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Shakiness at Solectron Continues -- 9:00 AM EST
by Elyssa Jaffe
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Valued at 1.33x its book value and 14.8x expected 2003 EPS (ending 8/03), shares of Solectron [SLR:NYSE] appear to be trading at highly attractive levels. And with the stock near four-year lows, certainly it would seem that investors would be wise to snap up shares of this leading contract electronics manufacturer. But we're not yet ready to rate the stock at Buy, as the industry has yet to recover from the severe technology slump of 2001 and specifically from the lack of orders flowing from telecom suppliers. While Solectron has scaled its operations accordingly, it's still holding excess capacity beyond normalized levels. As for the industry, we have pushed back the timeframe for estimated recovery to the end of 2002, at the earliest, and thus expect this group of stocks will remain in limbo awaiting a resurgence in budgets. For these reasons, we continue to rate Solectron at Hold.
Recently Solectron has been outshown by Flextronics [:Nasdaq], which deploys a more nimble strategy that engenders greater margins. Furthermore, Solectron is heavily exposed to the telecom industry, which has been wallowing for quite some time. One of Solectron's largest customers is Nortel Networks [NT:NYSE], which accounts for almost one-fifth of Solectron's revenue base, and recently cautioned that it saw a flat global equipment market in 2002. With its customers suffering a huge drag in business, Solectron is not a candidate for a speedy recovery. And considering that Flextronics warned late Monday that profits would come in below expectations in its Q4 due to telecom equipment weakness, Solectron appears even more at risk.
Last month Solectron's leading competitor, Sanmina-SCI [:Nasdaq] warned that it does not expect to see an economic rebound until 2H:02, which would indicate sometime in the May-July period. We believe this forecast to be optimistic and anticipate the company further pushing out its timeline. Likewise, when Solectron announces fiscal Q2 results next month, we would expect extreme caution in management commentary regarding its outlook for the upcoming quarter as well as for the remainder of the fiscal year.
As for the company's fiscal Q1, Solectron experienced a 2% decline in sales of PCs/Notebooks, and we expect this trend to continue into Q2. Telecom also declined at the same rate. And with 37% of its revenue under pressure, we are concerned about revenue targets for the quarter and year. Solectron indicated last quarter that it expects Q2 revenue of $2.7bn-$3.2bn and EPS of $0.01-$0.04, below previous estimates of $3.4bn and $0.07, respectively. This despite the fact that Solectron closed the acquisition of C-MAC Industries in December and will add about $1.4bn in CY:02 revenue. We are certain that there will be further tweaking involved in guidance.
Solectron continues to restructure its business in the changing environment. Its third wave of changes will result in charges of $300m over the next few quarters. This clearly signals that more problems lie ahead. The company does have close to $3bn in cash on its balance sheet, which will help it weather the weak environment, but we think there will be a wave of disappointment still to come when the contract manufacturers express belief in a weak market for the rest of 2002. Given a valuation that is seems too reasonable to ignore, we continue to rate the shares at Hold. We await fiscal Q2 results, which are due on March 21.
Market Timing From the Technical Desk
On Nov. 14, we said: "Solectron [SLR: NYSE] has been trending lower for the last year. However, a slight rebound from the Sept. 17 dip and some sideways trading led to an unspectacular bullish breakout of the downtrend line drawn through the Jan. and Aug. 2001 peaks. If this breakout holds true, then we expect a rise to fill the Aug. 9 down gap and a challenge to a higher downtrend line. However, the relative average volume on the breakout and lack of momentum may lead to some short-term consolidation. Therefore, IDEAglobal expects Solectron to rise to $16.50 in two to three months."
Solectron hit a high of $16.45 after our last call, but then turned south again. Large losses were seen in Dec. 2001, but this likely signals a probable bottom to come. Currently, there is a threat of retreating further to $7.50, as it trades at 52-week lows at $8.92. However, we are bullish for the intermediate-term though and see shares rising to $10 in one to two months.
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