January 22, 2017 | 9 Pages CFA Report 1 | Page Fiscal Year Ends Dec Rating: Hold Price: $71.30 Price Target: $78.08 52-wk Range: $45.23-$73.15 Market Capitalization (M): 6,387.5 Shares Outstanding (M): 89.6 P/E: 11.56x Enterprise Value (M) 8,840.2 EV/EBITDA 9 Arrow Electronics Inc. DATE: 30-DEC-2016 TICKER: NYSE: ARW GICS SECTOR: INFORMATION TECHNOLOGY RECOMMENDATION: BUY (9.5% RETURN) CLOSING PRICE: $71.30 TARGET PRICE: $78.08 INDUSTRY: TECHNOLOGY DISTRIBUTORS Executive Summary Investment Recommendation We are initiating coverage with a BUY rating and 12-month price target of $78. Our target price is calculated using a discounted free cash flow valuation method. We validated our target price by using comparative analysis with eight competitors. The target price represents a 9.5% return on investment from the December 30 th closing price of $71.30, which implies an alpha of 0.9%. Arrow Electronics Inc. is the leading global distributor of electronic components by market share. Evolution of the Internet of Things The electronics equipment wholesaler industry is benefitting from the evolution of the Internet of Things (IoT). According to Gartner, Inc the IoT base will grow to 26 billion units installed by 2020, representing a 28x increase from 0.9 billion in 2009. Due to Arrow’s value add services we believe that it is well positioned to take advantage of this explosive trend; however, the company’s ability to maintain its market share will be a key component of future performance. Investment in Cloud Computing Services Arrow has highlighted a fundamental driver of future growth to be increased investment in Cloud Computing Services and Engineering Consulting Solutions. The firm has expressed interest in pursuing this business segment due to 100% gross margins and increasing demand for Data Processing and Hosting services. Arrow Electronics has been able to grow revenue in this segment by 121% in the past 5 years alone. Reports from IBISWorld and the Bureau of Labor Statistics project that this industry will experience rapid growth in the next 5 years. Steep Growth in Asia Roughly 21% of revenue for ARW is generated from Asia. Their exposure to this region primarily stems from sales in China, India, and Japan. Rapid GDP growth expectancies in these countries coupled with increased demand for electronic components and consulting services put Arrow in a great position to capitalize from overseas expansion. Financial Data 2011 2012 2013 2014 2015 Revenue Growth 14.1% -4.6% 4.7% 6.6% 2.3% Gross Margin 13.8% 13.4% 13.1% 13.2% 13.0% EBITDA Gross Margin 5.1% 4.5% 4.5% 4.6% 4.5% EPS 5.3% 4.4% 4.7% 5.6% 5.8% ROE 17.3% 13.2% 9.8% 12.0% 12.0% ROA 6.2% 4.9% 3.5% 4.1% 9.3% -20% 0% 20% 40% 60% 80% 100% 120% 5 Year Total Return S&P 500 ARW
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January 22, 2017 | 9 Pages
CFA Report
1 | P a g e
Fiscal Year Ends Dec
Rating: Hold
Price: $71.30
Price Target: $78.08
52-wk Range: $45.23-$73.15
Market Capitalization (M): 6,387.5
Shares Outstanding (M): 89.6
P/E: 11.56x
Enterprise Value (M) 8,840.2
EV/EBITDA
9
Arrow Electronics Inc.
DATE: 30-DEC-2016
TICKER: NYSE: ARW
GICS SECTOR: INFORMATION TECHNOLOGY
RECOMMENDATION: BUY (9.5% RETURN)
CLOSING PRICE: $71.30 TARGET PRICE: $78.08
INDUSTRY: TECHNOLOGY DISTRIBUTORS
Executive Summary
Investment Recommendation
We are initiating coverage with a BUY rating and 12-month price
target of $78. Our target price is calculated using a discounted free
cash flow valuation method. We validated our target price by using
comparative analysis with eight competitors. The target price
represents a 9.5% return on investment from the December 30th
closing price of $71.30, which implies an alpha of 0.9%. Arrow
Electronics Inc. is the leading global distributor of electronic
components by market share.
Evolution of the Internet of Things
The electronics equipment wholesaler industry is benefitting from the
evolution of the Internet of Things (IoT). According to Gartner, Inc
the IoT base will grow to 26 billion units installed by 2020,
representing a 28x increase from 0.9 billion in 2009. Due to Arrow’s
value add services we believe that it is well positioned to take
advantage of this explosive trend; however, the company’s ability to
maintain its market share will be a key component of future
performance.
Investment in Cloud Computing Services
Arrow has highlighted a fundamental driver of future growth to be
increased investment in Cloud Computing Services and Engineering
Consulting Solutions. The firm has expressed interest in pursuing this
business segment due to 100% gross margins and increasing demand
for Data Processing and Hosting services. Arrow Electronics has been
able to grow revenue in this segment by 121% in the past 5 years
alone. Reports from IBISWorld and the Bureau of Labor Statistics
project that this industry will experience rapid growth in the next 5
years.
Steep Growth in Asia
Roughly 21% of revenue for ARW is generated from Asia. Their
exposure to this region primarily stems from sales in China, India, and
Japan. Rapid GDP growth expectancies in these countries coupled
with increased demand for electronic components and consulting
services put Arrow in a great position to capitalize from overseas
expansion.
