Reason for Report: 2Q08 Earnings Update
Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 2Q08 Earnings Update
Prev. Ed: July 7, 2008; Initiation of Coverage by A broker (broker material considered till July 3)
Brokers’ Recommendations: Neutral: 66.7% (6 firms); Positive: 22.2% (2); Negative: 11.1% (1) Prev. Ed.: 7, 3, 1
Brokers’ Target Price: $17.00 (↓ $4.06 from the last edition; 6 firms) Brokers’ Avg. Expected Return: 17.2%
Note: A flash update on 2Q08 earnings was done on July 24, 2008.
*Note: Though dated July 31, share price and broker material are as of July 28.
Portfolio Manager Executive Summary
Benchmark Electronics, Inc. (BHE or the Company) has grown to be the third-largest virtual electronic manufacturing services provider in the world by offering a full range of services to OEMs primarily seeking low to medium full system assemblies on a turnkey basis. Its services include design, prototype, material procurement, printed circuit board and full-system assembly, test, logistics and aftermarket support. Benchmark operates sites in nine countries (US, Ireland, Mexico, Brazil, Singapore, The Netherlands, Romania, China, and Thailand).
Key factors for determining an investment strategy for BHE are as follows:
· BHE is a leading provider of electronics manufacturing services to electronics OEMs.
· BHE’s customers include major OEMs focused on telecommunications equipment, computers, industrial control equipment, medical devices, video/audio/entertainment products, and testing and instrumentation products.
66.7% of the firms rated the stock neutral, 22.2% positive, and 11.1% negative. Brokers’ target prices range from a high of $19.00 to a low of $14.00 with an average of $17.00. Firms expect a return of 17.2% from the stock based at the current price.
Bulls – (Equivalent ratings: Buy and Overweight) – 2 firms or 22.2% – Target price provided by one firm (Needham) is $18.00. The firms hold a positive view on the stock and prefer to buy the stock at current levels. The firms see the Company’s increasing backlog of incremental business as a positive for the stock, and believe it will expand its margins going forward.
Neutral Stance – (Equivalent ratings: Hold, Peer Perform, and Market Perform) – 6 firms or 66.7% – Target price estimates provided by this group of firms range from $16.00 to $19.00. The firms believe BHE is well-positioned with consistent long-term growth trends, but remains susceptible to the near-term macroeconomic challenges.
Bears – (Equivalent ratings: Sell and Underweight) – 1 firm or 11.1% – The lone bearish firm (Merrill) provided a target price of $14.00. The Company‘s exposure to telecom and enterprise computing markets remains a cause of concern. Further, the Company‘s leverage opportunities will be offset by the end market demand pressures.
Long-Term Outlook: Operating in the printed circuit boards industry, BHE is well positioned in the manufacturing electronics market and will continue to grow over the longer term as it becomes more efficient and continues booking new programs. BHE with a total market capitalization of $988.8 million competes with FLEX and JBL. Unlike its competitors in the EMS and original design manufacturer (ODM) markets that aim at high-volume, low-margin business, Benchmark’s strategy is to drive topline growth through lower production volumes that require flexibility and personalized customer service. One firm (Zacks Investment Research) believes that BHE is better positioned than its peers in non-traditional markets such as Medical and Test & Instrumentation. Firms believe the Company will achieve growth rates in the intermediate term (next 1–2 years) because of its significant amount of new contract wins. However, in the longer term, the Company will face risks, which include the cyclical nature of order wins and the general inconsistency in EMS demand, a largely undiversified revenue base (top two clients, SUN and EMC represent a substantial part of revenue), and competition risk with Tier-I EMS providers. Firms expect total revenue to increase at a 3-year CAGR (’07-’10) of 2.2%, net income at a CAGR of 4.0% (’07-’10), and cash flow from operations at a CAGR (’07-’10) of (22.7%). The Digest average long-term growth rate is 17.5%.
July 31, 2008
Recent Events
On July 24, 2008, BHE announced its 2Q08 financial results. 2Q08 revenue was $682.4 million versus $756.3 million in 2Q07. 2Q08 GAAP net income was $22.4 million, or $0.33 per diluted share versus $25.9 million, or $0.35 per diluted share in 2Q07. On a non-GAAP basis, 2Q08 net income and EPS were $23.6 million and $0.35, respectively versus $28.6 million, or $0.39 per diluted share in 2Q07.
Overview
Firms have identified the following factors for evaluating the investment merits of BHE:
Key Positive Arguments / Key Negative ArgumentsStrong Fundamentals
· The Company has a strong balance sheet and positive net cash and ROIC above its cost of capital.
· The Company is a top quality supplier with strong execution and services that carries industry-leading financial metrics and returns.
· BHE can drive revenue and earnings growth and sustain strong cash flow regardless of end-market conditions through strong new win rates and share gains.
Competitive Position
· Focus differentiates BHE from its high-volume peers. BHE concentrates on low-volume production that requires increased flexibility and more intense customer service.
