I'm proposing a pair trade here, shorting SNX against really any of their OEM suppliers or reseller customers that you like on the long side. For the purposes of this discussion I will focus on the market leader in the space, Ingram Micro (NYSE:IM) as the long.
SNX has been on a tear since with the stock troughing at $32.60 4/22/13 to Friday 8/9/13 close of $50.80. 56% appreciation in 109 trading days! You would think that this company had posted at least one blow-out quarter over this time period however that's not the case. In both their May and Feb 2013 quarters they printed some revenue upside and in-line EPS but gave guidance below consensus at the mid point (much more so in Feb than May).
SNX is a broadline IT distributor that competes with Ingram Micro and Tech Data. They distribute mainly PC related products (PCs, Hard Drives, monitors, and peripherals and software) and some low end server and networking parts to Value Added Resellers (VARs) and retailers. CDW is an example of a reseller customer, as is Insight Enterprises and PC Connection. Most of their VAR customers however are smaller and private. SNX big suppliers include a who's who of old school technology companies- HPQ, MSFT, Lenovo, Acer, IBM, INTC, STX, WDC and CSCO.
This begs the question of why the massive outperformance? SNX is a well managed company and in the past SNX has consistently outgrown competitors and expanded margins however that' s not the case in the recent past. I think it's a combination of low valuation and technical factors (RUT outperformance) as the space is really not very exciting and recent earnings growth certainly doesn't justify it. Short interest was relatively high around earnings on a days basis as SNX doesn't trade a lot of volume (about 200K shares/day) but the short interest on a days basis wasn't high relative to itself historically so that's not the main driver of this move. Excitement around CDW's IPO in the adjacent reseller space probably gave multiples some boost. The other explanation could be SNX as an acquisition target however I doubt that is the case. Usually these companies make niche acquisitions to expand their products lines or larger acquisitions to expand their geographic reach. Since SNX is mainly in NA their business overlaps directly with IM and TECD- the only two distributors that are really big enough to buy them. And it make no sense for their OEM suppliers to buy them. In fact most companies 5-6% GMs are extremely dilutive so this rules out most companies as an acquirer.
Valuation and Earnings Growth
The FC consensus has SNX growing revenues 3.7% in F2013 with two quarters left. The street is modeling $3.83 for SNX F13 EPS down from $3.99 in F12 and $4.11 in F11.0. The market leader in the space Ingram Micro has been growing earnings reporting $1.69 in F11, $1.95 in F12, and the street is modeling $2.26 for F13. I believe IM on an organic basis is growing revenues at a similar clip to SNX even though they are much bigger and have 25% exposure to the weak economies of Europe. There is no large disparity in terms of their level of indebtedness with $1.74 net debt at SNX and $1.32 at IM after the most recent quarters. And it's not like earnings are depressed right now and I should be looking 2-3 years out for more normalized numbers so I will use a straight Price to Next Twelve Months earnings estimates as my valuation metric. SNX trades at 12.7x NTM estimates vs IM at 9.7x NTM estimates (Friday 8/9/13 close), a full 30% premium. SNX has at times traded at a premium to IM however but that's not always the case so that's not the explanation for the massive disparity.
The forward PE multiples for distributors are very low versus the S&P's current 15.5x range. However these old school tech stocks, especially PC stocks, have had depressed multiples for years now and it's not like the PC market is improving. If anything growth in other areas these distributors are exposed to like enterprise hardware and networking seems to be slowing. Another reason their multiples are so low is their razor thin margins. IM has GMs in the 5% range while SNX are in the 6% range. This translates into OMs in the low 1% range for IM and low 2% range for SNX. And margin expansion in their core distribution business is capped because their big suppliers (like HPQ and MSFT) don't want to give them a bigger share of the profits pie. SNX also has a higher margins services business but it's only 2% of overall sales. Also, it's not like any of their suppliers are knocking the ball out of the park right now-HPQ, MSFT, Lenovo, INTC - they are all struggling and looking to just stabilize their own margins. Their largest suppliers (HPQ is by far the largest for both of them, about a third of SNX business) watch their PnL closely and if they see continued margin expansion they compensate them less for distributing their products. This has happened with reseller NSIT this year from their big supplier MSFT- two material program changes that will hit gross margins throughout the year. So the only real way besides operating leverage that they are able to expand margins is through new higher margin product lines which they are constantly seeking and acquiring sometimes through M&A. For IM margins seem to be stable at best and while SNX has done a great job of expanding margins, more recently their margins seem to have peaked in F12.
I may be early on this trade but when it turns it's going back to $44 very quickly (11 x NTM street estimates) and probably lower. Upcoming catalysts are HPQ/DELL earnings next week and then TECD earnings later in August. There is just no margin expansion story or growth story here that justifies SNX trading at a higher multiple than all it's direct comps, customers and suppliers.
Disclosure: I am short SNX.