Following Texas Instruments' (NYSE: TXN ) surprisingly bullish revision to second-quarter guidance last week, tech stocks saw a surge. In particular, semiconductors and electronics producers were large beneficiaries of the bellwether's hints of impending economic salvation. The Semiconductor Holdrs ETF (AMEX: SMH ) saw a 2.5% gain last Monday among a mostly flat broader market.
Texas Instruments' rosy forecasts are another signal that things aren't getting any worse. But is now the time to follow the rest of the market and buy into chip makers and other companies that make the components of the electronics that consumers buy in mass during more jubilant times?
The good
Specifically, I decided to look at whether the electronics manufacturers at the bottom of the food chain who've been some of the worst victims of the current downturn are finally on stable enough footing for investors to consider buying.
Electronics manufacturing services providers such as Nam Tai (NYSE: NTE ) , Jabil (NYSE: JBL ) , and Flextronics (Nasdaq: FLEX ) are logical beneficiaries of Texas Instruments' predicting higher demand. As soon as companies like Texas Instruments start receiving more orders, they outsource orders to companies like Nam Tai and Flextronics, which ramp up production.
The larger firms are happy to outsource the hyper-competitive and capital intensive duties to someone else. They'll keep the higher-margin product design and marketing for themselves, thank you very much.
The bad
And companies like Nam Tai and Jabil have been happy to oblige this arrangement. Yet it's easy to see the daunting challenges overseas electronics manufacturers face. There are low barriers to entry, and little ability to differentiate a business and create an economic moat. Throw in a dash of high fixed costs and a hint of low return on those assets, and you've baked a bad business model.
The so ugly it's beautiful
Yet as much as I feel that overseas manufacturing is the Washington Generals of business models, I can't help but cast an admiring eye at Nam Tai and its mixture of consumer and mobile gadgets, the latter of which Texas Instruments proclaimed to be an area experiencing large demand increases this quarter.
A quick glance at the balance sheet shows Nam Tai currently trades at a discount to its cash on hand and carries little debt. Far from being some fly-by-night operation, it is listed on the NYSE and is subject to the increased corporate governance standards that come with it. Also, despite its prolific record as a stable and profitable player in China's electronics manufacturing core, the company still trades at a discount to its closest competitors:
|
Company
|
Cash/Debt (millions)
|
Gross Margins (TTM)
|
Enterprise Value to TTM Sales
|
|
Nam Tai
|
230.2 / 9.2
|
10.1%
|
0.04
|
|
Jabil
|
774.9 / 1,242.7
|
6.5%
|
0.16
|
|
Flextronics
|
1,821.9 / 2,969.6
|
4.6%
|
0.15
|
Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.
Nam Tai is better capitalized than its competitors, has historically (and recently) run an operation with superior margins, and trades at an anemic sales multiple when considering its enterprise value. Investors have seemingly given up on the company's core operations adding any value to the business. In fact, judging by the fact that the company trades at a discount to its net cash, investors seemingly expect the company's core business to destroy existing capital it has on hand.
Yet, that line of thinking isn't totally irrational. Nam Tai will destroy capital in the near term; the company is expected to post continued losses until there is significant rebound in the demand for the underlying mobile gadgets and consumer electronics it makes. Without a sustained improvement of global macroeconomic conditions, the company should prove unable to cut enough costs to be profitable.
Also, the current climate makes unlocking the value of the company's cash more difficult than usual. In better times, a larger competitor might be tempted to gobble up the firm, since the acquisition would be so cheap net of cash. However, Nam Tai's industry is more concerned with survival than opportunistic buyouts that could provide current shareholders a nice profit over the company's current market price.
Finally, the company is extremely reliant on a small group of customers. While Nam Tai counts large, stable industry titans such as Qualcomm (Nasdaq: QCOM ) , Sony (NYSE: SNE ) , and Texas Instruments on its customer list, the combination of its four largest customers made up nearly 58% of its 2008 sales.
Having a couple of customers that could hold a company over a barrel isn't my idea of fun during a recession where sales and margins are already stressed.
Foolish final thoughts
So, Nam Tai's got some warts hiding behind its sterling balance sheet, and faces some challenging quarters ahead. Throughout the market downturn, management has shown a relatively stable and conservative hand. It canceled orders deemed too low-margin, and has run an overall tight ship, although that conservatism also resulted in the company suspending its dividend, which I wasn't as happy about.
While many firms in the semiconductor and manufacturing sectors now face problems because they ignored the cyclical nature of the industry and took on excessive debt, the other side of the coin is that Nam Tai may be beyond a prudent reserve and at a level where it's hoarding cash at shareholders' expense.
Nam Tai does look attractive and I wouldn't fault an investor for taking a look at the cash on hand and buying. Yet I see no rush to jump in at this time. Even before the recession hit full bore, the company was struggling with increased competition that was forcing it to reduce sales to maintain margins. When combined with some of the negatives stated above, I find its business outlook troubling.
Until I see more signs that the company's core business can generate value in the long run, I'll ignore thoughts of buying in on speculative bumps in the road like Texas Instruments' announcement, and closely follow reports and developments from the company itself.
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