Is This Goldman Conviction Buy Really a Buy?

Electronics manufacturing services company Jabil Circuit (NYSE: JBL  ) was down in the dumps late last year after issuing a horrible outlook. But 2014 has started on a positive note for Jabil after Goldman Sachs upgraded the company from Neutral to Conviction Buy. Goldman analyst Mark Delaney is of the opinion that Jabil could be a good long-term buy and the stock's cheap valuation was one of the reasons behind the upgrade.

Delaney has a price target of $20 for Jabil, and believes that the company is in for steady earnings growth after a period of weakness last year. Jabil had to contend with numerous tailwinds at the end of 2013 due to weakness at key customers such as BlackBerry, Apple (NASDAQ: AAPL  ) , and Cisco (NASDAQ: CSCO  ) . However, given the company's cheap trailing P/E of less than 10 and the prospects of its clients engineering a turnaround, Jabil might prove to be a value play going forward.

Apple goodness on the way?
Jabil suffered when BlackBerry's latest turnaround effort -- the BB10 -- failed to take off. As such, Jabil decided to disengage with BlackBerry and instead focus on more profitable propositions. So, the company can now move forward without carrying the baggage of a failed client in the form of the Canadian smartphone maker.

Now, Jabil can focus on better opportunities from Apple. Apple taps Jabil for manufacturing plastic cases for the iPhone 5c and the metal exteriors of the iPhone 5s, according to WSJ. However, the company saw an unanticipated shift in demand from Apple as the iPhone 5c didn't turn out to be as successful as expected. But, Jabil management remarked that "[w]e're well-positioned with this customer, and our relationship is strong. We'll reallocate assets and resources to different revenue streams for the same customer over the next 2 to 3 quarters." 

So, it can be assumed that Jabil is working with Apple for its upcoming products, and the two to three quarter timeline suggests that the company can turn in a strong second half this year. Going by rumors, it is expected that Apple has a strong and innovative pipeline for 2014. Last year, Apple CEO Tim Cook indicated that consumers can expect new (read: innovative) products in 2014, and recent rumors corroborate this claim.

According to the South China Morning Post, Apple could release the next iPhone in two versions with two different screen sizes.  Cupertino is reportedly working upon 4.7- and 5.5-inch versions of the iPhone 6, both of them armed with sapphire displays. Numerous sources across the web carry the same view as Apple is looking to fight the likes of Samsung, LG, and HTC, all of which have been arming their flagships with large screens.

If Apple indeed follows this path, it could bring new buyers into its fold. Bigger screen phones are quite popular in Asian markets such as India and China (20% of smartphones shipped in China last year had at least 5-inch screens), and Samsung expects this trend to carry over into the U.S. and Europe. So, as Apple probably works on better devices and generates higher demand, Jabil's diversified manufacturing segment (DMS) will see better business.

Jabil's DMS segment accounts for half of its top line, and this is the segment that serves Apple. So, with a potential uptick in Apple's prospects this year with bigger phones and a probable iWatch, Jabil can count on this customer for growth.

Another big opportunity
The next important segment which can see an uptick in the long run is enterprise and infrastructure. This business closed the year on a weak note as Cisco, another of Jabil's key customers, reduced its growth forecast. However, Cisco is working on something big in the form of the Internet of Things.

Cisco believes that there will be 50 billion connected objects by 2020, generating a huge stream of data as objects such as alarm clocks and coffee makers communicate with each other. The expected boom in connected devices due to the Internet of Things will result in higher demand for communication equipment, resulting in more business for Jabil.

Final words
Jabil has seen difficult times of late, with shares down close to 20% in the last six months. However, this has made the stock extremely cheap as we saw above. If the company's business gradually picks up going forward, driven by the prospects of its clients, Jabil will be a good buy at current levels.

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