2023-04-20 03:37:07 ET
Summary
- TD Synnex is a dominant player in the technology distribution sector, with the largest revenue share.
- The shift toward digital transformation priorities is likely to make the market less cyclical.
- SNX has a favorable position in terms of cash deployment and is well positioned as a defensive stock in the case of a potential downturn.
Thesis
TD SYNNEX ( SNX ) is a company that distributes technology products and offers a wide range of solutions for distribution, systems design, and integration in the technology sector. Given its dominant position in the IT Distributor market and its emphasis on an expanding mix of high-growth technologies, I expect SNX to maintain a rate of top-line growth that is at least as fast as the underlying IT spending environment. I also expect that SNX's robust financial position and ability to generate free cash flow will open up additional opportunities for the company to grow its revenue (via M&As) and return value to its shareholders (via dividends and share repurchases). All of the above, plus the fact that SNX stock is trading in-line to its peer group (Arrow (ARW) and Avnet (AVT)) despite its larger size and positive outlook, leads me to give it a buy recommendation.
Scale
SNX is a multibillion dollar powerhouse in the technology distribution sector, where it is responsible for bringing to market products from the world's leading and emerging technology vendors and assisting customers in developing solutions to optimize business outcomes for their end-user customers. Even though there is a great deal of competition in the IT Distributor market, SNX has the largest revenue share, followed by Ingram Micro, Arrow, and Avnet. In the IT Distribution sector, having a large scale is essential because it enables companies to explore and allocate resources to various opportunities such as new products, services or expanding globally. This helps to increase revenue which can be leveraged against fixed costs, leading to higher profits and cash flow. These profits can then be utilized for various purposes, such as acquiring other companies, buying back shares or paying dividends. In essence, this can be viewed as a virtuous effect as well, where the larger player continues to get bigger and stronger as it has the financial resources to do so. The large industry players like SNX keep growing and consistently outperforming the underlying market , so the proof is in the pudding.
Another way to look at the significance of scale is from the bottom up. The larger the distributor, the more inventories it can hold (product offering advantage), the greater its bargaining power (gross margin advantage), and the greater its distribution capabilities (market access advantage). The greater the size of a player, the more difficult it is for new players to disrupt their market position.
Secular trend
The IT Distribution market is driven by spending on information technology, which has a history of being cyclical. The shifts in spending toward digital transformation priorities from companies are likely to make the peaks and troughs less noticeable in the future. IT spending is expected to grow in the mid-single digits over the next couple of years, and I believe this will have a significant impact on the cyclical nature of the market and improve the underlying growth rate. That being said, I do recognize that worries are growing about the long-term viability of IT spending in light of the challenging macro backdrop caused by geopolitical unpredictability, inflation, supply challenges, and so on. Consumer spending is beginning to slow as a result of these difficulties, but I anticipate IT spending to be more robust than in previous years due to the fact that digital transformation is evolving from a passing fad to a systematic and long-term plan for Enterprises. I think that companies who are focused on IT spending will experience a more positive demand environment in this particular area and that it will be more resistant to market fluctuations.
Margin
I expect operating margins to increase slightly in the near future as a result of an increasing proportion of high-growth technologies, which generate higher-than-average margins, and prudent management of operating expenses. I believe it is crucial to manage expectations by acknowledging that it may take some time before we see the benefits of the shift in the product mix reflected in the profit margins. Nonetheless, considering the company's track record of surpassing its objectives, there is a possibility for improvement in the execution of the mix shift, and also through cost synergies resulting from the merger, which may exceed our initial projections.
Balance sheet
In my opinion, SNX has a favorable position regarding the distribution of cash through dividends, share buybacks, and investments (both organic and inorganic). I expect SNX net debt leverage to continue tracking lower (to low 2x) and its cash conversion cycle to be shorter than in previous years (20+ days vs 40+ days previous), which is positive. Additionally, SNX's ability to withstand economic downturns is strong due to its defensive nature, which is supported by prudent working capital management and strong cash flow generation.
Competition
There are several other major companies in the technology distribution market, despite the fact that SNX is one of the largest. Although Arrow and Avnet are on opposite ends of the size spectrum, I see them as rivals nonetheless. Direct competitors include Ingram Micro and ScanSource Inc. (SCSC), as well as SYNX and Arrow. Each company in the industry faces intense competition due to the need to stockpile goods in order to satisfy customer demand and ensure timely shipment. I would consider all these players to be scaled player, and realistically, this will never be an industry where there is a monopoly. Even with competition, I believe the market is big enough to sustain all of them together. But, relatively, I would place my bets on the biggest player - which is SNX.
Conclusion
I believe SNX is a well-positioned player in the technology distribution sector with a dominant position in the IT Distributor market, a strong financial position, and the ability to generate free cash flow, which opens up additional opportunities for the company to grow its revenue and return value to its shareholders. Moreover, SNX's scale, ability to withstand economic downturns, and focus on high-growth technologies position it well for future growth. While competition in the industry is intense, SNX's competitive advantages, coupled with the secular trend of growing IT spending, make it a buy.
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TD Synnex: A Well-Positioned Player In The Technology Distribution Sector