· Additional revenue expected from new contract wins. / Competitive Threat
· Highly competitive and fragmented industry where competitors with greater resources often target market share at the expense of margins.
· The Company is trying to switch to a lower cost structure in a price competitive market, which could affect the overall profitability of the Company.
New Program Costs
· Higher-than-anticipated new program costs and pricing pressure may tend to lower margins.
· Inability to improve gross margin because of difficulty in ramping new or existing programs might hinder BHE’s growth.
Pricing Pressure
· Pricing and utilization trends in the EMS industry could be a cause of concern.
Customer Base
· BHE’s two largest customers, Sun Microsystems and EMC, could lead to greater revenue volatility.
Texas-based Benchmark Electronics, Inc. (BHE or the Company) provides electronics manufacturing services (EMS) to original equipment manufacturers (OEMs). The Company offers design (Computer Assisted Engineering, Computer Assisted Design (CAD), engineering for manufacturability, circuit board layout, prototyping and test development) and manufacturing (printed circuit boards and subsystem assembly, box build and systems integration) services. It also provides engineering services including product design, printed circuit board layout, prototyping, and test development. BHE offers services to OEMs of telecommunication equipment, computers and related products for business enterprises, video/audio/entertainment products, industrial control equipment, testing and instrumentation products, and medical devices in the United States, Brazil, China, England, Ireland, Mexico, Singapore, and Thailand. Additional information on BHE is available at its website: www.bench.com.
Note: BHE’s fiscal year ends on December 31.
July 31, 2008
Revenue
Provided below is a summary of total revenue as compiled by Zacks Research Digest:
Revenue in $ M / 2Q07A / 1Q08A / 2Q08A / 3Q08E / 2007A / 2008E / 2009E / 2010EZacks Consensus / $668.00 / $2,847.0 / $3,053.0
Digest Average / $756.3 / $684.3 / $682.4 / $664.6↓ / $2,915.9 / $2,732.9↓ / $2,898.8↓ / $3,109.0↓
Digest High / $756.3 / $684.3 / $682.4 / $673.1 / $2,915.9 / $2,774.7 / $3,091.9 / $3,150.0
Digest Low / $756.3 / $684.3 / $682.4 / $650.0 / $2,915.9 / $2,716.7 / $2,788.7 / $3,068.0
Y/Y Growth / 0.9% / -9.1% / -9.8% / -1.2% / 0.3% / -6.3% / 6.1% / 7.3%
Q/Q Growth / 0.5% / -6.8% / -0.3% / -2.6%
Co. Guidance / $650.0-$690.0
According to the Zacks Digest model, 2Q08 total revenue was $682.4 million, down 9.8% y/y and 0.3% q/q and below the guidance range of $715.0 million - $750.0 million. The quarter’s results were also below the Street consensus of $727.0 million. The revenue softness was attributed to the sharp decrease in the volumes of 2-3 mature programs in Computing in addition to the particularly weak demand conditions in semiconductor equipment.
During 2Q08, BHE’s largest customer, Sun Microsystems, accounted for 17.0% of total revenue versus 19% in 1Q08, showing an 11.0% q/q decline. According to one firm (J.P. Morgan), the decline was due to the negative impact of product transitions for the V490 and V890 and some Galaxy servers.
Provided below is a summary of segmental revenue as compiled by Zacks Research Digest:
Segment Revenue in $ M / 2Q07A / 1Q08A / 2Q08A / 3Q08E / 2007A / 2008E / 2009E / 2010EMedical Devices / $97.1 / $89.4 / $95.5 / $96.3↓ / $365.6 / $383.4↓ / $437.0↓ / $0.0
Telecommunications / $105.8 / $116.2 / $119.5 / $121.2↓ / $433.8 / $483.8↓ / $534.1↓ / $0.0
Computer Systems / $408.4 / $349.0 / $327.7 / $310.0↓ / $1,550.0 / $1,322.7↓ / $1,377.3↓ / $0.0
Test & Instrumentation / $53.9 / $33.9 / $31.3 / $28.1↓ / $184.8 / $121.8↓ / $119.8↓ / $0.0
Industrial Controls / $91.2 / $95.8 / $108.4 / $107.8↑ / $385.6 / $421.6↑ / $478.5↑ / $0.0
Total Revenue / $756.3 / $684.3 / $682.4 / $664.6↓ / $2,915.9 / $2,732.9↓ / $2,898.8↓ / $3,109.0↓
Provided below is a graphical analysis of segmental revenue:
Medical Devices (14.0% of 2Q08 total revenue): Medical revenue was $95.5 million in 2Q08, down 1.6% y/y but up 6.9% q/q. Major customers in this segment include Medtronic, Siemens Medical, Abbott labs, St. Judem, and Guidant.
Telecommunications (17.5% of 2Q08 total revenue): Telecommunications revenue was $119.5 million in 2Q08, up 13.0% y/y and 2.9% q/q. Telecommunication includes manufactured equipment for customers such as Tekelec, ADCT, and Motorola.
