- EMS leader Flex’s exposure to high-growth markets should ensure a strong revenue outlook through 2025.
- With margins also moving higher on mix benefits and cost discipline, earnings should also ramp up in the coming years.
- At current levels, the stock has largely discounted the core business (ex-NEXTracker), so a spinoff could unlock significant value.
Flex Ltd. (NASDAQ:FLEX) is a leading electronics manufacturing services (EMS) company with one of the lowest-cost production footprints within the industry due to its presence in emerging markets. The core business is solid and should benefit from secular growth opportunities given its diversification into higher growth end markets.
Margin expansion is also a mid-term theme, as management's cost discipline should ensure ample operating leverage when conditions normalize post-COVID. FLEX's utility-scale solar tracking solution, NEXTracker, offers an additional upside lever over the long term - it operates in an oligopolistic tracker market and is set to grow in line with the broader utility solar power space.
Market conditions have led to a spinoff delay, however, allowing investors to buy core FLEX and NEXTracker at an attractive valuation. Using the recent $3bn valuation by private equity would imply a discounted valuation of ~5x fwd P/E for the core business - unwarranted, given the quality of the management team and the growth/margin profile of the key Reliability segment. A re-rating toward higher-value peers like Plexus at a mid-teens EBITDA multiple would imply a significant upside from here.
Leveraging Secular Growth in Key End Markets
As outlined at its investor day, FLEX has pinned its hopes on several high-growth markets, including next-generation automotive, cloud data centers, and digital healthcare. In total, these businesses currently contribute ~15% of revenue, although the projected 20% CAGR through 2025 implies an outsized contribution going forward.
For context, the next generation automotive end market factors in higher electric vehicle volumes and their richer technology content, as well as EV charging infrastructure, so FLEX is well-positioned to benefit from the secular EV shift. With auto connectivity over 5G to edge infrastructure also embedded, FLEX's expected 50% CAGR through 2025 signals its ambition here. In addition, the continued cloud data center expansion is also guided to drive a 14% CAGR through 2025, while digital healthcare solutions are expected to grow at a 14% CAGR as well. This leaves growth for the remaining Flex business at a steady ~7% CAGR through 2025 - at the upper end of the broader EMS industry growth rate (5%-7%/year).
Near and Mid-Term Guidance Move Higher
Heading into 2023, the company expects revenue to reach ~$27.8bn (+8.5% YoY) and deliver a high single-digit annual revenue CAGR through 2025. Unsurprisingly, much of the growth will be driven by high-growth verticals such as next-gen mobility, cloud, and healthcare (>20% annual growth), with its remaining businesses growing at a steady >7%/year. Operating margins are also guided to come in strongly at ~4.8% for 2023, driving overall EPS of ~$2.16/share.
Over the medium term, a >5% adjusted operating margin scenario seems well within reach given the combination of revenue growth, mix improvements, and efficiency gains (mainly from automation). Core FLEX (ex-NEXTracker) will drive ~$1.73 in EPS in 2023 and ramp up to $2.65 of non-GAAP EPS in 2025, implying strong bottom-line growth from NEXTracker as well.
While the overall EBIT margin outlook will come as no surprise given Flex's solid track record as well as the accretive mix shift toward auto and medical, the high single-digit revenue CAGR through 2025 was a particularly positive surprise. Plus, the mid-term guide does not account for capital allocation gains from buybacks and M&A, so there remains ample room for upside to the guide.
The NEXTracker Opportunity
Embedded within the FLEX portfolio is NEXTracker, the market leader in utility-scale solar tracking with a dominant IP moat (patent protection for the next decade). With over 50GW deployed in recent years, NEXTracker has also built a solid track record, ensuring a "sticky" customer base with high switching costs. The only real competition at NEXTracker's scale is ARRY, although, with backlogs on the rise, there's ample profit potential for both players. Unlike NEXTracker, ARRY went public in 2020, and since then, FLEX management has hinted at a potential spinoff down the line. Per management, NEXTracker achieved revenues of >$1bn and double-digit operating margins in 2020 (in line with peers), so extrapolating this based on the industry growth profile, NEXTracker should hit ~$1.2bn of 2021 revenues and ~$200m of EBITDA for 2021. Depending on how the company navigates semi shortages, there could be some volatility in 2022/2023, but I think the long-term earnings power is intact.
Valuation-wise, TPG's recent investment in NEXTracker converts offers a good indication - a ~$3bn valuation would imply a 2.5x revenue multiple or ~15x EV/EBITDA on 2021 numbers. While I think this could prove conservative given the timing (ARRY and FTCI multiples are well off their highs), ~$3bn for NEXTracker would imply a deeply discounted core FLEX (ex- NEXTracker). Assuming FLEX achieves its long-term financial model (high-single digits revenue and >5% EBIT by 2025), core FLEX is guided to hit EPS of $2.65/share. Further adjusting for the ~$3bn enterprise value for NEXTracker and assuming net debt declines to ~$1bn, core FLEX is on sale at an implied ~5x earnings at current levels.
FLEX Enterprise Value (FY 2021)
Minus: NEXTracker Enterprise Value
Equals: Core FLEX Enterprise Value
Minus: Net Debt (Cash)
Equals: Core FLEX Market Cap
Divide: Diluted Shares Outstanding (FY 2025e)
Divide: Core FLEX FY 2025e EPS (in $)
Equals: Core FLEX FY 2025e P/E
Source: Author, Company Financials, Market Data (27th April 2022)
Deeply Discounted Industry Leader with a Potential Spinoff Catalyst
Overall, FLEX offers investors a compelling "heads I win, tails I don't lose much" scenario - this is a combined business trading at a low to mid-single-digit EBITDA multiple despite incurring transitory COVID-19 costs. Plus, the overall business should grow revenue at a GDP plus rate for the years to come, with cost discipline and accretive M&A/buybacks also likely to boost the EPS growth algorithm for the mid to long term. Finally, we've yet to see NEXTracker's earnings power come through, but with solar recovering from its COVID lows, we could finally see management proceed with spinning off the asset.
Valuations are much different from when ARRY was listed, though, so I don't see NEXTracker commanding the multiples we saw in 2020. Still, NEXTracker's ~$3bn valuation at its last funding round is a start, so using that as an anchor implies a deeply discounted ex-NEXTracker multiple of ~5x mid-term earnings power. Relative to the growth/margin profile and FCF generation that core FLEX is capable of, I see ample room for the stock to re-rate.
This article was written by
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