citi: SANM: Sanmina-SCI Delays 10-K Filing, Expect No Change to Outlook
HOLD (2)
Speculative (S)
Mkt Cap: $2,323 mil.
December 15, 2005
* On Thursday Dec 15th, Sanmina-SCI announced the delay in its annual 10-K filing due to a reclassification of taxes. This marks the second consecutive year SANM has delayed its annual 10-K filing (2004 due to expense identification).
* Our analysis reveals that reported FY05 (Sept) GAAP net income will be reduced by approximately 1% or $9.7 million resulting in GAAP income of -$1,006m vs. -$996m and GAAP EPS of --$1.93 vs. -$1.91 previously and no change to pro forma EPS. The reclassification consists of removing a tax benefit from the income statement thus lower net income and placing this item as a tax valuation allowance directly in the equity section of the balance sheet. By our experience, incremental expenses associated with additional auditor and filing fees should not be meaningful. The company expects to file its final 10-K filing within the 15-day extension that expires on Dec 30th.
* Continued below....
FUNDAMENTALS
P/E (9/06E) 13.8x
P/E (9/07E) 8.8x
TEV/EBITDA (9/06E) 8.8x
TEV/EBITDA (9/07E) 6.3x
Book Value/Share (9/06E) $4.84
Price/Book Value 0.9x
Revenue (9/06E) $11,975.0 mil.
Proj. Long-Term EPS Growth 15%
ROE (9/06E) 6.9%
Long-Term Debt to Capital(a) 39.6%
SANM is in the S&P 500(R) Index.
(a) Data as of most recent quarter
SHARE DATA . RECOMMENDATION
Price (12/15/05) $4.42
Rating (Cur/Prev) 2S/2S
52-Week Range $8.56-$3.53
Target Price (Cur/Prev) $4.75/$4.75
Shares Outstanding(a) 525.6 mil.
Expected Share Price Return 7.5%
Div(E) (Cur/Prev) $0.00/$0.00
Expected Dividend Yield 0.0%
Expected Total Return 7.5%
SUMMARY CONTINUED
* We do not expect any of this to have a material impact on the company's
outlook for December quarter revenues of $2.8-$2.9B (+1% to +5% q/q) and EPS
of $0.06-$0.08 (consensus at $2.852B and $0.07, Citigroup at $2.9B and
$0.07).
* Maintain Hold, Speculative risk rating (2S) and $4.75 target price (7.5%
potential upside).
VALUATION
Our target price for Sanmina-SCI is $4.75. We believe the EMS and connector
stocks as a whole should trade more closely with the S&P Industrial cycle
rather than their own 5-10 year historical averages. Historically, we find the
S&P Industrials have traded in a PE range of 15-23x with a mid cycle of 18x.
We believe that the total EMS industry on average will trade in a similar range
with some companies experiencing premiums while others experience discounts,
based on individual company fundamentals. We are using calendar 2006 EPS
estimates (excluding stock option expense) at this time as we believe investors
are focused on 2006 projections with fairly limited visibility into 2006 and
beyond. We will roll forward our forward EPS estimates used in our valuation
methodology using a forward 12-month timeframe as the year progresses.
We believe that given the maturity of the EMS and connector industries, both
sectors will more closely resembles the industrial segment compared to past
historic multiples that were impacted by the 1990s decade of sector wide growth
followed by the downturn of 2001-2004. We believe the EMS and connector
fundamentals are more likely to resemble the industrial sector (acquisitions,
dividends, stock buybacks, focus on ROIC, etc) with growth and ROIC profiles
more similar to the industrials, thereby warranting our valuation approach.
Our price-to-earnings valuation methodology begins by using the mid cycle S&P
industry PE of 18x that we adjust for individual company premiums or discounts
based on scorecard analysis. We use a scorecard approach as a guide to help
determine any premium/discount to the industrial mid cycle multiple. We
currently use +/- 10% as a guidepost for each of the seven factors that we
believe have a material impact on valuations but note that the 10% increments,
weights of each factor (currently equal weight), and individual factors may
change depending on market and industry conditions. We employ this scorecard
across all our covered companies.
Item Criteria Valuation
Premium/
Discount Result
Revenue Revenue outlook of 9% for calendar 2006 and 8.6% 0 = discount
Outlook for calendar 2007 is about in-line with the
industry growth forecast of 9% for each year.
Some companies (JBL & APH) are expected to post
consecutive 05/06 double-digit years of revenue
growth warranting these companies a +1.
Customer & No single company greater than 10% of total 0 = discount
Segment revenues yield +1 while customer >15% yields
Concentration --1. SANM has two companies (IBM and
Risk Hewlett-Packard) that are each greater than 10%
of total revenues, but none that is higher than
15%.
