JBL - Jabil: Why It Deserves A Premium Valuation

2023-03-24 05:23:25 ET

Summary

• Jabil is in transition into growing markets that offer superior revenue growth, longer product cycles, and higher margins.
• JBL's diverse global presence positions it well to adapt to changes in supply chains.
• Returns from investing in JBL will primarily come from rising valuations rather than earnings growth.

Description

In my opinion, Jabil ( JBL ) is a buy rating because of the company's ongoing transition into more promising and expanding markets like electric vehicles, healthcare, cloud computing, and renewable energy. These sectors offer superior revenue growth, longer product cycles, and higher margins. JBL has certainly proven to have made strides in diversifying its business, as evidenced by its recent financial results, which show solid results and better margins despite weaknesses in some markets. For FY23, management has also provided an increase in margin guidance. Finally, Jabil's global reach puts it in a good position to adjust to shifts in supply chains. All in, valuation should re-rate upwards, driving bulk of returns.

4Q22 results

The relative strength in higher margin end markets and the transition in Cloud to consignment drove JBL's 4Q22 results and the increase in operating margin guidance for FY23. Despite weakness in the more cyclical end markets, management believes JBL will continue to reap the benefits of secular tailwinds in sectors like renewable energy, healthcare, and electric vehicles. Most impressive to me was the reiteration of the FCF guide of >$900 million despite the fact that higher inventory levels. What's more, management is laser-focused on hitting $1 billion in FCF asap. To give context, $1 billion in FCF = near 9% FCF yield, which is extremely attractive in the current environment of high rates). Management, I believe, has set off a domino effect of optimism with these earnings, which has sent the stock up 10% since its release. However, I think it's important to point out that the stock has rebounded sharply from its $48.80 low, and that some current shareholders may be looking to cash out while the getting is good. That said, as long as JBL keeps doing what they say they will do, I won't be too concerned.

Guidance

Overall, the forecast for FY23 revenues remains unchanged, but there are some differences in revenue guidance for various end markets. Industrial and semi-cap revenue guidance for FY23 is up 13% year-over-year, compared to the previous forecast of up 10%, due to the strength of renewables offsetting weakness in semi-cap. The new forecast for 5G wireless and cloud revenue is down 6% year-over-year, which is better than the previous forecast of down 8% year-over-year by 200 basis points. Previously, digital print and retail were expected to remain flat, but they are now projected to increase by 3% year-over-year. Unfortunately, sales in connected devices are expected to be lower than previously thought, with a predicted revenue decline of 17% year-over-year instead of the previously forecasted decline of 11%.

Valuation

In my opinion, investors must understand that the returns from investing in JBL will not be primarily driven by earnings growth. According to my model, a large portion of returns will result from rising valuations; thus, having a positive sentiment and narrative surrounding the stock is critical (which JBL has as evident by share price movement). This means that the market is willing to give JBL credit for future performance, resulting in value for existing shareholders. My model shows two scenarios below: one with no change in multiples, implying fair value, and one with a change in multiples to 11x (1 standard deviation from average), implying a 26% upside.

The question now is whether JBL has what it takes to persuade the market to value it at 11x. I believe the answer is yes. I believe a premium to historical is justified given the solid top-line execution, margin expansion (net margin is expected to improve from here on to above 3% range, which higher than the entire past decade - I believe this is a structural change in margin profile which warrants a change in multiples), and resulting high-quality FCF (FCF is expected to increase from past 3 years average of sub $250+million to over an average of ~$1 bill in the next 3 years). As previously stated, the well-diversified business model benefits from outsourcing trends, market share gains, on-shoring plans, and long-term growth trends in EV, renewables, healthcare, and automation. So far, the market appears to have discounted all of these, which presents an opportunity.

Risks

Given that a sizeable chunk of returns comes from swings in valuation, learning how investors view risk is crucial. Slowing growth related to Apple, which accounts for a significant portion of sales in FY22 (around 19%), represents, in my opinion, the key downside risks. There has been some diversification of the customer base as a result of offering a wider variety of products, but everything is still branded with the AAPL name. Thus, JBL could be seriously impacted by the poor sales of Apple products. JBL's capacity to capitalize on the identified secular trends is the next major uncertainty that must be addressed if margins are to grow. The thesis will be doomed if initiated programs are not well executed.

Summary

I give a buy rating to JBL due to its transition into growing markets like electric vehicles, healthcare, cloud computing, and renewable energy, which offer superior revenue growth, longer product cycles, and higher margins. The company's 4Q22 results and margin guidance for FY23 reflect the strength of its higher margin end markets and its transition to consignment in Cloud. JBL's diverse global presence positions it well to adapt to changes in supply chains. However, investors must understand that the returns from investing in JBL will primarily come from rising valuations rather than earnings growth. Risks include the dependence on Apple for a significant portion of sales and the ability to capitalize on identified secular trends. Overall, JBL has the potential to deliver attractive returns for investors who are willing to be patient and believe in the company's long-term prospects.

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