Neutral on Jabil – Analyst Blog

We have a Neutral rating on Jabil Circuit, Inc. (JBL) with an expectation of revenue growth based on a recovery in the overall EMS industry in the current year and next, aided by an improving economic environment and a rise in the IT spending.

EMS Industry Expected to Grow

We believe that the EMS industry is well positioned to demonstrate strong growth over the next few years, driven by non-traditional or emerging EMS sectors such as industrial and medical and improving technology spending.

While the trend towards outsourcing in networking, enterprise computing, consumer electronics and other sectors are mature, JBL is seeking other sectors to drive growth all over again. Further, growth in consumer electronics will benefit Jabil, moving forward.

Although Jabil’s EMS division fell in 2009 due to weak end market demand, we expect the company’s EMS revenue growth to be fueled by growth in both traditional and non-traditional sectors in 2010.

We also believe the strong performance of non-traditional sectors, diversity in its revenue channels and a customer base across the globe should help Jabil deliver higher revenue growth in 2010.

However, the EMS industry is more sensitive to the overall economy than their customers. This volatility can cause significant drops in the stock prices if overall economic activity slows. Slowing of certain end-markets can exert significant pressure on contract manufacturers as excess inventory is absorbed. This causes utilization levels to fall, stretching already thin profit margins.

Further, slower industry growth means that competition between the companies has become more intense. Jabil’s main competitors include Hon-Hai Precision Industry (operating under the brand name Foxconn), Flextronics International Ltd. (FLEX), Celestica Inc. (CLS), Sanmina-SCI Corp. (SANM), Benchmark Electronics (BHE) and Plexus Corp. (PLXS) as well as other EMS companies.

Results and Outlook

Despite the unfavorable seasonality, Jabil had earlier posted year-over-year growth in profit for the second quarter of 2010, benefiting from significant year-over-year margin expansion on modest revenue growth. Management said that since fiscal 2004, the results for the second quarter of 2010 represented the lowest sequential decline in revenue and core operating margin.

During the second quarter earnings, Jabil provided a decent outlook for the third quarter. The company expects net revenue for its third quarter of 2010 in the range of $3.1 billion to $3.3 billion, an increase of 3% to 10% sequentially.

The EMS division is expected to grow 8% sequentially, while the consumer division is expected to grow 5%. The AMS division is expected to have consistent revenues with those of the second quarter.

Core operating income is expected in the range of $100 million to $120 million, a growth of 4% to 25% sequentially. As a result, core operating income margin is expected in the range of 3.2% to 3.6%.

The guidance mid-point represents a revenue growth of approximately $600 million or 22% on a year-over-year basis, while core operating income represents a growth of $80 million or 81% on a year-over-year basis.

Core EPS for the third quarter is expected to be 30 cents to 36 cents, a growth of 3% to 24% sequentially. In our view, this is very positive, as results continue to improve.

Valuation

Shares of Jabil are trading at a multiple of 16.4x our fiscal 2010 EPS estimate of $0.99, a slight premium to the industry. Given improvements in JBL’s operations, strength in the non-traditional sector, new business wins and expectations of potential revenue growth from a recovery in the EMS industry, we do believe that the stock should trade at a P/E closer to its 5 year growth rate of 17.2%.

The company’s business outlook is improving as a result of improving end-market demand. However, higher spending, rising inventory levels and intense competition will be a drag on near-term results.

However, we would like to be on the sideline till we get more clarity on the recovery of the business. Our long-term recommendation for Jabil is Neutral. Our price target of $17.00 represents a P/E multiple of 17.2x estimated 2010 EPS, a premium to its peers.