Why Flextronics Is Not a Good Buy

Electronics manufacturing services provider Flextronics International (NASDAQ: FLEX  ) has underperformed ever since the company reported its second-quarter results in October. Flextronics was trading at a rich valuation of around 30 times earnings before reporting results. Being the manufacturing partner of Google (NASDAQ: GOOGL  ) for the Moto X and Microsoft for the Xbox One, investors were expecting a robust outlook from Flextronics.

However, the stock is down close to 20% over the last three months, with much of that decline attributable to a weak third-quarter outlook. Flextronics management cited "near-term pressure from the broader demand environment" as the reason behind a subdued outlook.

But then, management is optimistic that Flextronics is well-positioned in the long run. But, should investors buy into the long-term optimism at a trailing P/E of almost 28, especially considering there is a cheaper alternative available?

Not a pretty picture
Flextronics' financial performance hasn't been great. Its revenue grew 3.8% in the previous quarter, while net income was down 21% as compared to the year-ago period. The company suffered from operational inefficiencies and higher start-up costs associated with its new program ramp ups. In addition, Flextronics is also experiencing softness in its end markets as three of its four business segments are expected to decline into the single digits in the ongoing quarter. 

Networking, industrial, and the high-reliability solutions businesses are facing weakness due to various reasons. Weakness in telecom, semiconductor equipment sales, and the medical device market are dragging Flextronics down, offsetting the tremendous growth seen in high-velocity solutions. 

A key partnership
Revenue from high-velocity solutions was up 36% on a sequential basis in the previous quarter, accounting for almost a third of overall revenue. This segment is expected to grow another 15%-20% in the current quarter, with majority of the revenue coming from Flextronics' Google partnership.

In September, Flextronics was assembling 100,000 units of the Moto X every week at its Texas facility. Also, Motorola management had stated that Flextronics is capable of assembling "tens of millions" of phones a year, if needed. This suggests that Google plans to stick to Flextronics as its manufacturing partner in the foreseeable future, and it wasn't surprising when it chose Flextronics once again to manufacture the lower-cost Moto G after sales of the Moto X ran into rough weather.

Reviews suggest that the Moto G is one of the best smartphones under the $200 price point and Google is looking to tap into the emerging markets with this device.  Hence, Flextronics might be producing more units of the Moto G considering the fact that it is aimed at a fast-growing market. According to IDC, the sub-$200 smartphone segment will be the driving force behind higher smartphone shipments going forward as such phones are priced well for emerging markets. 

Jabil Circuit: A better buy
But Flextronics' Google partnership pales in comparison to its rival, Jabil Circuit (NYSE: JBL  ) . Jabil is manufacturing partners with Apple, a relationship that began last year when it started manufacturing the aluminum casing for the iPhone 5. Apple contributed 20% to Jabil's top line last quarter. So, Jabil has a high-volume smartphone player on its client list, and is way cheaper than Flextronics.

Jabil's P/E ratio of 11 is less than half of Flextronics'. In addition, Jabil also has a dividend yield of 1.60% while Flextronics does not. So, investors looking for a value pick in electronics manufacturing services would be better off buying Jabil as the company has strong catalysts ahead of it.

What next for Flextronics?
Flextronics' valuation is not in its favor. The company is facing short-term weakness and as such, there might be a better point of entry in the future.

It cannot be denied that Flextronics is making some good moves -- such as its Google partnership and the recent acquisition of RIWISA, which provides automated precision plastic solutions for the medical industry. Flextronics has also improved its standing at Google and is manufacturing the Chromecast devices. In addition, Flextronics is reported to be manufacturing 90% of the Xbox One units.

Hence, the company does seem to have good prospects, but investors should consider waiting for a better entry point as its valuation doesn't justify its financial performance yet.

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