This Tech Company Lowered Guidance, Who's Next?

Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

With a background of global growth slowing and worries over emerging markets, investors could be excused for bracing themselves for the latest results from IT focused contract manufacturer Jabil Circuit Inc (NYSE: JBL) and they certainly didn’t fail to disappoint. Margins are under pressure and end markets are weakening, it’s a tough environment out there. Whether this is already priced into the stock or not is anybody’s guess. I want to dig deeper into the results and see what we can read across from them into other companies and industries.

 

Jabil Circuit’s Q4 Results

A quick summary of the headline results and guidance

  • Q4 Revenues of $4.3 billion vs. estimates of $4.2 billion
  • Q4 Non-GAAP EPS of 54c vs. estimates of 58c
  • Q1 Revenue guidance of $4.3-4.5 billion vs. estimates of $4.5 billion
  • Q1 Non GAAP EPS guidance of 51-62c vs. estimates of 67c

 

Revenues came in better than expected but margins are under pressure and the revenue and earnings guidance is weak. The problem is not only a weakening global environment, but also an ongoing structural shift in IT spending from hardware towards software and services.  The value of the intellectual quotient in the average IT good is increasing and hardware spending is losing out as a consequence.

From a geographic perspective a familiar refrain was heard. Asia and Americas revenues were described as stable while Europe was described as ‘very poor’.  In response I would contribute my refrain that Europe has been weak for a while now and as this weakness ‘anniversaries’, growth numbers for the region will look better for some companies. I wouldn’t discount the potential for the Euro Zone debt crisis to flare up again but I think the greatest uncertainty lies with emerging market growth prospects.

Jabil reports in three business segments of which the revenue share is as follows.

<img src="/media/images/user_12882/jabil1_large.png" />

The surprise for Jabil came in the diversified manufacturing services (DMS) segment where growth was at 12% when 17% had been expected.Part of the problem here is that it has been ramping up capital expenditures in order to manufacture casings for Apple’s (NASDAQ: AAPL) iPhone. Apple is a very important customer for Jabil and is believed to be responsible for around 10% of its sales. Understandably it is not keen to disclose too many details about its work for Apple but it would come as no surprise if the operational disappointment here was due to meeting Apple’s exacting standards. Great for Apple shareholders and device users, but not so good for Jabil Circuit.

High velocity services (HVS) actually declined less than expected by 10% when 22% had been forecast previously. However I wouldn’t get too excited because HVS sales are expected to decline 24% in the next quarter.

 

Industry Read Across by Segment

The intriguingly named HVS segment largely comprises of automotive systems, set top boxes, printers, circuit boards and point-of-sale solutions. Automotive appears to be doing well, but there is weakness in the set top boxes and mobile handsets. Rather surprisingly the printers business was described as being ‘strong’.

Turning to the DMS segment it was a mixed picture. Specialized services (24% of total revenue) growth was good with the under performance coming from healthcare & instrumentation (8%) and industrial and clean tech (12%). The problem here is due to three reasons.

First, Governments around the world are cutting back on clean technology and solar investment. They are simply not areas that many countries are willing to subsidize in the way that they have done previously.

The second reason is that the dynamics of the solar industry are changing. It is no longer the nascent high initial capital investment industry it once was and has now matured to a lower investment phase where rampant Chinese price competition has made conditions very hard for global OEMs.

And finally, Government spending on defense and aerospace has been underperforming as austerity driven cutbacks start to bite. In addition, I think there is a long term tendency with defense spending to shift towards intelligent systems from hardware spending.

 

What This Means to Who

Jabil’s competitor Flextronics (NASDAQ: FLEX) covers many of the same markets and with 26% of its sales in ‘high velocity solutions’  there is cause for concern. The company has forecast mid single digit growth in this segment for the September quarter. In light of what Jabil just reported , investors have the right to question this. However, Flextronics has a large part of its revenues in Integrated Network Solutions (communications, networking, storage) which are areas where Jabil is doing okay.

It is a similar story at a rival contract manufacturer Sanmina-SCI (NASDAQ: SANM) which recently gave notice of some divergence in its end markets. Just like Jabil it is seeing strength in communications, medical and aerospace, but areas like computing and storage are flat. Meanwhile the real weakness is in traditional IT contract manufacturing areas like circuit board printing and mechanical components. Sanmina previously said that defense revenues were good, but I'm wondering if this will be the case following Jabil's commentary.

With regards the specific weakness expressed in solar and capital spending in their industry.  I think investors in Applied Materials (NASDAQ: AMAT) should take note. The company has gone to great lengths to position itself in solar. It's not something that AMAT shareholders don’t know about, new orders in the energy & environmental solutions (EES) division were down to just $35 million in the quarter from $318 million last year. However, Jabil's weal commentary suggests more restructuring costs could be on the way for AMAT. A turnaround in solar doesn't look likely anytime soon.

For Jabil shareholders, the proposition remains the same. It is a geared play on global growth with a growth kicker from potential blockbuster sales of Apple's new iPhone. If you like both then pick some up but don't expect Jabil to do well if the economy carries on slowing.

 


SaintGermain has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple. Motley Fool newsletter services recommend Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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