It has been about a month since the last earnings report for Arrow Electronics (ARW). Shares have lost about 3.8% in that time frame, underperforming the S&P 500.
Will the recent negative trend continue leading up to its next earnings release, or is Arrow Electronics due for a breakout? Before we dive into how investors and analysts have reacted as of late, let's take a quick look at the most recent earnings report in order to get a better handle on the important drivers.
Arrow Reports Q2 Results
Shares of Arrow Electronics have lost 0.1% so far this year compared with the industry’s rally of 6.4%.
Persistent weakness in key verticals like industrial, transportation and automotive, together with foreign exchange headwinds and U.S. tariffs is taking a toll on investor confidence.
Notably, the company recently released mixed second-quarter 2019 results, wherein both the top line and bottom line declined year over year, despite beating the consensus estimate.
The fall in revenues and earnings, coupled with weak outlook for global components business, is expected to further hurt investor confidence in the stock. Notably, Arrow’s shares have lost 11.2% since the earnings release.
However, progress in cost optimization, focus on long-term growth strategy, and commitment toward the expansion of engineering are positives.
A Peek Into Q2 Results
Arrow’s non-GAAP earnings of $1.60 per share beat the Zacks Consensus Estimate of $1.56 but decreased 27.3% year over year.
Notably, continued deceleration in the industry for components in the trailing quarters resulted in an unfavorable customer mix due to a demand shift to lower margin products. This is keeping the bottom line under pressure.
The company’s revenues were $7.35 billion, down 1% from the year-ago quarter. After adjusting for the impact of foreign currencies and spin offs, the figure increased 2% from the adjusted sales of the prior-year quarter. The top line also beat the Zacks Consensus Estimate of $7.29 billion.
Further, the company faced foreign currency headwinds amounting to $148 million on sales and 6 cents on earnings during the quarter.
Adjusted revenues from Global Components improved 2.1% year over year to $5.19 billion. The segment gained from design activity. However, on a reported basis, revenues declined 0.3%.
Region wise, the segment’s revenues from the Americas decreased 2.5% due to high levels of inventory with customers. Adjusted sales from Asia climbed 5.1%, partly driven by a surge in demand for the company’s low-margin wireless device business.
Global components contribution from Europe rose 4.4% on an adjusted basis but declined 2.2% on a reported basis.
Adjusted revenues from Global Enterprise Computing Solutions (ECS) came in at $2.07 billion, up 1% year over year. However, revenues from this segment declined 1.6% on a reported basis.
ECS revenues from the Americas declined 0.4% after adjusting for the divestiture of Unified Communications and foreign currency changes. Adjusted sales from Europe jumped 5% year over year but declined 2.8% on a reported basis.
ECS growth was driven by strong momentum in servers, infrastructure software, industry standard servers and security. However, weak demand for IT hardware, particularly in the areas of storage and proprietary servers, dampened growth.
Many customers continued to shift their manufacturing operations out of the United States to avoid tariffs, posing a significant threat to Arrow. This led to the push out of several high value orders.
Moreover, backlog and lead times declined year over year in the reported quarter. Lead times contracted more for semiconductors than for passive and electromechanical parts. The overall book to bill remained below parity at 0.95.
Nonetheless, Arrow’s focus on automation continued to deliver significant back-office savings in areas like IT, accounting, order processing and shipping, among others.
Gross profit decreased 8.1% from the prior-year quarter to $841.2 million.
Arrow’s non-GAAP operating income plunged 23.5% to $242.7 million. Non-GAAP operating margin of 3.3% was 100 basis points lower.
Demand shift to lower margin products coupled with lower revenues kept margins under pressure.
Balance Sheet and Cash Flow
Arrow exited the quarter with cash and cash equivalents of $270 million compared with $352 million in the previous quarter.
Long-term debt was $3.2 billion compared with $3.6 billion at the end of the prior quarter.
The company’s cash flow from operations was $405.4 million.
In the second quarter, Arrow returned approximately $150 million to shareholders through stock repurchase program, and was left with approximately $539 million of authorization.
Excluding the financial impact from the PC and mobility asset disposition business, for the third quarter of 2019, sales are expected between $6.85 billion and $7.25 billion.
Global components sales are projected in the range of $4.93-$5.13 billion. Global ECS sales are estimated to be $1.93-$2.13 billion.
Interest expenses will presumably be about $54 million, as a result of which, the company projects non-GAAP earnings per share in the range of $1.62-$1.74. Average non-GAAP tax rate around the higher end of the 23.5-25.5% range is included in the guidance.
Foreign currency headwind of approximately $90 million on sales and 5 cents on earnings per share is expected in the third quarter.
Profitability improvement activities for the ECS, which was undertaken during the fourth quarter of 2018, are expected to continue through 2019.
Management expects enterprise computing solutions operating income to increase year over year in the third quarter.
Nonetheless, the company expects significant electronic content growth for industrial, transportation and automotive industries, and remains optimistic to return to growth in the near term.
Moreover, the winding down of PC and mobility device disposition business is expected to enable accelerated implementation of next generation technologies like AI, industrial automation, smart cities and vehicles. This is expected to boost the company’s business and returns to shareholders.
How Have Estimates Been Moving Since Then?
Estimates review followed a downward path over the past two months. The consensus estimate has shifted -6.96% due to these changes.
At this time, Arrow Electronics has a strong Growth Score of A, though it is lagging a bit on the Momentum Score front with a B. Following the exact same course, the stock was allocated a grade of B on the value side, putting it in the second quintile for this investment strategy.
Overall, the stock has an aggregate VGM Score of A. If you aren't focused on one strategy, this score is the one you should be interested in.
Arrow Electronics has a Zacks Rank #5 (Strong Sell). We expect a below average return from the stock in the next few months.
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