Arrow Upgraded to Outperform

We recently upgraded our recommendation to OUTPERFORM from NEUTRAL on Arrow Electronics Inc. (ARW) in anticipation of strong performance in the upcoming quarters.

Arrow reported solid results for the second quarter driven by strong growth across all geographies and products. Arrow offers its products in two segments – Global Components and Global Enterprise Computing Solutions.

Global components sales in the second quarter grew 44% year over year and 4.1% sequentially, driven by solid growth in all regions. In particular, sales in North America continue to rebound and are now approaching levels last seen in 2001 driven by broad-based strength.

The enterprise computing solutions business registered a 21% year-over-year growth in sales and a 22% sequential growth in sales. The strength in business was driven by double-digit growth in storage, software, services and industry-standard servers.

Margins continue to show improvement as a result of cost-cutting activities undertaken by management in recent months including reducing headcount, freezing employee incentives and eliminating salary hikes.

Arrow is already well positioned with a number of large customers, thereby shifting the corporate focus for building and maintaining the small and medium-sized customer base. Arrow has chalked out a plan for growth through small and disciplined acquisitions. The electronic components and the computer products distribution is a low-margin business and Arrow being a player in that market heavily depends on acquisitions.

The companies acquired also have lower gross margins and lower operating costs. In the near term, management expects the lower-gross margin profile of these companies to exert a slight negative pressure on both the gross and operating margins. However, their lower operating cost structure is eventually expected to offset this drawback.

In recent times, Arrow completed the acquisition of reverse logistics services provider–Converge, parts catalog retailer–Verical Inc, and Sphinx Group Limited a UK-based value-added distributor of security and networking products.

Cumulatively, these acquisitions are expected to be accretive to earnings by $0.05 to $0.10 per share on an annual basis. This is in addition to the $0.10 to $0.12 accretion from the A.E. Petsche acquisition that Arrow closed in December 2009. The recent acquisition of Shared Technologies is also expected to be accretive to earnings in the range of $0.10 – $0.12 per share in the first full year of operation.

Estimates have been on the rise in the past sixty days. The current Zacks Consensus Estimate for 2010 is $3.78, up by $0.58 in the last two months.

Although Arrow faced tough times between late 2008 – early 2009, performance has been improving steadily since then. We expect overall demand and margins to improve as volumes ramp up. Management’s guidance was encouraging with both the top and bottom lines poised to grow in the second half of 2010.

Our OUTPERFORM recommendation is supported by the Zacks #1 Rank, which translates to a short term STRONG BUY rating.

ARROW ELECTRONI (ARW): Free Stock Analysis Report

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