THE DAY AHEAD: Solectron may benefit from economic downturn

COMMENTARY -- Contract equipment vendor Solectron (NYSE: SLR) answered a lot of questions with solid first quarter earnings and floated a thesis that the company could actually benefit from an economic downturn. And when a company counts Cisco, Nortel and Ericsson as its largest customers, maybe you should listen to it.

Get used to the" recession proof" thesis -- you're likely to hear it a lot from the contract equipment crowd, especially since Jabil Circuits (NYSE: JBL) reports its first quarter earnings after the bell Tuesday.

"The company can benefit from a slower economy because companies accelerate outsourcing," said Solectron CFO Susan Wang on a conference call. "We're best positioned to withstand market swings. There are pockets of weakness, but it's mitigated by outsourcing."

Wang had to tackle the slowdown question since Goldman Sachs lowered estimates Monday based on the growth of electronics gear already outsourced. Analysts tried to poke holes in the Solectron tale, but Wang kept coming back with the same answer -- Solectron may land more business because of a slowdown.

The numbers prove Wang's point. The company raked in a profit of $190.6 million, or 31 cents a share, on sales of $5.7 billion. More importantly, Solectron reiterated its previous guidance, but noted that its internal projections are higher. Meanwhile, component shortages have eased, a situation that could help margins and inventory turns.

Solectron was boosted by networking and telecommunications equipment customers, which outsource heavily to the company. Networking represented 29 percent of sales with telecommunications accounting for 22 percent of sales. Wang said the company could see more growth in networking and telecommunications if the industry struggles. Solectron's largest customers in order were Ericsson (Nasdaq: ERICY), Cisco (Nasdaq: CSCO) and Nortel (NYSE: NT).

Solectron has slight exposure to the PC downturn, but said it's feasible that its box building business could see more opportunity as PC vendors outsource to save costs. Solectron acquired NatSteel Electronics -- which makes products for Apple Computer (Nasdaq: AAPL) -- to boost capacity.

Despite all the optimism (rare given the large amount of tech profit warnings), Wang may have annoyed analysts by not talking up guidance. She projected second quarter revenue of $5.4 billion to $5.7 billion with earnings in the 29 cents to 30 cents a share range excluding charges. Wang practically admitted she was lowballing projections. If the company doesn't grow at all sequentially for 2001 (and officials don't expect that outcome), it'll almost reach its goal of $23 billion in annual sales.

When asked whether she was being too conservative, Wang hinted that more guidance would come when Solectron closes the NatSteel purchase. "I look forward to providing upward guidance as major events unfold," she said.

Disinformation?

Wang also tackled a bunch of rumors surrounding the company, and even tried to pin the "disinformation" on short sellers. Here's how Wang shot down various market worries:

• On slowing demand for the PC sector, Wang said the company saw it coming and was among the first to flag weak PC sales. Indeed, a check on Solectron's fourth quarter call verified Wang's contention.

• On telecommunications end market woes filtering to Solectron, Wang said the company is still benefiting from new optical gear. Networking sales were up 23 percent sequentially and telecom sales jumped 32 percent.” The telecommunications industry is behind in outsourcing," she said.

• On reports that Solectron was canceling orders, Wang had an explanation. She said the company did cut back some component orders to bring inventory levels more in line. Solectron customers were anticipating shortages and asking the company to stock up on components. Now that component woes have eased, Solectron is moving toward its "just in time" manufacturing norm.

• On inventory, Wang also offered some clarification. Inventory surged in the quarter sequentially due to component hoarding. Solectron customers are paying the company to hold the inventory, but it doesn't appear on the financial statements, she said.

Jabil preview

The story for Jabil may not be as rosy. Jabil gets 35 percent of its business from PCs and PC-related peripherals, and the company was conservative with its previous guidance.

On the company's first quarter conference call (4:30 p.m. EST), you can expect management to talk about reallocating its programs to higher growth businesses. ING Barings analyst Patrick Parr is projecting earnings of 26 cents a share, in line with consensus, on sales of $1.15 billion.

Given Jabil's PC exposure, "some incremental softening seems unavoidable," said Parr in a research note. Most of the bad news, however, is factored into Jabil's stock price. Parr also came back to the recession-proof argument.

"If the weakness in technology were to continue, we would expect outsourcing to accelerate, with Jabil and the other firms likely to see the counter-cyclical trend of accelerating sales," he said.TDAIN

• Solectron tops estimates, sets 2001 targets
• Day Ahead archive
• Get The Day Ahead>