Tech Data Profits Drop (News) December 1, 1999

Tech Data Profits Drop

By Richard McCaffery (TMF Gibson)
December 1, 1999

Computer products distributor company Tech Data (Nasdaq: TECD) sputtered down more than $1 to about $23 this morning after reporting earnings of $0.60 per diluted share, below last year's mark of $0.63. The results were a penny ahead of analyst estimates.

Falling computer prices and price wars among distributors led to lower results.

Unfortunately, the Clearwater, Florida company doesn't expect things to improve next quarter as customers have delayed purchases because of year 2000 issues. Tech Data officials expect Q4 earnings in the range of $0.64 to $0.69 per share, while analysts expected Q4 earnings around $0.77.

Also, Anthony Ibarguen, Tech Data's president and chief operating officer, announced this morning that he's leaving to join Internet Capital Group (Nasdaq: ICGE), a Wayne, Pennsylvania company that invests in the business-to-business Internet industry. Ibarguen helped Tech Data build sales and rise to prominence over the last three years.

Despite lower profits, third-quarter sales sparkled, with the company reporting revenue of $4.3 billion, up 31.5% from $3.3 billion last year. Sales for the first nine months of 1999 jumped 59% to $12.21 billion, up from $7.68 billion last year.

The stock dipped because of lower Q4 estimates, which means that earnings growth will be pretty much flat in 1999. Tech Data should earn about $2.30 this year, up a penny from last year's results.

Long term, Tech Data is expected to grow earnings about 20% annually. This doesn't match returns in the 40% to 50% range achieved the last two years, but it's respectable.

Investors might look at the company's sales, expected earnings, and price-to-earnings ratio and think the market has missed something. Why would a company expected to grow earnings 20% next year trade at a low P/E of about 10?

The answer: Because sales, earnings, and P/Es don't drive intrinsic value, and the market knows this. Value is created when companies generate increased cash flows and invest it well enough to earn a profit above the cost of capital. Investors that chase companies with low P/Es, therefore, aren't panning for gold, they're turning over rocks.

Now, Tech Data isn't junk. It's a topflight company in its industry and is working to increase efficiencies and add value -- the company transacts more than $2 billion annually in sales over the Internet. But it competes in a supercompetitive industry with very low margins and inventory that declines in value almost by the hour. This makes it awfully hard for the company to defend its turf and turn a buck. Falling computer and computer product prices continue to drive margins lower.

In the third quarter, for example, Tech Data's operating margins held firm at a woeful 2%, but gross margins declined to 5% from 6% a year ago. In other words, the company is selling products at a level about 5% above cost. Those are slim pickins (not to be confused with Slim Pickens).

As a result of increased competition and margin erosion, Tech Data is having more trouble generating cash from operations. Now, cash from operations is not the same as cash flow, which everybody seems to define differently. Cash from operations is the main source of a company's cash-generating power: No cash from operations means no positive cash flow.

Tech Data's Q3 cash flow statement isn't available yet, but for the first six months of the year Tech Data reported negative cash flow from operations of $12.9 million, compared to positive cash flow of $358 million from the same period last year. Heavier interest payments and increased cash outlays to suppliers and employees relative to cash received from customers accounted for much of the difference.

It's been a nasty year for computer distributors, thanks in part to the success of Dell's (Nasdaq: DELL) direct sales model, which skips distributors such as Tech Data and sells directly to end users. The whole industry has fallen out of favor as a result, and it doesn't look like the environment will change anytime soon.

Investors interested in Tech Data, therefore, should look for the company to do more than rack up sales or even generate strong earnings growth. Instead, look for improvements on the cash flow statement and balance sheet in terms of the way it manages assets, and look for it to build value in the services it provides customers.

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