Summary
- Sanmina has had strong growth but margins weakness is masked.
- A higher than expected PPI print is likely to weigh on the stock and SANM is likely to see margin declines in the next quarter.
- However growth is still strong and technical analysis suggests a neutral outlook, so I suggest a 'hold'.
Thesis
Sanmina ( SANM ) has seen consistent growth, however I believe there is margin degradation that is currently masked. I have a neutral outlook on the stock due to 2 key reasons:
- Sanmina has had strong growth but margins weakness is masked
- A higher than expected PPI print is likely to weigh on the stock
Sanmina has had strong growth, but margins weakness is masked
Sales growth QoQ (Company Filings, Author's Analysis)
The last 5 quarters for SANM have been remarkable with very consistent QoQ growth of more than 7.5% on average. The quality of this growth is robust and broad-based as well:
IMS revenue growth QoQ (Company Filings, Author's Analysis)
The integrated manufacturing solutions ((IMS)) segment, which makes up 80.7% of revenues has been the relative growth leader with 8.0% QoQ growth on average for the past 5 quarters.
CPS revenue growth QoQ (Company Filings, Author's Analysis)
The components, products and services ((CPS)) segment makes up 19.3% of revenues. It has also grown resiliently, albeit at a smaller clip over the past 5-6 quarters. Despite the smaller top-line growth, it has had a greater contribution to gross profit due to a higher gross margin profile; 13.3% for CPS vs 6.9% for IMS). CPS' gross profit mix has increased from 28.6% to 31.7% over the past 5 quarters. The following section describes the reasons:
Gross profit margin (Company Filings, Author's Analysis)
Overall, this has led to an optically rather stable gross profit margin profile.
However, the last quarterly print has been boosted by a 140bps gross margin boost in the CPS segment:
CPS gross profit margin (Company Filings, Author's Analysis)
Management attributes the last quarterly jump in gross margins to a "better product mix".
This has made up for a steady fall in IMS due to input cost headwinds:
IMS gross profit margin (Company Filings, Author's Analysis)
The balance of a 90bps gross margin improvement is due to unallocated items, which remain at constant rates.
Key Message
IMS is the major growth driver of the stock, but is facing some small declines in margin headwinds. CPS is growing below the company average, but has benefited from a product mix that has led to better pricing.
I am skeptical about the sustainability of the gross margin benefit boost in CPS as history shows that product mix shifts are not reliable structural changes. For example, in Q4 FY22, management cited a worse product mix as being the major reason for lower gross margins.
Therefore, if we assume that the 140bps gross margin boost in CPS to be temporary, then according to my calculations, Q1 FY23 data would already show a sharp gross margin decline of 30bps from 8.1% to 7.8%. This may not seem like much, but for the electronic manufacturing industry, which operates on thin margins at high volumes, it has a large impact. And I fear this is likely to get worse:
A higher than expected PPI print is likely to weigh on the stock
PPI MoM (MyFXBook, Author's Analysis)
On 16th February 2023, the Producer Price Inflation ((PPI)) print came in at 0.70%, which is 30bps higher than the consensus expectations of 0.40%. Over the last 10 years of PPI data, the average surprise has been +1.10bps. So a surprise of +30bps is quite meaningful and highly relevant for SANM's electronic manufacturing services business.
I believe this is likely to cause higher than expected margin pressures on SANM, not just for the current quarter, but likely for future quarters as well. This is because as discussed earlier, I believe the product mix benefit is not structural.
Moreover, based on my calculations using 118 months of data, the chances of a higher actual PPI print in the month succeeding a positive surprise is 14.0%. The chances of another positive surprise in the month succeeding a positive surprise print is much higher at 36.8%. As markets price securities based on expectations, I believe this suggests a meaningful upside risk to PPI and broader inflation numbers and hence SANM's gross margins.
You can check my calculations on these PPI statistics here .
Technical Analysis
If this is your first time reading a Hunting Alpha article using Technical Analysis, you may want to read this post , which explains how and why I read the charts the way I do, utilizing principles of Flow, Location and Trap.
Relative Read of SANM vs SPX500
SANM vs SPX500 Technical Analysis (TradingView, Author's Analysis)
On the relative ratio chart of SANM vs the S&P500 ( SPY ) ( SPX ), sellers have sharply reacted at the monthly resistance marked by a prior local high. I believe the prices are due to regain buyside liquidity at the monthly support area, following some consolidation.
Standalone Read of SANM
SANM Technical Analysis (TradingView, Author's Analysis)
On the standalone chart of SANM, we see a sudden, sharp move up later in the trend. The speed of the move up here is much faster than the moves up as the bottom was forming and the trend was turning upwards. Notably, the sharp move up was not preceded by a false breakout to the downside. Based on my research on bubbles and euphoria across global financial markets, this is a sign of euphoria. Hence, I am skeptical of further upside, except perhaps to re-touch the monthly resistance at $70.51. I expect a reset back down to $42.98 over the upcoming months and quarters.
Positioning
SANM's gross margins in the last quarter appeared optically steady, with a 140bps boost in CPS gross margins masking a gradual decline in IMS gross margins due to rising input costs. With higher than expected PPI prints that have 36.8% chance of continuing to surprise on the upside in February, I believe SANM is likely to see margin declines in the next quarter.
Despite this headwind, growth remains strong and the technicals also suggest a neutral outlook for now. Hence, I rate SANM a 'hold'.
For further details see:
Sanmina: Masked Margin Weakness Likely To Unravel