FLEX – Flextronics International Ltd.

[ni-co]

FLEX is essentially a white label hardware manufacturer and supply chain manager for many of the Silicon Valley tech companies with factories scattered around the world trading at a 12-13% 2015 FCF yield (based on management's expectations).

 

I stumbled upon FLEX in Larry Robins' Delivering Alpha presentation.

 

What got me really interested is their strong focus on FCF and capital allocation. Having seen Robbins' presentation, I took a look into their latest annual report. Right there in the third paragraph of the letter to shareholders CEO Mike McNamara stated:

 

While we are all extremely proud of these fiscal 2014 achievements, it is important to not lose sight of what made this all possible, namely our ability to deliver continuous improvement in our key business metrics, our strong sustainable cash flow generation, and our disciplined approach to capital allocation and returning value to you, our shareholders.

 

and even better on the following page:

 

Our strong levels of consistent free cash flow generation have been above our investment requirements, creating an opportunity for Flextronics to consistently return value to shareholders in the form of stock buybacks. During the past four fiscal years we have used $1.7 billion to repurchase 259 million shares, which was the primary driver in reducing our shares outstanding by over 27%. This has allowed our long-term investors to see their ownership stakes in Flextronics consistently rise, while also allowing us to retire shares that we believe are undervalued relative to our long-term earnings potential.

 

Now this is kind of interesting: Robbins mentioned that they had been restrained by Singapore law (they are incorporated in Singapore) to maximally buy back 10% per year but lobbied the government to change the rules and are now allowed to buy back 20%.

 

There is also an investor day presentation from May which I found very useful to get an understanding of the business FLEX is in.

 

What do you guys think?

 

Edit: I forgot an important point that was also made by McNamara in his presentation: Because of the tech companies outsourcing ever more complex products and parts to manufacturers like FLEX and demanding worldwide distribution, supply chain management has become increasingly more complex. This gives companies with FLEX' global footprint a significant advantage over newcomers. Barriers to entry are much higher today than 10 or 20 years ago – in virtually every country in the world. Competitors like Foxconn are only beginning to expand into other countries where FLEX already is, giving FLEX a head start e.g. in Europe or Brazil.

[topofeaturellc]

Its basically commodity assembly - the supply chain story just doesn't ever pan out because all of them can do that. And the cost curve is really flat.  And the contracts are written in such a way that the customers can bail pretty much anytime they want.  Not just that but the 500 pound gorilla takes advantage of a subcontractor pool that has a much lower cost of capital than you and I and is more vertically integrated.

 

At least the industry finally learned to stop buying factories from OEMs.

 

But it might work if that cashflow is real. Who knows!!

[ni-co]

Yes. That's all true. However, what I tried to say is that there are not that many companies worldwide that actually can do this kind of commodity business. This gives the larger manufacturers some pricing power and the barrier to entry is getting larger, too. You cannot simply open a new plant in China and be in business – the large manufacturers are already there and at much greater scale.

 

FLEX is one of the 800 pound gorillas. They are the second largest electronics manufacturer globally. What I find interesting is that disruption in this area has already happened. Foxconn and FLEX are the survivors and are now gaining pricing power. It's a commodity business, yes, but because of the economies of scale there's also an oligopoly in the making – at least for certain products and at certain scales.

 

But it might work if that cashflow is real. Who knows!!

 

As long as they keep repurchasing shares it's real enough for me. ;)

[topofeaturellc]

You don't need many players in a high fixed cost/low variable biz with low capital requirements for pricing to be permanently punk. 

 

The idea that "few players = oligopoly = high returns" is really not true.

[Haasje]

I agree it's not a business that is likely to deliver sustainable returns above cost of capital but if you buy it cheap enough any business can be a good investment.

[Spekulatius]

You don't need many players in a high fixed cost/low variable biz with low capital requirements for pricing to be permanently punk. 

 

The idea that "few players = oligopoly = high returns" is really not true.

 

Most consumer goods (Cellphones, game consoles) are build by several contract manufacturers to diversify supply chain risk and keep a lid on costs. I don't think there is a moat there - there are probably 5 that can compete with FLEX but there are also several regional ones (in China) that can build millions of units. Good capital discipline is necessary for this stock to work. I kind of doubt the FCF yield, because there is a lot of Capex necessary.

[ni-co]

Thanks for your input, guys. You've convinced me not to pull the trigger. I still like the capital allocation story, but there is simply too little information within the annual reports to filter out what part of FLEX's FCF is derived from their low-margin commodity business and what part is attributable to their higher-margin medical/automotive/defense/aerospace business (which they call "High Reliability Solutions") – where they might have some kind of competitive advantage.

 

Therefore, having thought about your arguments, there is no way for me to predict FCF even roughly for the next few years.

[topofeaturellc]

there really isn't a sustainable advantage in those businesses either.  Its a better business then the ones where they compete with the chinese, but it is still brutally competitive between the handful of competitors who can do it.  Like the IT assembly is like a 5-6 ROC and the other stuff is 7-8