A Steep Road to Recovery Lies Ahead for Jabil Circuit

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The year-to-date stock price chart of contract electronics manufacturer Jabil Circuit (NYSE: JBL) closely resembles that of a roller coaster track. After rising steadily in early 2012, the stock has tumbled down as a number of factors have weighed on the company’s performance.

The shares went into another sharp descent after Jabil posted fourth-quarter results. Although the top line was more or less in line with what analysts expected, a gaping miss on the bottom line and a tepid outlook for the ongoing quarter sent shares south.

Jabil’s revenue in the quarter remained stagnant at $4.3 billion from the year-ago period as growth in its Diversified Manufacturing Services business was offset by declines in enterprise & infrastructure and the high velocity business. The company is facing a number of challenges in its end markets due to sluggish economic conditions and it could be quite some time before Jabil investors could heave a sigh of relief. And there a number of reasons why I’m saying this.

Enterprise Under Pressure

Jabil’s enterprise segment has been under pressure for some time now and the story was no different this time. A sluggish economy has led to tighter spending by telecom companies and this has affected performance of equipment makers such as Cisco (NASDAQ: CSCO), which is one of Jabil’s most important customers. As a result, revenue from this segment declined 5% from last year.

Cisco said last month that it expects muted technology spending as carriers are not willing to fire on all cylinders as far as infrastructure build-out is concerned. Moreover, the uncertainty regarding technology spending in Europe is here to stay for a reasonably long time according to Cisco.

Hence, Jabil’s business from Cisco was in for some turmoil as its illustrious client was treading cautiously. And looks like the same happened as Jabil said that it expects only one 10% customer for the current fiscal year as against three last year, with Research In Motion and Apple (NASDAQ: AAPL) completing the line-up. Jabil says that its only 10% customer would be from the diversified manufacturing services segment, and hence, I believe that its business from Cisco has indeed gone down.

Challenges Ahead

Moving on, we come to the high velocity business, which contributes one-fourth to Jabil’s top line and has been struggling. Revenue from the segment dipped 10% from last year as weakness in mobile handsets and set-top boxes eclipsed the positive momentum shown by automotives. It appears that Jabil doesn’t expect much from this segment as high velocity is expected to fall 24% this fiscal year.

However, it is the diversified manufacturing services (DMS) business about which management seemed quite upbeat on the conference call. This segment has grown at an annual rate of 33% over the past three years and contributed 45% to Jabil’s top line last fiscal year. The company is looking to move “deeper and more aggressively” into this market and grow this business further. However, even this positive comes with some significant challenges.

Firstly, Jabil has been facing difficulties in the Clean Tech business, wherein it supplies photovoltaic (PV) modules to solar manufacturers. The solar industry is itself going through tough times as countries are not providing subsidies for solar installations and projects in the same way they used to a couple of years back.

And once you throw in the uncertain economic conditions, the chances for a recovery in clean tech diminish further as governments would rather use their funds somewhere else. In addition, demand in defense & aerospace and industrials is also expected to be muted going forward.

Gratifying Apple Through Pain

However, specialized services under DMS have done pretty well, although at the cost of margins. Jabil makes the aluminum casing for Apple’s iPhone 5 and has made huge investments to meet the smartphone maker’s huge demand. Out of capital expenditures of $481 million incurred during the fiscal year, 70% was allotted to DMS with $202 million of expenditure incurred in the fourth quarter itself.

This suggests that Jabil was ramping up production for the iPhone at a rapid pace and hurt its margins in the process. Apple has already sold 5 million units of the iPhone and is facing challenges to match up to the demand. Hence, Apple is most probably pushing its component suppliers to meet the supersonic demand generated by the iPhone 5; as a result, Jabil’s margins might be in for some more tanking.

But it should be considered that Jabil’s presence in Apple’s books could turn out to be a positive over the long-term. The iPhone 5 has already bettered the iPhone 4S and should eclipse its nearest competitor, the Galaxy S III pretty soon. Hence, Jabil could prove be a good long-term bet once it manages to streamline costs and other areas of its business improve once the economy brightens up.

The Bottom Line

The way I see it, Jabil remains a long play on the economic recovery. If you are willing to buy and hold it for a long, long time, Jabil might prove to be a good buy. However, its high velocity business is doing worse than the other two businesses, which are more or less doing decently under pressure. This is a pretty strong reason why I would prefer to watch Jabil from the sidelines till its high velocity business shows signs of life.

But if you’re willing to wait and are ready to see out the developments in high velocity, a dividend yield of 1.5% might come in handy. What do you think?

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