2023-04-23 04:55:28 ET
Summary
- FN has demonstrated a strong track record for growth and profitability over the past decade, and the company's focus on operational excellence has allowed it to maintain its market leadership.
- In the second quarter of fiscal 2023, FN posted impressive results with record-breaking revenue.
- Using a discounted cashflow analysis, we can estimate the intrinsic value of FN to be substantially less than the company's current market price.
Intro
Fabrinet ( FN ) is a fascinating company , and I've been keeping an eye on them for some time. They are a global manufacturer of complex optical and electronic components and sub-assemblies, serving a diverse range of industries, including telecommunications, automotive, industrial, and medical.
FN's strength lies in its ability to deliver high-quality products that meet the standards of its customers, and the company's focus on operational excellence has allowed it to maintain its market leadership position in the industry.
In the second quarter of fiscal 2023, FN posted impressive results with revenue above its guidance range at $668.7 million, a record-breaking quarter for the company and a year-over-year increase of 18%. While the company faced supply constraints during the quarter, it managed to mitigate the impact and delivered non-GAAP operating margins of 10.9%, setting a new quarterly performance record.
FN's ability to execute and respond quickly to changing market dynamics has been key to its success, and I believe the company is well-positioned to continue producing strong financial results in the future. In this article, we will delve into FN's outstanding quarter and estimate the company's intrinsic value to help intelligent investors determine whether FN stock is a sound investment opportunity in today's market.
Performance
As an investor, I always keep my eyes peeled for companies that demonstrate consistent growth and profitability. FN caught my attention with their recent Q2 earnings report, which beat both revenue and earnings estimates.
In Q2, FN reported Non-GAAP EPS of $1.90, surpassing expectations by $0.03. Their revenue also impressed, reaching $668 million, an 18% increase year-over-year and beating estimates by $16 million. The company also set new quarterly revenue records in both its optical and non-optical businesses led by strong demand from its datacom and automotive customers. FN turned in these results despite challenging supply constraints which cost the company approximately $20 million in revenue for the quarter.
FN's strong Q2 is not a unique performance from the company. In fact, over the past decade, FN has demonstrated a strong track record for growth and profitability. The company has grown its revenue from $641 million to $2.2 billion over the previous ten years, an impressive feat.
Data by Stock Analysis
However, it's worth noting that the company has reported decreasing free cash flow over the past four years. While this is certainly a concern, it's important to look at the bigger picture. Fabrinet has an average return on equity of 15.27% over the past ten years, indicating that they have been able to effectively manage their finances and generate profits for their shareholders.
Data by Stock Analysis
In addition to their strong financial performance, FN also has a solid balance sheet. With a debt-to-equity ratio of just 0.03 and a current ratio of 3.0, the company is well-positioned to weather any financial challenges that may arise.
It's also worth noting that FN has outperformed the total return of the S&P 500 by a significant margin. Over the past five years, FN has delivered a total return of 219%, compared to just 71% for the S&P 500.
Data by Seeking Alpha
Looking ahead, FN expects Q3 revenue to be in the range of $640M to $660M. Their GAAP net income per diluted share is expected to be in the range of $1.59 to $1.66, while their Non-GAAP net income per diluted share is expected to be in the range of $1.86 to $1.93. These are encouraging projections and suggest that FN is poised for continued growth.
It's also encouraging to note that FN is investing heavily in long term growth projects. FN's CEO, Seamus Grady, emphasized the company's commitment to long-term growth in a recent statement during the company's Q2 earnings call, stating that.
Investing in our long-term growth remains a top priority for Fabrinet. As you know, our recently opened Building 9 provides us with significant capacity to continue to scale our business over the next several years and we continue to ramp new programs for our customers in this state-of-the-art 1 million square foot facility.
When you consider all of these factors, it's clear that FN is a company worth watching. Their recent Q2 earnings report only adds to the company's strong track record of growth and profitability. With positive projections for Q3, it seems likely that FN will continue to deliver value to their shareholders for years to come.
