We are downgrading Jabil Circuit Inc. (JBL) to Neutral from our previous Outperform rating on negative investor sentiment, as the softer demand environment for electronic products could limit the stock’s appreciation in the near term.
While key end markets remain strong, a slowdown in overall economic activity, particularly in Europe could limit growth. We remain cautious, given a probable downside risk to its near-term results and lower our price target to $11.00.
Moreover, Cisco Systems (CSCO) last quarter earnings and revenues disappointed investors as they were expecting the company to post solid results. Cisco’s results indicate a slowdown in several important areas such as routers and switches, which can only be attributed to the macro weakness, especially in Europe. A slowdown at Cisco is negative for Jabil, since Cisco is one of its largest customers (13% revenue share in 2009).
Jabil also has a fairly high level of debt that we believe may limit financial flexibility going forward. Cash and cash equivalents were $600.3 million and long-term debt (including the current portion) was $1.13 billion at the end of the third quarter of 2010. Cash was down $193.8 million and debt declined $70 million from the previous quarter.
The company’s net cash balance (cash less debt including current portion) was a deficit of $525.7 million or $2.43 per share in the third quarter of 2010 versus $402.2 million or $1.87 per share in the second quarter of 2010. The company’s high leverage poses a massive risk to its overall financials.
Jabil’s business outlook continued to improve in each of the last four quarters and its third quarter 2010 results beat the Zacks Consensus Estimate.
Jabil provided a better-than-expected guidance for the fourth quarter and expects the full year 2010 to be a record year in terms of both revenues and earnings.
Core EPS for the fourth quarter is expected to be in the range of 45 cents to 50 cents, a growth of 13% to 25% sequentially. The company expects net revenues for its fourth quarter of 2010 to be in the range of $3.8 billion to $4.0 billion, an increase of 10% to 16% sequentially and above the Consensus Estimate of $3.40 billion.
We expect Jabil to witness strong revenues, margins and earnings growth by the end of fiscal 2011 on account of new business wins from major OEMs, recovery in end-market demand, new program ramp up and resurgence in IT enterprise spending.
Moreover, a recovery in the overall EMS industry, aided by a reviving economic environment and rise in IT spending could further boost Jabil’s results. Jabil is also expected to benefit from a strong growth in the Mobility, Aerospace and defense, Healthcare, Instrumentation and Industrial, Networking and Storage segments over the long term.
Jabil’s shares are currently trading near the low end of its historical average P/E range (4.8X to 44.2X trailing 12-month earnings). It also currently trades at a discount to the industry.