ROIC>WACC ROIC>WACC yields a premium while ROIC5x), free cash flow ($0.24
CY2006E), and uses of cash (no dividends and no stock repurchases while other
companies do).
Risks we see to the stock achieving our valuation target include the following.
* Economic Slowdown -- A general economic slowdown (globally or in key
markets) could have a negative impact on the company's financial results
and cash flow generation. While the company is somewhat diversified
with business operations in personal business computing (33.5%),
communications (30%), enterprise computing and storage (15.7%),
industrial, medical, defense and aerospace (12.5%), and multi-media
(8.3%), a meaningful pick-up or slowdown in any of these key markets
could benefit or adversely impact the company.
* Customer Concentration -- IBM and HP have consistently been the two
biggest customers for Sanmina over the last few years. These two
customers account for over 20% of sales in total and any notable
increase or decrease in orders from these customers could have a
meaningful positive or negative impact on the company's overall results
and could cause the shares to trade above or below our target price.
* Slowdown in Outsourcing Trend - EMS companies have been able to grow at
a CAGR of 48% during 1991-2000. However, this pace has plunged during
the past 4 years following the tech bubble. Although penetration rate of
outsourced manufacturing is considered low at 21%, we have not witnessed
a notable pick-up in secular growth in outsourced manufacturing. If
sluggish growth in secular outsourcing continues, low utilization rates
and poor margins could trigger further restructuring and poor quality of
earnings.
* Sale of receivables -- Sanmina-SCI sells a portion of its accounts
receivables to a financial institution in order to help with and
expedite the collection of such accounts. As of the end of the June
quarter (September 10-Q filing not yet available, $84 million of account
receivables were factored. There can be no assurance of the
collectability of the factored receivables that do have several
covenants (recourse). Deterioration in the quality of receivables could
impact the company's cash flow generation and ability to continue using
factoring to expedite cash conversion.
* Margin Expansion -- Sanmina-SCI's operating margins at 2.1% are notably
lower than the sector average and the company has been experiencing
headwinds in expanding its margins as a result of low top-line growth
and restructuring activities. If the company's revenue growth
accelerates and restructuring activities proceed better than expected,
we could see better margin improvements. This could lead to our shares
trading above our target price or below our target price should the
opposite become true.
* Restructuring Progress -- Since 2000, Sanmina has put in place various
restructuring programs to realign its operations, however, the company
has failed to demonstrate significant benefits from such actions. The
company is currently in the midst of phase three restructuring plan, and
we believe that the company will likely have meaningful restructuring
charges in the remaining part of 2005 and into 2006. Better or worse
than expected restructuring progress could pose a positive or negative
risk to our target price.
* Currency Fluctuations -- Sanmina-SCI sells its products around the world
and is subject to fluctuations in currency rates. Over 73% of its sales
derive from locations outside of the US. While the company has
approximately 36% of its operations in international locations resulting
in a natural cost hedge to some extent, there can be no assurance that
currency fluctuations will not have a material impact to the company's
earnings in the future.
The impact of these items could cause the stock to trade above or below our
target price.
INVESTMENT THESIS
We rate Sanmina-SCI 2S (Hold, Speculative Risk) with a target price of $4.75.
We believe EMS and connector investors will increasingly focus not only on
revenue and earnings growth but also on ROIC and favorable capital deployment.
Our neutral view on SANM shares is attributed to the following: 1) Near average
industry growth, but operational fundamentals lag competition; 3) Stock not
likely to move higher until restructuring gains meaningful traction; 4) ROIC
below peers despite meaningful improvement; and 5) Valuation supports Hold
rating at this time.
COMPANY DESCRIPTION
Sanmina-SCI Corp. is the third-largest electronics manufacturing services (EMS)
company in the world. SCI Systems (acquired 12/7/01) was one of the pioneers
in the EMS industry. The combined company manufactures complex printed circuit
board assemblies, custom-designed backplane assemblies and subassemblies,
multilayer printed circuit boards (also known as PCBs--Sanmina-SCI is the
largest manufacturer of this component in the world) and custom cable and wire
harness assemblies; and tests and assembles electronic sub-systems and systems.
Sales by end markets include: 33.5% personal business computing, 30%
communications, 15.7% enterprise computing and storage, 12.5% industrial,
medical, defense and aerospace, and 8.3% multi-media. Top customers include
IBM and HP that represent greater than 20% of total sales followed by several
other companies.
I, Jim Suva, research analyst and the author of this report, hereby certify... |
