<DAILY DOUBLE>
Thursday, January 7, 1999
Solectron Corp.
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Phone: 408-957-8500
Website: http://www.solectron.com
Price (1/6/98): $86 1/16
HOW DID IT DOUBLE?
Electronic contract manufacturing (ECM) companies as a group have been absolutely scorching investments over the past three months. If it weren't for the Internet stocks hogging all the ink, the rise of the group as a whole would certainly be making more headlines. A look at the charts of some of the largest names in the business, including Plexus Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PLXS)") else Response.Write("(Nasdaq: PLXS)") end if %>, Jabil Circuit <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JBL)") else Response.Write("(NYSE: JBL)") end if %>, and SCI Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SCI)") else Response.Write("(NYSE: SCI)") end if %>, show a remarkable similarity -- a minor dip in October followed by an impressive bounce to new highs. Owners of the largest name in the sector, Solectron Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLR)") else Response.Write("(NYSE: SLR)") end if %> have also found their shares recently doubling.
Solectron's earnings are certainly not the primary reason behind the move, even though they have been showing modest increases of late (quarterly earnings reported last month were up 37% versus the previous year). When a company moves in sync with its peers, like Solectron has, it is likely that an improvement in the entire sector is behind the stock. While the ECM business has had minor changes in its fundamentals over the past quarter, the perception about the economy and the market has drastically changed. The worries about a global slowdown have been replaced with worries about missing out on the bull market in technology stocks. The result has been stocks in the sector, intimately tied to the fortunes of the electronics industry as a whole, moving skyward.
BUSINESS DESCRIPTION
Solectron is the world's largest provider of contract manufacturing services for electronics original equipment manufacturers (OEMs). Instead of attempting to manufacture complex circuit boards themselves, companies can outsource their manufacturing operations to outfits like Solectron. OEMs can then take advantage of Solectron's expertise and economies of scale as well as reduce their own investment outlay in plants, equipment, and labor. Outsourcing is hot, and Solectron has been riding the wave.
Solectron's customers read like a Who's Who in the technology arena, including Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>, Cisco Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>, and Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>. These companies come to Solectron because they've learned that Solectron can execute many highly specialized manufacturing tasks more cheaply and efficiently.
On December 21, 1998 it was announced that Solectron was going to be added to the S&P 500 index.
FINANCIAL FACTS
Income Statement
12-month sales: $6,097.1 million
12-month income: $217.8 million
12-month EPS: $1.79
Profit Margin: 3.6%
Market Cap: $11,076.2 million
Balance Sheet
Cash: $194.8 million
Current Assets: $2,106.4 million
Current Liabilities: $1047.4 million
Long-term Debt: $387.8 million
Ratios
Price-to-earnings: 48.1
Price-to-sales: 1.8
Solectron Snapshot
HOW COULD YOU HAVE FOUND THIS DOUBLE?
The ECM industry has some extremely attractive attributes, especially in light of the craze to outsource over the past several years. In fact, the sector was featured in Industry Focus 1998, where "strong growth into the next century" was predicted. While Solectron was not ultimately chosen as the best investment idea in the group, the reasons to be interested in the sector were clearly explained. Industry Focus 1999 also devotes a chapter to the industry, and is certainly worth a read for those interested in learning more.
Occasionally stopping by the Fool's Hall of Portfolios would have been another way to find the company, since Solectron was a member of the Boring Portfolio from late 1996 to early 1997. While the old managers of the Boring Portfolio may have had too quick a trigger finger when they sold the stock back in March of 1997, the company was highlighted in a buy report as well as numerous nightly columns in the portfolio.
WHERE TO FROM HERE?
Solectron has been extremely active recently buying manufacturing assets from the likes of IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> and NCR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NCR)") else Response.Write("(NYSE: NCR)") end if %>. Furthermore, the company has recently filed a $1 billion "shelf" registration for debt securities, which gives the company plenty of additional firepower to grow by acquisition in the coming years. Solectron's purchases have added value in the past, and there's no reason to think the company can't profitably buy more plants in the future. In addition, Solectron's size offers benefits such as distribution efficiencies and buying power.
Investors seem to have a love/hate relationship with the ECM sector, and right now the market loves Solectron and its peers. The multiples assigned to Solectron's stock, however, are now at historically high levels. I think Industry Focus 1999 said it best, "The price you pay for a company definitely has an impact on your returns. The current prices of companies across the sector incorporate a lot of highly optimistic assumptions. While there is good reason to be optimistic about the sector and particular companies in it, an investor making a new entry into the sector would not do poorly to wait for a fatter pitch than the market is currently throwing."
In other words, Solectron is an attractive company, and waiting for the cyclical nature of market perception to swing back to "hate" (with its subsequent lower prices) is a solid strategy. Keeping the stock on the radar while investing in patience seems like the best bet at this point.
-- Paul Larson
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