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Morningstar | Outlook Takes Shine Off Avnet’s Otherwise Decent Quarter; Maintaining $45 FVE

Avnet’s fiscal third-quarter results were in line with previous guidance, if slightly lower than our internal expectations, for both revenue and earnings. As presaged in calls from suppliers earlier in the week, demand for electronic components was slightly diminished in the quarter and sales for Premier Farnell (which the firm has rebranded as Farnell) were slightly disappointing. Management also provided fiscal fourth-quarter guidance, which was slightly lower than our expectations due to weaker macro conditions. Farnell weakness and macro headwinds aside, we are pleased with Avnet demonstrating progress on the cost controls it targeted and we believe Avnet’s long-term thesis is on track. We are maintaining Avnet’s narrow-moat rating and our current fair value estimate of $45 and note that shares are currently fully valued.

Third-quarter sales decreased by 2% year over year to $4.69 billion to roughly the midpoint of prior guidance. Electronic component sales were down 1.7% versus the prior-year period and down 8% sequentially. This was primarily due to weakness in China and Europe offsetting solid demand in the Americas. One bright spot for component sales was the continuing demand for interconnect and passive products, which grew in the high-single digits on a year-over-year basis. Farnell sales were down 6% year over year, and 3% sequentially, which was materially lower than our forecast. Management blamed the weakness on Brexit concerns in the U.K. slowing catalog customers. While management described its ongoing efforts to facilitate growth with the higher-margin Farnell--including targeted marketing in certain regions and adding SKUs--it detailed strategy changes in the approach to Avnet Integrated in the Americas. These changes are meant to focus the manufacturing solutions unit (which currently accounts for roughly 9% of sales) on higher-margin opportunities and helped contribute to overall growth in the region during the quarter.

In terms of profitability, both weakness in lower-margin China sales and solid demand for passives helped contribute to the firm’s gross margin expansion of 80 basis points sequentially to 13.3%. Adjusted operating margins for the firm were similarly solid at 3.8%, especially for Farnell, where they expanded 160 basis points year over year to 12.4%. Adjusted earnings per share for the quarter were $1.07. Management’s guidance for the upcoming quarter assumes revenue declines by nearly 7% year over year to $4.7 billion with weaker expected sales in Europe and Americas and slight sequential increase in Asian revenue. The mix shift to lower margin Asian sales is expected to contribute to adjusted earnings per share declining sequentially by 3% to $1.04 in the fourth quarter.