2023-10-03 10:45:58 ET
Summary
- Sanmina has had a couple of years of good growth as the company has recovered from the pandemic, but the growth seems to halt with a low Q4 guidance.
- The company has still continued to expand its operating margin along the company's long-term trend, increasing earnings despite turbulent long-term revenues.
- As Sanmina currently trades with a low P/E and a price below my DCF model estimate, I have a buy-rating for the stock.
Sanmina Corporation ( SANM ) has managed to improve its operating margin quite consistently in the long term, with the current year being no exception. The stock seems to price in a rougher future for Sanmina as the company's growth slows down after a pandemic recovery. I believe that the stock still has potential even after a good stock rally - my DCF model estimates an upside for the stock, constituting a buy rating for the stock.
The Company
Sanmina provides technology and supply chain solutions to companies. Sanmina's operations range from the medical industry into oil and gas, as the company has a range of offerings:
The company's stock has doubled in the past five years as a result of Sanmina's improved operations:
Financials
In the company's long-term history, Sanmina has had a turbulent revenue track:
The mixed track has since evolved into a more promising amount of growth - Sanmina has achieved an organic growth of 17.5% in fiscal year 2022 after a poor revenue performance in the Covid-19 pandemic. The company is also experiencing a good amount of growth in the current fiscal year, as the company is set up for a revenue growth of around 14% in the year.
Sanmina's growth seems to be mostly due to low comparison numbers - the company's revenues decreased by 15.6% in FY2020 as a result of the pandemic, and I believe the growth is related to a recovery from the low figures. The current trailing revenues are above the FY2019 level prior to the pandemic, but as inflation has been quite high in the period after FY2019, the growth in nominal terms should be expected. The company's Q4/FY2023 guidance seems to suggest the same - the company guides for revenues between $2.1 billion and $2.2 billion, below the previous year's Q4 figure of $2.23 billion:
Sanmina relates the guidance to a poor performance of the communication networks and cloud infrastructure segment. In the longer term, I still see some growth potential for Sanmina. I believe the growing need for stable supply chains and the growth of the cloud infrastructure market do provide some opportunities for Sanmina to grow its top line.
Although Sanmina's revenues have fluctuated in the company's history, the company has managed to grow its EBIT margin quite constantly - the margin has grown from 0.9% in FY2002 into 4.5% in FY2022, with further margin expansion in Q1-Q3 of FY2023.
The margin expansion has attributed massively into Sanmina's growing earnings. The expansion has been achieved with both a small gross margin increase as well as operating expense leverage - Sanmina's gross margin has grown 0.7 percentage points from FY2012's level of 7.2% into FY2022's level of 7.9%. Operating expenses have stayed pretty much stable in the same period although revenues have grown: SG&A expenses were $241 million or 3.95% of revenues in FY2012, and were $247 million or around 3.11% of revenues in FY2022.
Sanmina has a strong balance sheet , as the company has around $657 million in cash and equivalents and around $334 million in long-term debt, of which $18 million is in the current portion. Sanmina is distributing the excess cash in the form of share repurchases - the company repurchased around $51 million worth of stock in Q3 according to the company's Q3 presentation.
Valuation
Currently, Sanmina has a low forward price-to-earnings ratio of 8.4, around 18% below the company's ten-year average of 10.3:
The low ratio seems partly justified as the Q4 guidance is quite weak, and the company has a large amount of capital expenditures , weakening the company's near-term cash flows.
To further analyse the valuation, I constructed a discounted cash flow model. In the model, I estimate a revenue growth of 14.2% for the current year, in line with the company's guidance for the Q4. As the Q4 guidance shows weakness, I have a small growth estimate of 2% for FY2024 - I believe the company can achieve a higher growth but seems to be experiencing a hiccup. After FY2024, I estimate a growth of 5.5% that slows down into a perpetual growth rate of 2% in steps - the estimate represents a good organic performance, as some of Sanmina's segments have potential for growth. Also, I believe the higher-than-average capital expenditures show the management's confidence in investing for future earnings, growing my confidence in future growth.
For Sanmina's EBIT margin, I estimate a growth of 0.4 percentage points from FY2022 to FY2023 into a level of 4.9%. Going further, I estimate the margin to still scale slightly more, as the company has demonstrated a very good amount of margin leverage in the past - I estimate Sanmina's EBIT margin to grow into 5.6% in steps. As Sanmina has a large amount of CapEx, though, I estimate earnings to convert into cash flows somewhat poorly.
The mentioned estimates along with a cost of capital of 11.41% craft the following DCF model with a fair value estimate of $68.75, around 27% above the current level:
The used weighed average cost of capital is derived from a capital asset pricing model:
CAPM (Author's Calculation)
Sanmina had around $10.1 million in interest expenses in Q3/FY2023. With the company's outstanding interest-bearing debt, the company's interest rate would come up to 12.06% - I believe the interest expenses also include capital leases that are operative in nature. Instead of the mentioned estimate, I use a rough estimate of 6.17% - the estimated rate is 1.5 percentage points above the United States' 10-year bond yield , leaving a good safety margin in the estimate. As Sanmina leverages debt quite moderately, I estimate the company to have a long-term debt-to-equity ratio of 10%.
On the cost of equity side, I use the US' 10-year bond yield of 4.67% as the risk-free rate. The equity risk premium of 5.91% is Professor Aswath Damodaran's latest estimate. Yahoo Finance estimates Sanmina's beta to be 1.20 , a relatively normal figure. Finally, I add a small liquidity premium of 0.4% into the cost of equity, crafting the figure into 12.16% and the WACC into 11.41%, used in the DCF model.
Takeaway
At the current price, Sanmina seems to be a worthy investment to look into. The stock seems underpriced according to my DCF model estimates, as the company has demonstrated high margin growth and a good growth for a couple of years, going above the pre-pandemic level. The investment case does still have risks, though, as my DCF model could be wrong in estimating growth: I believe the current growth is mostly related to a pandemic recovery. I do still believe that Sanmina has organic growth potential in the long-term too - unless my thesis around slight further margin leverage and revenue growth crumbles, I believe a buy-rating is justified for the moment being.
For further details see:
Sanmina: Cheap If The Performance Is Sustained