Sanmina: The Power Of Margin Expansion And Value Unlocked (NASDAQ:SANM)

Sanmina Gives Weak 2024 Outlook and Stock Crashes

On November 6, 2023, Sanmina Corporation (NASDAQ:SANM) released its Q4 earnings report. The company missed both revenue and EPS estimates, reporting $2.05B in revenue, a 7% YoY decline, and $1.42 in EPS, a 5% YoY decline. The company also gave a weak outlook, expecting revenue between $1.85B to $1.95B and EPS between $0.98 to $1.08, both below consensus. Sanmina blamed the weak outlook on ongoing adjustments in customer inventories, especially in the communications and cloud end-market, which accounts for 40% of its total revenue.

The market reacted negatively to the earnings report, sending Sanmina’s stock price down by almost 15% the next day. In this article, we want to examine if the market is valuing Sanmina fairly and if there are any hidden opportunities for value creation or not.

Sanmina is a Niche Player in the EMS Market

Sanmina operates in a highly competitive and cyclical EMS market, where it faces strong competition from other EMS manufacturers, such as Jabil (JBL), Flex (FLEX), and Celestica (CLS). As you can see below, Sanmina has the worst 1-year price performance compared to its EMS peers (-30%)

Looking at Sanmina’s business performance and its position in the EMS market, we think that Sanmina is a Niche player. One characteristic of a Niche player is that it is unfocused and does not innovate or outperform others (as per Gartner) and this is exactly what we are seeing with Sanmina.

We believe that Sanmina’s poor price performance is due to its underperformance and weak growth prospects. The market does not think that Sanmina can grow its business.

CEO: $10B – $12B Revenue Target in 3 Years

In the earnings call, Sanmina’s CEO Jure Sola shared his vision for the company’s future and stated that their internal goal is to reach $10B to $12B in revenue in three years.

Jure Sola (CEO):

I just want to remind in my prepared statement, I said, hey, we have a goal internally to grow this company a lot bigger than what we are today. And our — as I mentioned, we — in the next 3 years, we expect to be in the range $10 billion to $12 billion. So we are focused on growth, but we’re going to make sure it’s the most profitable growth.

He also added that the company is positioned very well in all the segments and that it has a lot of upside potential, especially in the energy, auto, medical, and defense and aerospace segments.

We want to check how realistic this growth aspiration is. We know that Sanmina’s revenues are expected to decline during the first half of 2024. Analysts 2024 revenue estimation is $8B (-10% YoY) and 2025 estimation is $8.9B (+12%).

We believe that Sanmina’s growth depends more on the macro environment, so if 2025 and 2026 can be favorable years for the semi-industry, Sanmina might grow to the low-end of its aspiration target which is $10B. Basically, the 3-year CAGR for Sanmina will be 4% which is just above the yearly US inflation target. We see this scenario as the best case for Sanmina unless it develops a better business strategy or transformation.

Sanmina’s Diversification Strategy: A Strength or a Weakness?

Sanmina claims to have a diversified portfolio of products and services across different segments (see below). However, this strategy may not be working for the company.

One of the challenges of diversification is that it can dilute the company’s focus and competitiveness in specific markets. Our view is that the company does not have the necessary capabilities and focus to excel in any of the multiple end markets it serves, each with different dynamics. By offering a broad range of end-to-end contracting services across various end-user markets, Sanmina finds itself thinly spread. When compared to more capable competitors in each end-market, the company struggles to achieve the same level of growth. For example, Sanmina’s revenue in the Industrial/Medical/Defense/Aerospace/Automotive segment accounted for 65% of its revenue in Q4 2023. These are all high-growth industries meaning they should drive significant growth. But Sanmina’s revenue in this segment slowed down to 2.5% YoY growth which means it is facing strong competition from more capable players.

We believe that Sanmina needs to adopt a more strategic diversification approach if it wants to grow its business. The company should identify its strengths and should diversify only into markets or technologies that are aligned with its core competencies. This would complement and enhance its existing core portfolio rather than diluting it.

The Positives: Increasing Margins, Healthy Balance Sheet

Despite the earnings miss and the projected revenue decline for FY2024, Sanmina also reported some positive numbers in its Q4 results. The company improved its non-GAAP profit margin from 7.9% to 8.7% YoY and non-GAAP operating margin increased from 5.3% to 5.7% YoY. This shows company is executing with discipline and demonstrating operational efficiency. The company margins seem to be in a good trajectory as you can see below:

In terms of the balance sheet, the company generated a free cash flow of $39 million in Q4 totaling $45 million for the full year. Sanmina also reduced debt to $338 million, resulting in a very low debt-to-cash ratio of 0.51x. With $668 million in cash, $338 million in debt, and $1.53 billion in liquidity, Sanmina maintains a very healthy balance sheet.

Valuation

Based on the analyst consensus estimate for fiscal 2024, Sanmina’s current price implies a forward P/E ratio of 9.9x, significantly below its five-year historical average of 12.8x (-23%). Additionally, the current enterprise value of $2.26 billion implies a forward EV/EBIT ratio of 5.13x, which is 25% below the five-year historical average of 6.9x.

Applying the 5-year average P/E ratio to the current EV gives us a price target of $60. We think this is a fair valuation for the company, as it has improved its operating margins to their highest level in two decades.

Risks

• The company faces strong competition in a volatile industry. It has to compete with leading global contract manufacturers like Jabil who have superior supply chain management capabilities, and very advanced technology usage.
• The company is not resilient enough in terms of supply chain. It relies on a number of external parties to source and produce its products, which may be disrupted by geo-political events or macro slowdowns.

Conclusion

Sanmina faces challenges in its business, such as an inefficient growth strategy and a strong competitive environment. We think that the market has reflected these factors in the valuation of Sanmina. However, Sanmina also has some positive aspects that are not captured by its current price. It has a very strong balance sheet and its operational efficiencies continue to improve its margins every quarter. We think this margin improvement trend will drive its valuation higher even if its revenue does not grow.

In conclusion, there are positive factors in Sanmina’s business and we see it as a good value investment. We rate Sanmina as a Buy.