Financial Data 2011 2012 2013 2014 2015
Revenue Growth 14.1% -4.6% 4.7% 6.6% 2.3%
Gross Margin 13.8% 13.4% 13.1% 13.2% 13.0%
EBITDA Gross
Margin 5.1% 4.5% 4.5% 4.6% 4.5%
EPS 5.3% 4.4% 4.7% 5.6% 5.8%
ROE 17.3% 13.2% 9.8% 12.0% 12.0%
ROA 6.2% 4.9% 3.5% 4.1% 9.3%
Debt/Equity 53.4% 49.0% 53.8% 50.1% 57.8%
-20%
0%
20%
40%
60%
80%
100%
120%
5 Year Total Return
S&P 500 ARW
2 | P a g e
Investment Risks
Key investment risks associated with Arrow consist of diminishing
margins in electronics equipment sales and increasing competition for
the Electronic Component Wholesale industry. This risk originates from
low barriers to entry and a lack of differentiation between products.
Component revenue for Arrow is primarily driven by global
semiconductor sales; Bank of America Merrill Lynch analysts estimate
growth in this sector to be stagnant in upcoming years. The firm also
relies on a concentrated group of vendors in the Enterprise Computing
Solutions space which exposes them to supply-side risk. ARW has
historically relied heavily on debt financing, so increasing interest rates
could potentially prevent lucrative investment opportunities including
stock repurchases and acquisitions.
Company Description
Arrow Electronics Inc. (ARW) was founded in 1935. It is now a global
corporation that is listed as a fortune 150 company. Arrow is divided into
two primary business segments, Global Components Retail and
Enterprise Computing Solutions. The primary target market for Arrow
consists of industrial and commercial consumers of electronic
components. Arrow specializes in supply chain logistics and serves as an
intermediary between producers and consumers of electronic equipment.
The firm partners with over 100,000 manufacturers and industrial clients.
Arrow is headquartered in Colorado; however, the company has over 460
locations in 85 different countries.
Products and Services
Enterprise Computing Solutions (ECS)
Arrow ECS is a “comprehensive portfolio of IT solutions” that accounts
for 38% of total revenue. ECS consists of 5 parts:
1) Comprehensive Distribution Services including everything from
engineering and integration support to warehousing.
2) Advanced Solutions Lab for resellers to design, test, build and demo
solutions for their customers.
3) Global Training Services with more than 1,000 vendor authorized
training courses available on-site, online and in 42 Arrow training
classrooms in North America.
887.6, 7%
5,858.3, 48%
1,686.5,
14%
443.8, 4%
3,384.0, 27%
FY 2015 Global ECS Revenue
Storage
Software
Standard
Servers
Proprietary
Servers
Other
Products and
Services
Numbers in Millions USD
Source: Bloomberg Finance, LP and ARW FY '15 10K
11,721.5
50%6,788.7
29%
4,771.8
21%
ARW FY'15 Revenue by
Geography
North America
Europe
Asia/Pacific Source: Bloomberg Finance LP
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4) Business Intelligence Services for solution providers to help them
better understand the current/future industry environment and support
business growth opportunities.
5) Financial Solutions for both solution providers and their end-users.
Global Components Retail
Arrow is the largest global distributor of electronic components. This
segment of the business currently makes up 62% of total revenue. Within
the global components business segment about 66.0% of the company’s
sales consist of semiconductor products and related services; about
19.0% consist of passive, electro-mechanical and interconnect products
(capacitors, resistors, potentiometers, power supplies, relays, switches
and connectors); about 10.0% consist of computing and memory, and
about 5.0% consist of other products and services.
Competitive Positioning
Enterprise Computing Solutions (ECS)
Arrow’s ECS prospects can be viewed in the context of Data Processing
& Hosting Services and Enterprise Software Publishing. According to a
2016 report from IBISWorld, total revenue of Data Processing & Hosting
Services was $144.4 billion and expected to grow at a rate of 4.8%
through 2021. The industry’s growth is characterized by the trend of
businesses outsourcing their IT storage to capitalize on the dependability
and integration offered by cloud-based solutions. While Arrow does not
engineer or host the platforms that increasingly house industrial
information, its role as an intermediary allows the company to bridge the
gap between smaller to medium-sized value added resellers (VAR’s) that
do not have the capital or expertise to engineer the design-chain of their
own data systems. ECS also consists of the distribution of enterprise
software, the total market of which saw revenues of $37.9 billion in 2016
and forecasted to grow at 4.5% through 2021. The products delivered by
this industry consist of customer relationship management (CRM) and
enterprise resource planning systems (ERP). Vertical integration in this
segment may pose a threat to Arrow’s foothold; the company recognizes
this and attempts to proactively offer its customers leading-edge
solutions that easily fit into their supply chains.
Electronic Components
No major players currently have an influential position in the global
electronic parts and equipment wholesale sector. 13,261 businesses
compete for $361.7 billion in revenue worldwide. Forecasts from
IBISWorld predict annual growth between 2016-21 will average
3.2%. In a mature life-cycle industry with a significant number of
competitors, success is driven by strategic acquisitions that increase
geographic reach and effective customer relationship management. Over
the past several years, distributors such as ARW have flocked to the
developing world where rising incomes and increased usage of
electronics have given way to higher demand. Meanwhile, prices for
semiconductors and other components have declined as a result of
manufacturing improvements. Due to the high concentration of
competitors, distributors have not been able to realize the increased
margins that would otherwise be brought about by these two factors, and
many, including ARW, accept lower operating margins as a cost of