Molex Beats, Stays Neutral - Analyst Blog

Molex Inc’s (MOLX) earnings for the fourth quarter beat the Zacks Consensus Estimate by 3 cents, or 6.8%. Although quarterly revenues beat analysts’ expectations by 3.3%, driven by continued strength across all except the automotive end market, earnings were impacted by the weaker gross margin.
 
Gross margins were impacted by logistics-related complications that are not expected to continue.  Shares were more or less stable in after hours trading, increasing by 0.9%.
 
Moreover, estimates are also relatively stable, with the few upward revisions largely offset by a few downward revisions. The surprise history is quite good, with the four quarter (including the Jun quarter) average at approximately 9.6%. 
 
Revenues
 
Revenues of $847.3 million was up 12% sequentially and 48.5% year over year, exceeding management expectations of $810-830 million, or up 7.1% to 9.7% sequentially. The company generates the bulk of its revenue from the connector market, so results continue to be positively impacted by the strength in markets using these products. Although consumer markets are softening, there was no noticeable impact on results in the last quarter.
 
Revenues by End Market
 
Telecommunications remained the largest market in the last quarter, with a revenue contribution of 25%. Segment revenues were up 12% sequentially and 55% from the year-ago quarter. Although infrastructure spending is improving, Molex is currently benefiting from the much stronger growth in smartphones. Management stated that Molex was well-positioned in this segment of the cell phone market, with wins at several major smartphone manufacturers.
 
The second largest end market was Data (22% revenue share), which increased 12% sequentially and 48.5% from the year-ago quarter. Segment performance was attributable to the continued increase in enterprise spending on servers, storage and networking products. Moreover, the company’s own socket products are being well received. Longer-term drivers in this market continue to be the migration to SAAS 2.0 and 16GB fiber channel networks in the storage market, as well as h popularity of notebooks and other MIDs.
 
Consumer Electronics, the third largest market, generated 20% of total revenues, representing sequential and year-over-year increases of 17.9% and 35%, respectively. The strength is primarily being driven by customers in Asia for digital still cameras, flat panel TVs and games. Additionally, automotive navigation is picking up in China and should be a growth driver going forward, although this strength will be partially offset by the maturing of the market in North America and Europe.
 
The automotive market brought in 15% of total revenues, declining 1.1% sequentially, although growing 48.5% from the year-ago quarter. The softness in this market is mainly due to the wind-down of incentive-related demand in Europe, partially offset by a recovering North American market and a growing Chinese market. Longer-term growth in the auto market will be driven by new functionalities, such as rear-view cameras, navigation systems, HD and satellite radios being incorporated into cars. The increasing electronic content in automobiles is a positive because it expands the market for the company’s connector technology.
 
Industrial generated 15% of revenues, a sequential increase of 12% and a year-over-year increase of 48.5%. Recovery in factory automation and new alternative energy projects are responsible for growth in this segment. The business typically reflects global GDP growth rates, which have been improving.
 
The remaining 4% of revenues came from medical/military markets, up 49.4% sequentially and 98% year over year. The increase in the last quarter was due to higher demand from key customers.
 
Orders
 
Orders were up 8.6% in the June 2010 quarter, the biggest increase in eight quarters. They were also up 58.1% from year-ago levels, reflecting strengthening across all served markets except for automotive. Backlog accumulation continued in the last quarter, increasing double-digits on both sequential and year-over-year basis.
 
Approximately 25% of total orders were in the telecom market, 22% in data, 20% in consumer electronics, 15% in industrial, 14% in automotive and 4% in medical/military. Orders were up strong double-digits across all end markets. However, there was sequential slowdown in industrial, which is entering a seasonally softer period and a sequential decline in automotive, impacted by softness in Europe.
 
The strong sell-through drove an 89% year-over-year increase in orders through distribution. EMS customers increased orders by 68% and OEM by 43%.
 
While the double-digit increase in orders was across all geographies, the Asia/Pacific South region remained the strongest, growing 74% from the year-ago quarter. Data, telecom and consumer markets fueled growth in this region. Asian markets also drove the sequential increase, although Asia/Pacific South outdid Asia/Pacific North.
 
Margins
 
Gross margin for the quarter was 29.9%, down 132 basis points (bps) sequentially and up 580 bps year over year. The strong growth from the year-ago quarter was undoubtedly due to higher volumes. The sequential decline was related to additional overtime, warehousing, freight and facility ramp up costs required for servicing demand during Molex’s strategic restructuring.
 
Operating expenses of $158.7 million were higher than the previous quarter’s $156.4 million. The operating margin was 11.1%, up 63 bps from 10.1% recorded in the previous quarter. Although R&D and SG&A expenses increased in dollar terms due to higher new product development costs and higher selling costs stemming from the higher volumes, overall operating expenses declined as a percentage of sales. The operating margin would have expanded more substantially if the gross margin had not declined.
 
Net Income
 
The pro forma net income was $71.1 million or 8.4% of revenue compared to $63.7 million or 8.4% of revenue in the Mar 2010 quarter and loss of $3.1 million or 0.5% of revenue in the Jun quarter of 2009. Our pro forma estimate excludes restructuring charges and loss related to unauthorized operations in Japan in the last quarter.
 
Including special items, the GAAP net income was $39.8 million ($0.23 per share) compared to a income of $35.1 million ($0.20 per share) in the previous quarter and loss of $219.7 million (-$1.27 per share) in the year-ago quarter. Molex took a goodwill impairment charge of $171 million in the year-ago quarter, which impacted GAAP results.
 
Balance Sheet
 
Inventories were up 11.8%, although inventory turns were flattish, going from 5.0X to 5.1X. Management stated that the second consecutive quarter of double-digit increase in inventories was due to purposeful inventory builds that could support demand while production was transferred pursuant to restructuring actions. Despite the very strong revenue growth, DSOs were flat at 79. Collection patterns have been improving over the last few quarters.
 
The company ended with cash as well as short-term investments balance of $394.9 million, down $48.5 million during the quarter. Cash generated from operations was $68.7 million. Capital expenses were $79.5 million, or 9.4% of revenues in the quarter. The company also spent $ $26.6 million on cash dividends.
 
Guidance
 
Management expects revenue of $850-880 million in next quarter, up 0.3% to 3.9% sequentially. The pro forma EPS is expected to be 42 to 46 cents a share, assuming a tax rate of 30%. The Zacks Consensus Estimate for the fiscal first quarter at the time of the earnings announcement was 39 cents, below the guided range.
 
To Summarize
 
Molex had a strong fourth quarter, with revenues and earnings easily beating the Zacks Consensus Estimate. The geographically diversified business helps offset the weakness in one region with strength in others. Order growth rates across served markets appear to be normal on a seasonal basis (barring automotive). Additionally, gross margin pressures will likely alleviate soon. As such, we expect analysts to raise estimates in response to the positive guidance.
 
We don’t like the lack of information on the situation in Japan. Additionally, since order growth rates do not indicate any major slowdown in the notebook market, we think this broadens the chances of cancellations. Additionally, capex spend appears to be on the rise, limiting free cash flow.
 
Considering these factors, we believe our Neutral recommendation is justified. We also do not think there will be very great movement in the share price over the next 1-3 months. Hence we have a short term Hold recommendation on Molex shares, denoted by the Zacks Rank of #3.