Motley Fool Evening News Discussed ECM Sector today
Reprinted a portion for your reading pleasure (they have discovered DIIG and AFLX, but not SFLX yet):
Centennial Correction
Contract manufacturers have replaced semiconductor manufacturers in the hearts of technology-enthused portfolio managers across America. Although many of the chip makers have enjoyed snappy recoveries since their panic lows in the summer, it is contract manufacturers that, as a group, have outperformed their peers in a close head-to-head race. With few exceptions, the companies have gained at least 50% since June and July. The most extreme instance is the incredible rise of JABIL CIRCUIT (Nasdaq: JBIL), up four-fold in the past six months.
As with any group of companies that enjoys a monster rise over a short period of time, the air can get pretty thin as the companies reach high altitudes. Ultra-hot CENTENNIAL TECHNOLOGIES (NYSE:CTN) is learning this painful lesson today as the stock is being smashed for $7 to $27 1/4 after posting earnings for its fiscal second quarter. If you are not familiar with the name Centennial Technologies,take a glance at the list of the top percentage gainers on the NYSE in 1996, and you will see that it held the number one spot. The company slaps together PC cards, those small credit-card-sized devices you plug into the side of your laptop computer. The company also gobbled up some contract manufacturers in the United States and England while ramping up production in order to maintain its breakneck growth.
Unfortunately for Centennial, contract manufacturing is a pretty rough and tumble low-margin business. Although the company hit its profit projections for its second quarter, gross margins plunged as the
company began to recognize revenues from its new contract manufacturing business. For those new to this column, contract manufacturing is when one company assembles an electronic product for
another company. Many times the contract manufacturer is also in the circuitboard manufacturing business and does the contract manufacturing as a value-added service, although the largest contract
manufacturers are completely focused on that business alone. Because it is an outsourced assembly gig, the margins are pretty thin, and the company must maintain a high volume in order to make a significant amount of money.
Apparently Centennial investors were not prepared to see the margins shrink to the degree that they have. This is kind of short-sighted if you really think about it, because the big contract players like SCI
SYSTEMS (Nasdaq: SCIS), SOLECTRON (NYSE: SLR), FLEXTRONICS (Nasdaq: FLEXF) and Jabil Circuit normally have gross margins in the 10% range and profit margins in the 3% to 6% range, far below the 11.75% that Centennial was getting with PC cards. Has Centennial fallen enough to reflect its new margins? With 18.47 million shares outstanding, the company has a $498.6 million market capitalization. Although it did not release its balance sheet with this quarter's results, last quarter it had $6 million in cash and negligible long-term debt.
Now, if you compare the $493 million enterprise value of Centennial to its trailing revenues, you get a really big number. To be fair, the company did book $31.7 million in sales this quarter, compared to $19.5 million the quarter before. If you take this $31.7 million and multiply it by four to get an annualized result -- as the company did add businesses that will continue to generate significant revenue -- you get a company that is trading at 3.88 times sales, still high for the group. To be unfair, backing out a one-time gain the company added $12 million in revenue, but only made $0.01 more per share compared to last quarter's results, evidence of those shrinking margins.
Not all of the contract manufacturing news lately has been bad. DII GROUP (Nasdaq: DIIG) rose $4 3/16 to $25 1/16 today after reporting earnings that were higher than expected, even though they were well below last year's results. DII Group owns Dovatron, a pretty large contract manufacturer. The firm bought a semiconductor manufacturer last year and has been consolidating its business. As investors now see a turnaround coming sooner that they had previously thought, they rewarded the stock. It is interesting to note that even after today's rally the stock still trades at 9.9 times next year's earnings estimates... estimates that might be going up. A similar move came from ADFLEX SOLUTIONS (Nasdaq: AFLX) last week as that specialized contract manufacturer turns its business around -- a business that, for the record, was recommended by Stephen Barnes (MF Yon) in Arizona Stock Analysis in the $8 to $9 range. Given all of the news and moves from the contractors, I am busily updating my spreadsheets and hope to have another article giving some more sophisticated comparative valuations for your perusal. Stay tuned.
There are posts on the DIIG threads and CTN threads discussing today's action in these stocks.
Paul |
