Sanmina: Earnings Fell Short (Downgrade) (NASDAQ:SANM)

Investment Thesis

Sanmina (NASDAQ:SANM) reported its Q2 2024 results on April 29, 2024. Revenue missed expectations by $60 million and EPS was a beat by $0.05. The company delivered revenue of $1.83 billion (-21% YoY), and non-GAAP EPS of $1.30.

The market’s reaction to Sanmina’s earnings was muted, likely due to very low expectations because of the ongoing weakness in the semiconductor and EMS sectors.

In our previous article, we issued a buy rating for Sanmina due to its very cheap valuation and margin expansion potential (see below):

The stock has appreciated 25% since then, but Sanmina sales plunged by 20% in the same timeframe. As a result, its valuation surpassed its five-year historical averages, so we are downgrading the stock to Hold. In this article, we will examine the Q2 earnings report, and revise our valuation accordingly.

Sanmina Says Business Has Leveled Out

Sanmina’s Q2 earnings report wasn’t much positive, with revenue falling 20% and Q3 guidance also below market expectations ($1.8 billion to $1.9 billion vs $1.97 billion consensus).

Sanmina management, however, was pleased with the results and indicated that the revenue has hit the bottom. The company is expecting improvements in upcoming quarters as it works out its inventories. However, the Q3 outlook indicates a flat revenue on a sequential basis, which suggests that the recovery will be slower than expected.

Looking at the segment results, the Communications and Cloud Infrastructure end markets were down the most (-36%). This heavy decline was largely due to reduced demand within the communications and 5G markets. We are surprised that the Cloud AI/ML business was unable to offset some of this decline, raising concerns about Sanmina’s competitive edge in the AI/ML end-market.

2024: Transition Year?

Sanmina’s leadership sees 2024 as a transition year. The company says that they have made significant investments in 2023 to accelerate growth, with the expectation of seeing returns in 2025. From the Q2 earnings call:

Jure Sola (CEO):

And then tuning things internally. I think — as we went through this morning I call it, transition year, we invested a lot in ’23 for a growth, and we positioned the company for growth. Unfortunately, demand went down because of inventory correction, what we meant because of COVID and then slower demand. Combination of those two things is a transition year. What you do in this type of environment? You basically look at your company and try to tune things up. So that allows us to do a better job as the market comes back and also most importantly is to take care of our customers better and deliver the better results for our shareholders.

The certainty of 2024 being a transition tear is a question for us. We have doubts that Sanmina is following the right business strategy to grow its business. As we explained in our previous article, the company is spread thin across multiple industries without a clear focus or competitive edge. This makes the company very cyclical and heavily dependent on the ups and downs of the semiconductor industry.

Positive: Operating Margin Holding

Despite the 20% revenue decline, Sanmina was able to meet its margin targets and hold its operating margin relatively steady at 5.4% (was 5.5% in Q1). This shows the company is executing with discipline and demonstrating operational efficiency during industry downturns. Also, another positive was the gross margin, which increased to 8.9% from 8.8% in Q1 due to favorable product mix.

In terms of the balance sheet, Sanmina has reduced its debt further to $321 million, resulting in a very low debt-to-cash ratio of 0.49x. The company has $651 million in cash, $321 million in debt, and $1.5 billion in liquidity, and maintains a healthy balance sheet.

Valuation – Above Historical Averages

The FY24 earnings estimates for Sanmina have come down significantly since the last two quarters. Based on the analyst consensus estimate for fiscal 2024, Sanmina’s current price implies a forward P/E ratio of 11.4, which is 15% above its five-year historical average of 10. Additionally, the current market cap implies a forward P/S ratio of 0.45, which is 32% above its five-year historical average of 0.34 (see below):

Because of the last six months price action, Sanmina is now trading at a premium compared to its historical averages. However, given the company’s ongoing operational discipline and future potential for margin expansion, we think that the current valuation is justifiable for Sanmina.

Conclusion

Sanmina is a cyclical EMS company that is heavily dependent on the semi-industry in order to recover its business. Despite the significant decline in its revenue numbers, Sanmina’s stock price has seen an increase over the past six months, leading to a valuation that is above its historical averages.

In conclusion, we think that the market is reflecting Sanmina’s margin expansion potential into its current valuation. Since the positives are being priced in, we don’t see any near-term event to positively impact Sanmina’s valuation. Therefore, we are adjusting our recommendation for Sanmina to a Hold status.