EUR 850.00 For Business Accounts Only

Morningstar | Arrow Reports Solid 3Q Results but Foresees Softness; Maintain $91 FVE

Arrow Electronics reported another quarter of record sales and strong earnings amid broad-based component demand. Guidance for the fourth quarter indicates that another solid quarter may be in store but management’s discussion, and indications from several of the firm’s suppliers, suggest a softer landing in the next year. However, we believe our thesis regarding Arrow Electronics’ long-term trajectory is on track and thus we are maintaining our $91 fair value estimate. Shares for the narrow-moat distributor are significantly undervalued, in our view, and despite trading up by more than 4% today, we believe there is a healthy margin of safety at current prices.

Third-quarter sales came in near the high end of guidance at $7.5 billion, a 9% increase year over year. Not surprisingly, global components led the way with 11% growth year over year on the back of strong demand as sales from the segment topped $5.3 billion during the quarter. Growth was broad-based across all operating regions and overall demand remains solid going into the next quarter with a current book/bill ratio of 1.03 (though lower than the 1.08 in the second quarter). Management indicated that the book/bill in Asia had dipped below parity but also reiterated that design activity in the region continued to grow in double digits. Impressively, operating margin in the components segment ticked up another 30 basis points sequentially to 5.1%. We expect further expansion throughout the year as design wins continue with suppliers.

Enterprise computing sales segment grew 6% year over year and were roughly flat with the prior quarter, with nearly 7% growth in the Americas region and 3% in Europe. Operating margin for the segment decreased by 80 basis points year over year to 3.9%, primarily due to the ongoing mix dynamic with lower-margin hardware making up a larger portion of sales.

Management detailed how the firm had added several value-added resellers, or VARs, over previous quarters but that these firms were currently only up and running on hardware products. We expect that margins for the segment will improve incrementally as these VARs are fully ramped with Arrow’s suite of software offerings but this process may take multiple quarters, not unlike the process of bringing in margin-dilutive fulfillment sales prior to design wins being registered. Our initial expectation was for the segment’s margin to improve sequentially with software making up a greater portion of the mix but these relationships, along with the continuing demand for hardware generally, will likely see segment margins depress even further in the fourth quarter before increasing in 2019.

Total sales in the fourth quarter are expected to grow by 5% year over year to $7.9 billion due roughly 7% growth from components offsetting flat sales in enterprise computing solutions over the same period. Management’s guidance for adjusted earnings in the next quarter assumes a sequential increase of 16% to $2.54 a share.