We've had this discussion on PE before.
The ECM sector PE trades a significant discount to the market PE, and to the sector growth rate of 25%. It seems like the market is punishing the ECM sector stocks for perceived cyclic risk and unpredictable "hits" to earnings when major customer programs end. For example, most of the domestic ECM players have had "hits" in the last 6 months or so.
For example, among the big players, Jabil is getting discounted now due to "flat earnings" projection for the May and August Qs that the company has attributed to inventory corrections and program transitions. The consensus estimate for FY98 ending in August, is $1.91, and for FY99, about $2.32, so the market has priced in about $2.10 over the next 12 months. The forward 12 month PE is about 18, well below sector growth of 25%. The market is clearly pricing in the possibility of some kind of periodic, unpredictable, earnings hit. BTW, I think the consensus is too low for FY99 for Jabil. The consensus of $2.32 is only a 21% increase in earnings year over year. I believe that Jabil will increase earnings by about 30-35%, so I expect about $2.50 a share. Jabil should grow faster than the sector growth rate, because its in the 'sweet spot' for growth; between $1B to $2B in annual revenue. In this range, a large outsourcing contract of about $350-500M should lock in a growth rate of 30+%. Also Jabil's largest existing customers are experiencing growth rates in excess of 20% annually (Cisco, 3Com, Quantum's DLT, Gateway, Dell). At 37, the stock is trading about 17 times my estimate of the next 12 month's earnings, and 15 times FY99 earnings. At the high of 70 last fall, the stock was trading about 35 times the forward 12 month earnings at the time, and on its double low of about 30 in Dec and Mar, it was trading about 14-15 times consensus forward 12 month earnings. This is why I have been buying this stock lately, the latest purchase at 35 on Thursday.
And the same analysis could be done on most of the sector leaders, like SCI, SLR, FLEXF, DIIG etc. I believe the market just doesn't like the downside surprises these companies sometimes spring on their shareholders. But in my view, its all statistical noise and nonsense. These companies will all grow over the long term (3-5 years) at a rate above the sector rate of 25%. Any drop-off in growth should be temporary. So if we hold several of the stocks, then we should see at least the 30-35% return due to sector growth, plus possible a multiple expansion. In some cases, I believe we will also see a margin expansion (like FLEXF) over time.
Right now the top dogs, SLR and SANM, are trading at 24 and 36 times the next 12 month earnings respectively. I see SANM as fully valued at this time, and SLR could surprise with upside growth, but neither is a buy IMO at the current price. At their lows last December, SLR traded at 15 times forward 12 month earnings, and SANM at about 19 times. But they are the trend-setters for the sector.
FLEXF is trading at 21 times consensus forward 12 months earnings, and since I believe the consensus is low, about 17-18 times my estimate. I continue to hold a large position there, waiting for the inevitable earnings upward revisions. DIIG looks interesting here at only about 12 times forward 12 month earnings. The Orbit snafu has taken the stock down from the 16-17 times forward earnings it hit last fall. DIIG has got a lot of uncertainty priced into the stock price.
Hadco has a much lower PE, but as a boardmaker, is facing some pricing pressure right now, and its long term growth rate should be in the 15-20% range, versus 30% for the top tier assemblers. Nevertheless, the stock looks interesting at the current valuation.
In summary, the market continues to price most of these stocks well below their LT growth rates. I believe this is due to the periodic stumbles that companies in this sector seem to experience. But I think , as these companies grow and diversify their customer base, there is less liklihood of a really serious stumble, so I don't believe this risk discount is appropriate. The underlying fundamentals in these stocks, simply do not change all that fast, or all that much.
This leaves an investor who can time his entry points well, an excellent opportunity to achieve above average investment returns. It also means, that an adroit trader, should be able to make some money trading against the excessive volatility in this sector.
Paul |
