FPA Capital Comments on Arrow Electronics
- By Holly LaFon
Given the relatively choppy markets this past quarter, particularly for technology stocks, we wanted to review a few of our technology investments that we consider relative safe havens. As shown below in Chart 1, one of the Fund's technology distributors, Arrow Electronics, Inc. ( NYSE:ARW )("ARW" or "Arrow"), performed well relative to the broader market and to relevant technology indexes during the 4Q 2018.
And while our other technology distributor investment, Avnet, Inc. ("AVT"), only performed in line with the broader index and relevant technology indexes, we think it's too early within the current semiconductor downturn to judge its performance as these downturns have tended to last closer to 15 months and we are only on month six.
Arrow's outperformance comes as little surprise to us as one of the features that we have liked about technology distributors is their resiliency during a semiconductor downturn. As shown in Table 2, outside of the financial crisis and the dotcom bust, these stocks historically have tended to outperform during a downturn, often even posting positive gains.13
Our investment thesis for both of these businesses is relatively simple. They are highly diversified, market-leading companies that have generated low double-digit returns on capital despite their relatively thin margins. We consider these returns reasonable, but not juicy enough to attract new entrants (read:Amazon) any time soon. Furthermore, we see these businesses as difficult to disrupt as they are not wedded to any particular technology and we expect continued top-line growth and margin improvement from both businesses over time. Finally, these firms tend to make large investments in working capital as they grow and can harvest these investments when their markets are shrinking producing countercyclical free cash flow. The free cash flows that may be generated during a downturn allow management to take advantage of attractive mergers and acquisitions ("M&A") opportunities or repurchase their own shares at discounted prices.
In addition to the above, we believe Avnet's management team is executing on several self-help opportunities that we think make that investment even more attractive and have sized the investment accordingly. In particular, management has embarked on a $240mm cost saving initiative that we believe is already bearing fruit and they are also working on increasing their working capital efficiency, which may ultimately free up close to $1b of additional capital.
We are not expecting straight-line, up-and-to-the-right performance out of these investments, so we intend to stay nimble and will look for opportunities to add to these positions should a broader market drawdown give us the chance to.
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The intrinsic value of ARW
From FPA Capital's fourth quarter 2018 shareholder letter.
This article first appeared on GuruFocus.
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The intrinsic value of ARW