Valuation
To estimate FN intrinsic value, we will employ a discounted cash flow ((DCF)) analysis. As you may know, DCF is a valuation method that estimates the intrinsic value of an investment by calculating the present value of its expected future cash flows.
To begin, the starting point for our DCF analysis on FN is the average of the last five years of free cash flows, which amounts to $91 million. We will use this as the base year for our projections.
Based on the average analyst estimates of earnings growth, we will assume a growth rate of 9% for the first ten years. After the first ten years, we will assume a more conservative growth rate of 2.5% in perpetuity to find the terminal value.
In addition, we will use a discount rate of 10% to reflect the long-term rate of return of the S&P 500 with dividends reinvested. Using these inputs, we can estimate the intrinsic value of FN to be $54.09. This represents a potential 43.3% loss for investors, compared to the current market price. This means that at the current market price, FN is overvalued.
Author's Work
It is important to note that the accuracy of our DCF analysis is dependent on the accuracy of our inputs, such as the growth rate and discount rate. While we believe our estimates are reasonable, they are subject to change based on unforeseen factors that may impact the company's performance. For these reasons it's important to use multiple different valuation techniques to provide a more complete understanding of the intrinsic value of a stock, as different methods emphasize different factors.
When evaluating a potential investment, another valuation technique I like is comparing the company's current valuation to that of its industry competitors to see if it is priced favorably. I like to use a range of popular valuation ratios, such as P/E, P/S, and P/B, among others. Seeking Alpha has a wonderful " Peers " page where you can easily find a range of all these popular valuations ratios for a company like FN and see how it stacks up against its industry rivals, see below.
Data by Stock Analysis
One thing all these valuation ratios have in common is that the smaller the value, the more undervalued the company is. If we calculate the average of all these ratios, we can identify the most undervalued company by finding the one with the lowest score.
According to this analysis the company that ended up with the lowest score and therefore is the most undervalued is Celestica Inc. ( CLS ) with a score of 3.62. CLS is a company which offers supply chain solutions across North America, Europe, and Asia. This comparative analysis signals that CLS may be a good company to evaluate to find value.
As for FN, the company finished third with a score of 8.78 which indicates that the company is cheaper than at least half of its competitors. The full results of this study are listed below.
1) CLS - 3.62
2) SANM - 5.23
3) FN - 8.78
4) CTS - 10.51
5) IPGP - 16.30
6) PLXS - 20.15
It is important to note that this comparative analysis has its limitations, as it does not directly take into account a company's future growth prospects, other than the PEG ratios. A company's growth prospects are essential in determining a company's intrinsic value. Therefore, its best to use the results of this valuation technique in concert with the results of the DCF analysis.
To sum up, based on our discounted cash flow analysis, FN does not appear to be a good investment opportunity currently, as it seems overvalued. However, in a comparison to its peers using several common valuation ratios, FN seems more undervalued than at least half of them. As a result, the overall valuation of FN is somewhat ambiguous and challenging to determine.
Takeaway
FN is a fascinating company, and I've been keeping an eye on them for some time. They have demonstrated a strong track record for growth and profitability over the past decade, and the company's focus on operational excellence has allowed it to maintain its market leadership position in the industry.
In the second quarter of fiscal 2023, FN posted impressive results with record-breaking revenue. Their ability to execute and respond quickly to changing market dynamics has been key to its success, and I believe the company is well-positioned to continue producing strong financial results in the future.
Looking ahead, FN expects further revenue growth in Q3. It's also encouraging to note that FN is investing heavily in long term growth projects, and this commitment to long-term growth is a top priority for the company.
However, when it comes to the valuation of the company, to estimate FN intrinsic value, a discounted cash flow ((DCF)) analysis is used. Using these inputs, the estimated intrinsic value of FN is $54.09, which represents a potential 43.3% loss for investors compared to the current market price. This means that at the current market price, FN is overvalued.
For further details see:
Fabrinet: Overvalued Despite Excellent Operating Results