Buy This Contract-Electronics Manufacturer on a Pullback

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Flextronics International (NASDAQ: FLEX) is in the business of providing design and manufacturing services to original-equipment manufacturers (OEMs) across the globe. The company has been in the news of late after landing a contract to assemble Google's latest smartphone, the Moto X. But before investors give in to the hype around the Moto X and how it will impact Flextronics' results, it is important to look at its recently-declared first-quarter report, which wasn't all that pretty.

A mixed performance

Flextronics' revenue declined 3.1% from the year-ago quarter to approximately $5.8 billion. This decline was primarily due to weakness in the telecom end-market. The company saw a decline across all segments, except high reliability solutions, which increased 16% year-over-year while the high-velocity-solutions segment remained flat.

Flextronics reported earnings per share of $0.16, which beat consensus estimates of $0.12, but nevertheless declined $0.05 per share from the year-ago quarter. SG&A expenses as a percentage of revenue increased 60 basis points, as a result of which the operating profit margin saw a contraction of 60 basis points. Also, net income as a percentage of revenue declined from 2.4% in the year-ago quarter to 1.8% this time.

Looking ahead

Flextronics recently concluded a deal to acquire Motorola’s manufacturing facility, equipment and employees in Tianjin, China and Jaguariuna, Brazil for an undisclosed amount. This makes Flextronics the biggest outsourcing partner for Motorola. These acquisitions are expected to provide growth to high-velocity solutions to the tune of 20% to 30% in fiscal 2014.

Late last year, Flextronics also acquired Michigan-based Saturn Electronics & Engineering. More than 70% of revenue of Saturn comes from the automotive sector. This acquisition will help Flextronics further enhance its visibility and presence in the automotive market going forward. The auto sector is on a roll, and this should help Flextronics improve its revenue in the future.

Acquisitions have always been at the core of the growth policy at Flextronics--in fact, over the last three years it has acquired 11 companies. In the first half of 2013, it acquired three companies catering to different markets like medical, manufacturing, hardware and LED design.

The company has also been restructuring by exiting from non-core areas by way of divestitures and also incorporating newer technologies for reduced costs, increased efficiency and productivity. New initiatives from ongoing investments are expected to yield higher volumes in fiscal 2014, with profitability remaining flat as a result of investments.

Other contract manufacturers

Jabil Circuit (NYSE: JBL) and Plexus (NASDAQ: PLXS) provide stiff competition to Flextronics, and this is something that is going to be a matter of concern going forward.  

Jabil's 3Q13 results were mixed. It beat consensus estimates on earnings but missed on revenue, which increased 5.1% from the year-ago quarter to $4.5 billion.

Jabil recently acquired privately-held Nypro for $665 million. This acquisition will boost Jabil’s position in key markets such as medical and healthcare. It will also help Jabil venture into the packaging market. Jabil plans to use the Nypro trade name for the purpose of jointly marketing its services in the healthcare and packaging industry.

Given a healthy cash balance, future acquisitions aren’t ruled out, although Jabil isn’t a frequent acquirer. The latest acquisition should start becoming accretive from fiscal 2014. 

Plexus posted its latest quarterly results last month, which saw earnings per share of $0.68 beat consensus estimates by $0.10 per share. Revenue came in at $571.9 million, which again beat consensus estimates.

Plexus has landed 28 new wins in the manufacturing-solutions group this year. This is expected to generate $210 million per year in revenue once production is ramped up. It also won a number of new contracts from GE Healthcare. Also, it has been consolidating its operational facilities in low-cost regions, as a result of which margins are expected to get better.

Conclusion

Flextronics operates in a difficult industry with strong competition around it. Jabil is its most potent threat and its latest acquisition of Nypro could make the going more difficult for Flextronics. But Flextronics' latest acquisitions, which make it the largest outsourcing partner for Motorola, might result in solid revenue gains in the future.

But the stock is trading close to its 52-week high and trades at a rich PE multiple of 29x while Jabil trades at half that multiple. So investors should wait for a significant pullback before buying shares of Flextronics for their portfolio.

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