The Wait Continues for Jabil Circuit


Though corporate changeovers are rare in the stock market, they are not impossible. The Street, nonetheless, will bet the odds that attempts will fail more than they succeed, regardless of how strong a company's management team may be. I can't fault investors for being skeptical, because for every successful conversion like IBM, there are also those that can never seem to get it right (Hewlett-Packard falls in this category).

However, though, I'm not sure where to place Jabil Circuit . While this company is still a leader in electronic manufacturing services, or EMS, Jabil has been working hard to differentiate itself from that business, which involves building/assembling components. But there's been weak demand recently, spurred by the declining PC market.

Consequently, the Street is not ready to price Jabil in a manner that suggests that management can either turn Jabil's fortunes around or that efforts at diversification will be meaningful enough to offset long-term share erosion. While these are valid concerns, I wouldn't count this company out just yet. But Jabil needs to do much better than what it posted in the second-quarter.

Sending the wrong signals
When a company like Jabil is going through periods of transition, the sequential comparisons tend to stand out even more. As noted, Jabil is already strong in electronic manufacturing. But management is pushing hard to get into diversified manufacturing services, or DMS. Unfortunately, Jabil sent the wrong signals to investors and the stock got punished.

First, overall revenue arrived at $4.4 billion, representing a 4% increase year over year. But revenue also declined 4% sequentially from $4.6 million in Q1. Meanwhile, the DMS business, which grew 20% last quarter, decelerated to just 11% growth. This had been Jabil's fastest-growing segment and comprised 47% of the company's overall sales.

So, while the Street was willing to give Jabil the benefit of the doubt in the last quarter, it's tough to feel good about the company's progression. Granted, the macro environment continues to be tough. And I'm willing to concede that the transition to DMS still deserves more time.

What's more, Jabil posted 15% decline in the high velocity segment, which continues to struggle after a 20% decline in the first quarter. There was a point when I thought Jabil looked undervalued. After these results, I can't make this same claim today.

Should we look beyond this quarter?
Aside from the disappointing results, management gave no indication that things will improve, as far as guidance is concerned. Overall revenue is expected to decline 2% for the third quarter. But after that, things were left to speculation. The company expects DMS and the enterprise segment to remain "consistent." In other words, take your best guess. Absent a solid forecast, this tells me that management is unsure of the direction of these businesses.

If there is good news, however, it's that Jabil has some very prominent customers in Apple and BlackBerry to help spur demand. Consider that when the DMS business soared 20% in the first quarter, it was largely due to stronger-than-expected demand for Apple's iPhone 5. Recent reports suggesting that Apple is ramping up iPhone distribution in China, while also planning to release a cheaper version of the smartphone, have to be considered strong catalysts for Jabil.

There are threats even with success
While there are doubts that Jabil can overcome obstacles in execution, there will still be concerns if/when Jabil truly shows signs of success. The company competes with the likes of Flextronics and Benchmark Electronics, which are waiting to see the outcome of Jabil's diversification efforts. There's no shame in emulating success.

These companies are biding their time and watching as Jabil make these investments to build its capabilities. But as soon as they get the signal, both Flextronics and Benchmark will be forced to follow a similar path. Their investors should demand it. Why wouldn't they? I don't believe Jabil is concerned about this today. But at some point, it will affect Jabil's margins if Flextronics can undercut in component builds.

What's it going to be?
That's hard to say at this point. However, for investors with patience, there's blood in the water: The stock is down 5% and is now trading at just 7.5 times fiscal 2013 earnings of $2.44. This is cheap territory. But we're also making a bet that the company can successfully execute its long-term strategy. Second-quarter results were disappointing, yes. But based on projected fiscal 2014 estimates of $2.77 per share, which pushes the P/E lower to 6, Jabil is worth the gamble.

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