GS: FLEX: lack of upside hurts credibility, but #s
were still ok; pressure = oppty
52-Week Range US$19-11
YTD Price Change -5.00%
Market Cap US$7.4bn
EPS Growth Estimate 15%
Due to high expectations, FLEX disappointed with in-line Jun-Q & barely in- line
guidance; emotions aside, we think #s were still solid & yield a good buy oppty on likely
pressure, particularly under $13. We had concerns about expectations but thought they'd
deliver on Jun-Q to offset conservative guidance. Though we were wrong on Jun-Q, we
maint our 64c CY04E & 90c CY05E. Our 05E seems conservative y-y: 11% rev growth,
gross mgn +30bp & 30bp SG&A leverage; closure of the NT deal should add 10c to 05,
though it's prudent to expect up to 5c dilution from potential financing (conservative
CY05 range would be 90c-$1.00). We recognize many will cont to question handheld
exposure & reliability of this level of earnings; we think risk to our est is a tech downturn,
not FLEX-specific. Simply put, for investors that want a modest valuation, high beta
stock, in expectations of a tech rally later this year, we think EMS is a good place to look,
& FLEX (IL/N) is a very good candidate on post-earnings pressure. Below we comment
on EMS & macro implications.
RECOMMENDATION: WE SEE 25% UPSIDE FROM $13
We use some traditional valuation metrics and a proprietary ROIC-based valuation. At $13 on
traditional metrics, P/E on our 90c CY05E is 14.4x -- slightly below 16x peer avg. Including the
NT deal & a potential financing, CY05 should be at least 95c; P/E at $13 would be 13.7x.
Price-to-tangible book of 4.27x is above 2.4x peer median, but 1.65x price-to-book and 0.5x
price-to-LTM revs are roughly in line with peers. An 18x P/E on our 90c CY05E or the $1.00
potential with NT would yield a $16-$18 stock in the medium term, or 25%-35% upside. Our
proprietary valuation methodology shows 20+% upside medium term, based on our current ests
incl charges. Given potential upside of ests and mix of valuation metrics, we see 25+% potential
upside from $13 with limited downside risk. We repeat that shares are compelling for investors
who believe tech is generally oversold and the market is poised for a seasonal tech rally later this
year; in the last 2 years FLEX has outperformed peers from July-Dec.
IMPLICATIONS: INVENTORY +8% ADJ; EXPECT EMS PRESSURE
(1) MACRO: Mgmt seems confused; they acknowledge recent flood of tech warnings, hence their
conservative guidance, but they do not see any cooling in their business. Inventory will no doubt be
a source of debate: reported inventory was +17% q-q but mgmt noted that half of the increase was
due to new business; this implies a 8-9% increase as the proper macro data point. This is a little
higher than the 5% increase we/mgmt would have expected (after all, FLEX has been flat for 2
qtrs) so we do not think it is a bad inventory number that should overly concern investors. As noted
below, we believe handsets were one source of minor excess inventory.
(2) HANDSETS/CONSUMER: Handset revs were strong, led largely by top customer Sony
Ericsson (up 40% q-q); this implies all other handset customers were actually down 6% q-q (other
top customers include MOT, ALA, SI, & NOK). We believe handsets were a modest source of
excess finished goods inventory.
(3) MIXED COMM INFRASTRUCTURE: FLEX is not a particularly large telecom supplier by
EMS standards. Telecom infrastructure (predominantly wireless) was down 3% q-q; their biggest
customer is ERICY, at ~5% of total revs, followed by some exposure to MOT, NOK, and SI
among others. In the context of a strong Mar-Q (+10% q-q), lukewarm Jun-Q results fit recent
datapoints. Datacom was +18% q-q, but again, datacom is only 8% of total revs and customers are
generally smaller names, such as Extreme and Quantum.
(4) COMPUTING: Segment revs were down just 2%, we believe attributable to lethargy in end
markets we've seen, and seasonal weakness for their largest segment customer, HPQ (~9% of total
revs, mostly ink-jet printers), as they prepare build for Sep-Q back-to-school & year end seasonal
improvement.
(5) NEGATIVE FOR EMS STOCKS; + FOR OUTSOURCING: Disappointment will no doubt
pressure the EMS group a few % on Tuesday, but we think that's an overreaction to pretty solid
results. FLEX also affirmed a very healthy outsourcing environment, robust pipeline of new
business, improved margins, and their view that the industry is nowhere near peak margins; we
roughly agree with the trends but disagree on magnitude, but we also note FLEX credibility
doesn't help this argument near term.
WHAT TO WATCH:
(1) KEY CUSTOMERS: HPQ news (~9% of revs, mostly ink-jet printers) & DELL (about 6% of
revs) report in Aug. Other top customers to watch for news flow include: Sony-Ericsson (15% of
revs, already reported good 2Q numbers), Siemens (~8% of revs) and MOT, ERICY, and ALA
(each 4- 5% of revs, reporting in the next week).
(2) HANDSETS: Sony Ericsson share and industry inventories are impt, at least for handset
sentiment on FLEX.
(3) CASH: Optg C/F of $166m and FCF of $100m were good numbers in the qtr and worthy of
continued watch as it indicates how big a potential financing might be.
(4) NEW DEALS: Mgmt mentioned the final stages of 2 new deals in the "several hundred million
revs" category; if these require some up front cash (which we suspect), it further increases
likelihood of a financing (perhaps debt or convert, since their equity level is unappealing).
SUMMARY OF F1Q05 (JUN) RESULTS VS OUR ESTS VS MAR-Q
GS est. As Reported MAR-Q
--------------------------------------------------------
Revenue $3.88B $3.88B $3.77B
Gross Margin 6.2% 6.4% 6.3%
Cash EPS $0.14 $0.14 $0.13
Inventory turns 11.3x 12.1x
DSOs 44 44
Cash Cycle 19 17
--------------------------------------------------------
Source: Goldman Sachs Research estimates and company reports.
SEGMENT BREAKDOWN
JUN-Q Q-Q
% of rev $ change
------------------------------------------------------
Ind, Med & Other 9% +3%
Comm. Infrastructure 16% -3%
Handhelds 37% +9%
Consumer 9% +3%
IT Infrastructure 8% +18%
Comp & Office 21% -2%
------------------------------------------------------
Source: Goldman Sachs Research estimates and company reports.
I, Stephen Savas, hereby certify that all of the views exp |
