to most consumers and investors. The Solectron merger increased FLEX's revenue and eliminated a competitor, but was done before the financial turmoil in 2008 which hammered the FLEX stock price weakened its end markets.
During the 2008 stock market meltdown the FLEX share price dropped from $12 to $8 to $4 and ultimately bottomed out at $1.23 in late 2008. In early 2009 they hit a low of $1.81 and then rose strongly as the year progressed. The sharp drop in the stock price was very shocking for me as an investor and was not justified by the fundamentals of the company. However there was much greater scrutiny of each company's financial position and their ability to repay debt.
During fiscal 2009 FLEX wrote off the entire $5.9 billion in goodwill off of the balance sheet. It was a bold move because shareholder equity also was reduced by $5.9 billion. Shareholder equity was reduced from $8.24 billion at year-end 2008 to $1.86 billion at year-end 2009. By fiscal 2010 debt had been reduced to around $2 billion and their financial stability was no longer in doubt. In fiscal 2010 FLEX revenues bottomed around $24 billion and profits were reduced by various restructuring charges.
Revenues rose back to $29 billion in fiscal 2011 as strong organic growth resulted in roughly 20% revenue growth and much improved profitability. Net Income was $596 million which translated to 75 cents per diluted share (on 790 million shares outstanding). Since fiscal 2011 revenues have continued to be up and down without showing sustained increases over time. However FLEX has been able to drive operating margins higher and has continuously added new capabilities to capture new business.
Flextronics has built a strong competitive position worldwide and is continuing to build out its capabilities in a disciplined and thoughtful manner. The focus has been on higher margins on a well-diversified base of business. Over the years FLEX has become well diversified with over $1 billion of business in 12 distinct market segments. Revenues have varied from roughly $24 billion to $29 billion since fiscal 2011 but profits have been much improved.
There has been an evolution of FLEX as a producer of products for some of the world's leading companies to enabling innovation by helping to design and engineer the next generation of products that will be part of the "Internet of Things." Estimates are that by the year 2020 there will be anywhere from 20 billion to 50 billion smart connected devices that will exchange information over the internet. FLEX is determined to be part of that growth story.
Bottom line is although revenues have been up and down over the years; the mix is shifting to higher margin activities, like design and engineering. Flextronics has also purchased various companies over the last several years to enter new markets and to extend their capabilities in new areas. They have also made targeted investments to upgrade and expand their capabilities to be able to offer a "one-stop shop" for many different companies and industry segments.
FLEX has been very concerned with showing that their debt is manageable and that free cash flow (FCF) remains strong. Cash has been returned to shareholders through share repurchases. Over the last 5 years FCF has averaged around $600 million per year and share buybacks have been about $400 million per year. They committed to returning at least 50% of FCF through buybacks, but have averaged roughly 66% of FCF returned through share buybacks.
Solid Performance in Fiscal 2016
FLEX reported results for fiscal Q4 2016 on April 28th 2016. Net sales for the fiscal year ended March 31, 2016 were $24.4 billion, and fiscal year 2016 adjusted operating income increased 5% to $792 million from $751 million in fiscal 2015. Adjusted earnings per diluted share (AEDS) increased 6 cents to $1.14 year-over-year.
"Fiscal 2016 profit and margin expansion continues to validate Flex's portfolio evolution and sketch-to-scale strategy. This also marks our third consecutive year of adjusted operating profit and adjusted
EPS expansion," said Mike McNamara, chief executive officer of Flex. "We are committed to continuing this strong trend, and remain focused on driving a continuously richer mix of business across the entire Flex Platform."
"Cash flow generation continues to be a hallmark for Flex, and a positive reflection of our culture of discipline and focused execution," said Chris Collier, chief financial officer at Flex. "We generated over $1.1 billion in operating cash flow and $639 million in free cash flow in fiscal 2016. This allowed us to continue fulfilling our commitment to consistently return value to our shareholders; this year we spent $420 million buying back almost 7% of our shares, representing an allocation of 66% of our fiscal 2016 free cash flow."
Portfolio Evolution and Sketch to Scale
Two margin expansion initiatives are "Portfolio Evolution" and "Sketch to Scale" as explained by CEO Mike McNamara in the Analyst Day presentation. Go to www.Flextronics.com to replay the webcast and to download or view PDF Presentations by the CEO, the CFO and various business unit leaders.
One step in portfolio evolution is that in 2015 the Lenovo Motorola China operations were wound down, which will eliminate a significant revenue headwind from future results. All of the roughly $2 billion decline in revenues in Flextronics 2016 results compared to 2015 can be shown to be from the winding down of the Lenovo Motorola China operations. They were wound down within budget and now Flextronics has eliminated their exposure to that line of business. A strong relationship continues with Lenovo Motorola in Brazil and India.
Portfolio Evolution as explained by the CFO is that they have targeted two segments for rapid growth. High Reliability Systems (HRS) and Industrial and Emerging Industries (IEI) will continue growing as a percentage of total Flextronics revenue. Those two segments were $4.6 billion in fiscal 2010 and grew to $8.6 billion in fiscal 2016. Flextronics projection to 2020 is that HRS and IEI will be roughly $13 billion in fiscal 2020, which will be 45% of Flextronics total revenue.
Other business segments are still able to generate operating profits for FLEX but may see declining revenues going forward. Traditional Servers and Storage were down 25% in 2016 which is a notable spot of weakness but other segments are picking up the slack. FLEX has made targeted acquisitions to build out capabilities in the HRS and IEI segments. Both of those segments are forecast to show revenue growth of over 10% for each year up to 2020.
Sketch to Scale means that FLEX is no longer just taking orders to assemble products. Now they collaborate on new smart connected products with different companies and organizations and the percentage of engagements where they design and engineer and then manufacture the product are increasing.
Investments in design and technology are paying off in market expansion and new customer additions. Sketch to Scale is projected to grow to 35% of revenue by 2020, up from just 7% in 2013 and 21% of revenue in 2016. It is one of the trends helping to drive operating profit margins up and will continue going forward.
Each year FLEX has been buying back shares to return capital to shareholders in a tax-efficient manner. $2.5 billion has been spent over the last 6 years to buy back 335 million shares at an average cost of $7.46 per share. That represents 33% of the outstanding shares. FLEX Management had committed to returning at least 50% of free cash flow each year in share repurchases and/or dividends.
At the start of fiscal 2011 Flextronics had 813 million common shares outstanding. By the close of Fiscal 2016 only 545 million shares are still outstanding. Of course there are shares issued for stock options and share bonus rewards but there is no doubt that FLEX has been serious about using free cash flow to reduce the number of shares outstanding.
When asked about dividends at the analyst day event the response was that at a 10% free cash flow yield and roughly 10 times earnings per share the stock looks like a good value and they want to repurchase as much stock as possible. The implication is that at some point a dividend payment may be instituted, but that for now the share repurchases are the best way to return capital to the shareholders.
Flextronics is finally hitting its stride and looking forward to 2020 they are projecting 12% earnings per share growth on a 3% gain in revenues. They plan to continue buying back shares. From $1.14 AEDS could increase to $1.43 by fiscal 2018 and around $1.80 by fiscal 2020. If this strong earnings growth can be achieved then $12 will look cheap as the stock price.
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.