Computer Systems (48.0% of 2Q08 total revenue): Computing revenue decreased 19.8% y/y and 6.1% q/q to $327.7 million in 2Q08 due primarily to the weak sales to the segment’s largest customer, Sun Microsystems.
Test & Instrumentation: (4.6% of 2Q08 total revenue): Test & Instrumentation revenue was $31.3 million in 2Q08, down 42.0% y/y and 7.8% q/q. The decline was due to the weakness in the semiconductor equipment market. Key customers include Agilent, Applied Materials, Credence and Texas instruments.
Industrial Controls: (15.9% of 2Q08 total revenue): Industrial control revenue was $108.4 million in 2Q08, up 18.9% y/y and 13.2% q/q. Key customers include Emerson, Honeywell, and Fluke Electronics.
Outlook
For 3Q08, BHE expects sales of $650.0 million to $690.0 million. For FY08, BHE declined to reiterate its prior revenue outlook for 2-5% growth. However, the Company did indicate that it expects 4Q revenue to improve sequentially based on the materialization of recent wins and new product ramps.
A total of 17 program wins booked in 2Q08 (versus 10 program wins in 1Q08) with an expected annual revenue run rate ranging from $86-123 million, which should benefit the topline in the beginning of FY09.
One firm (Raymond James) cautions that revenue estimates remain at risk due to the Company’s large exposure to a sluggish computing (48.0% of 2Q08 total revenue) business that is very vulnerable to the macroeconomic turbulence.
One firm (J.P. Morgan) observes limited visibility with regard to the timing and pace at which Benchmark’s new programs will ramp up and notes that faster-than-expected ramps could cause it to increase its estimates.
For more details on individual analyst opinions, please refer the ‘Consensus’ tab of the BHE spreadsheet.
Margins
Provided below is a summary of margins as compiled by Zacks Research Digest:
Margins / 2Q07A / 1Q08A / 2Q08A / 3Q08E / 2007A / 2008E / 2009E / 2010EGross / 7.2% / 6.6% / 6.7% / 6.8%↓ / 6.8% / 6.8%↓ / 6.9%↓ / 7.0%↔
EBITDA / 5.1% / 4.6% / 4.9% / 5.0%↔ / 4.9% / 5.0%↑ / 5.2%↑ / 5.1%↑
Operating / 4.0% / 3.2% / 3.4% / 3.4%↓ / 3.6% / 3.4%↓ / 3.7%↓ / 3.7%↓
Pre-Tax / 4.3% / 3.9% / 3.8% / 3.9%↓ / 3.8% / 3.9%↓ / 4.1%↓ / 4.1%↔
Net / 3.6% / 3.4% / 3.4% / 3.4%↓ / 3.3% / 3.4%↓ / 3.6%↔ / 3.5%↔
According to the Zacks Digest model, gross margin in 2Q08 was 6.7%, a decline of 50 basis points (bps) y/y but an improvement of 10 bps sequentially. The sequential increase was primarily attributed to the decline in revenue offset by lower SG&A expense. Gross profit was $46.0 million, down 15.6% y/y but up 1.8% q/q.
SG&A expense (3.3% as a percentage of total revenue) was $22.3 million in 2Q08, down 5.5% y/y and 3.0% q/q.
Operating income in 2Q08 was $23.4 million, a 22.9% decrease from $30.4 million in 2Q07 but a 6.2% increase from $22.1 million in 1Q08. Operating margin amounted to 3.4%, a decrease of 60 bps y/y but a 20 bps increase sequentially. The lower SG&A expense as a percentage of sales and improved gross margin resulted in the sequential operating margin improvement.
Interest and other income in 2Q08 was $2.3 million, a decrease of 22.5% from $3.0 million in 2Q07 and 47.2% from $4.4 million in 1Q08. Pre-tax profit in 2Q08 was $25.8 million, a decline of 21.5% from $32.8 million in 2Q07 and 2.8% from $26.5 in 1Q08. Pre-tax margin in 2Q08 stood at 3.8%, a decrease of 50 bps y/y and 10 bps sequentially. The effective tax rate in 2Q08 was 11.9% versus 16.5% in 2Q07 and 13.4% in 1Q08. Net margin in the quarter was 3.4%, down 20 bps y/y but flat sequentially.
Outlook
Management has not provided any specific guidance for 3Q08 and FY08. But expects SG&A expense to be roughly flat for the next few quarters. Management expects a tax rate of 12.0%-13.0% for 3Q08.
With the shift of BHE’s operations to the low-cost regions in Brazil, Mexico, Romania, China, and Thailand, one firm (Zacks Investment Research) expects margin improvements going forward.
As per the Zacks Digest model, COGS would decrease by 6.2% y/y in FY08 but increase by 5.9% in FY09 and 7.1% in FY10; and SG&A expense would decrease by 3.9% y/y in FY08 but increase by 1.7% in FY09 and 11.0% in FY10. In comparison, revenue would decrease by 6.3% y/y in FY08 but increase by 6.1% in FY09 and 7.3% in FY10.
For more details on individual analysts opinions, please refer to the ‘Consensus’ tab of the BHE spreadsheet.