Jabil -- A Treat*
By Dale "Curbludgeon" Wettlaufer (TMF Ralegh)

I think in another universe, where I had unlimited financial resources, at Halloween I'd hand out shares of the most promising companies I know. If you were to come to my door this Halloween, I think I'd hand out shares of electronics contract manufacturer (ECM) Jabil Circuit. And if you were a smart trick-or-treater, you'd think about hanging on to them for a little while.

First, the macro view of the sector. Electronics output is forecast to grow 7% per year, while the contract electronics manufacturers are expected to add 18 percentage points to that growth rate by increasing their share of yearly electronics production. Companies like Lucent Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LU)") else Response.Write("(NYSE: LU)") end if %> and Hewlett-Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> are increasingly outsourcing production and selling production assets to the contract manufacturers. The return on manufacturing is not as high as the return on investment for a purely intellectual property-based company.

That's especially the case with companies that do not run at capacity all the time. Sometimes a company will operate at 120% of capacity and sometimes 70% of capacity, both of which can hurt profitability. Since a well-run contract manufacturer can absorb that volatility and spread out production among a number of different original equipment manufacturer (OEM) clients, companies like Jabil can extract the most profit from the manufacturing process.

Jabil CEO Tom Sansone put it this way earlier this year, "Companies that are fully vertical with deep bricks-and-mortar exposure to product lines wind up with real downside risk anytime that total markets slow down..." Getting rid of that production capacity creates cash flow for OEMs to make acquisitions, gets rid of fixed expenses, and rids their balance sheets of inventory cycles and the attendant financing needs of those cycles. Instead, OEMs can concentrate on new products and product cycles, which is where more of the profit comes from in electronics.

So this is the other part of the growth story for the ECM. Jabil isn't necessarily a buyer of OEM assets, though. It has traditionally relied on greenfield expansion strategies, where it gets production assets at cost, which keeps its return on capital up. Its excellent operations and geographic blossoming have propelled this company into the top tier of contract electronics manufacturers.

Here are the tier-1 ECMs (above $1 billion in revenues) and their trailing twelve-month revenue growth rates:

SCI Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SCI)") else Response.Write("(NYSE: SCI)") end if %>...$6.805 billion...up 18%
Solectron <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLR)") else Response.Write("(NYSE: SLR)") end if %>...$5.288 billion...up 43%
Celestica <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CLS)") else Response.Write("(NYSE: CLS)") end if %>...$1.512 billion...up 65% (through six months)
Flextronics Int'l <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FLEXF)") else Response.Write("(Nasdaq: FLEXF)") end if %>...$1.425 billion...up 117%
Jabil Circuit <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JBL)") else Response.Write("(NYSE: JBL)") end if %>...$1.277 billion...up 31%

As a function of serving high-end customers such as IBM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %> and General Electric <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GE)") else Response.Write("(NYSE: GE)") end if %>, Plexus <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PLXS)") else Response.Write("(Nasdaq: PLXS)") end if %> is also an important industry presence. Plexus has seen revenue growth of only 3%, to $292.2 million, over the last nine months, but the company's return on new invested capital is very good.

For Jabil, fiscal 1998 return on beginning invested capital was 30% while the fourth quarter fell to 24.6%, due to the company's acquisition of a Hewlett-Packard print formatter manufacturing facility during the quarter. Should the company repeat its 1998 performance in the coming year, EPS could get to $2.50, much higher than the currently estimated $2.15.

Valuation-wise, it'd be nice to buy it below $40 per share, but my best estimate of intrinsic value (and that applies to my investment criteria and return needs, which doesn't apply to all investors) falls between $42.50 and $57.05, with $47.21 as the middle of my range (based on multiples-to-cash flow, DCF-to-equity, and DCF-to-firm considered). So at the moment, Jabil is not terribly undervalued, but I also believe that if things are going well with its customers and valuation multiples don't change drastically, the stock will be worth $50 to $63 next year.

Speaking of customers, here's the breakdown of Jabil's revenues from 1995 to 1997:

Revenue Distribution, Year Ended 8/97

 
                      1995  1996  1997 
 Communications         20%   30%   51% 
 Personal Computers     46    36    21 
 Computer Peripherals   23    25    16 
 Automotive and other   11     9    12 
 

* A Ghoul's Opinion represents the opinion of one Ghoul and in no way should be taken as the opinion of either the Motley Fool, Inc., the company in question or representative of anyone or anything else other than that specific Ghoul's thoughts.