Need for QE2 Seen in Pausing Electronics Manufacturing Services
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In the week before the Federal Reserve announced its $600 billion program to help spur the U.S. recovery, three makers of electronic equipment for companies such as Cisco Systems Inc. announced that demand for their products was weakening.
“Our customer forecasts are more uncertain,” Jure Sola, chief executive officer of San Jose, California-based Sanmina- SCI Corp., said on a Nov. 1 conference call. Some clients “have a lot of inventory in the pipeline” and “are worried about the economy.”
Policy makers led by Chairman Ben S. Bernanke cited the deceleration in business spending on equipment and software when they announced Nov. 3 that the Fed would purchase Treasuries in a second round of quantitative easing to prevent inflation from falling further and help bring down unemployment, which has remained above 9 percent since May 2009. While investment in this sector of the economy helped the U.S. emerge from the worst downturn since the 1930s, the Fed’s gauge of industrial production by high-tech companies expanded 10 percent in October, half the pace of the 20 percent increase in April.
“Telecom, and networking in particular, has been very strong, and what you’re seeing now is that there’s a pause,” said Sherri Scribner, a research analyst at Deutsche Bank Securities Inc. in New York. While contract manufacturers typically “have very good visibility into the quarter ahead,” now, “almost across the board” they are being “a bit more cautious.”
New Bloomberg Index
The new Bloomberg U.S. Electronics Manufacturing Services Index, which comprises 14 companies including Sanmina-SCI and St. Petersburg, Florida-based Jabil Circuit Inc., jumped 91 percent from June 2009, when the recession ended, through April 2010 and has since declined 9 percent. The Standard & Poor’s 500 Index climbed 29 percent before rising another 0.1 percent in the same periods.
“Capital spending is very important to sustaining a moderate recovery overall,” said Ethan Harris, head of developed-markets economic research in New York at BofA Merrill Lynch Global Research. “QE2 provides a small lift to capital spending, but it’s a very small stimulus.”
“I think what’s important about this quarter is that everyone commented on a slowdown,” she said. “Expectations may have been that things would continue to be strong, but we’re seeing a bit of pullback.”
Manufacturing spearheaded the U.S. recovery, which began in July 2009 after an 18-month recession. Central to that transition, and the subsequent expansion, was investment in business equipment and software. This component of gross domestic product grew at a 17 percent annual pace in the third quarter, compared with 25 percent in April through June, according to Commerce Department figures released Nov. 23.
Spending “is rising, though less rapidly than earlier in the year,” Fed policy makers said in a Nov. 3 statement at the conclusion of their two-day meeting in Washington.
Orders for U.S. goods meant to last at least three years unexpectedly decreased 3.3 percent in October, according to a Nov. 24 report from the Commerce Department, raising the risk that companies will scale back on investments in new equipment.
Demand for computers and electronics plunged 7.7 percent, the first decline since July and the biggest one-month drop since December 2008, when the central bank lowered its target rate on overnight loans among banks to near zero for the first time. The Fed has yet to raise rates.
Rise in Imports
“After a very strong increase in the first half of the year, business investment in equipment and software posted a smaller, but still solid, gain in the third quarter,” the Fed’s Open Market Committee said in minutes of the November 2-3 meeting released last week. “But rising demand for equipment and software during the third quarter was also satisfied in part by a further rise in imports of capital goods.”
The central bank also cited “constrained” consumer spending, “weak” investment in commercial construction and “depressed” levels of new-home construction in the FOMC statement as reasons for purchasing Treasuries.
The U.S. economy grew at a 2.5 percent annual pace in July through September, after expanding 5 percent in the last three months of 2009, according to the Commerce Department. Construction of new homes in October fell to a 519,000 annual rate, the fewest since a record low of 477,000 in April 2009, and the unemployment rate held at 9.6 percent.
Amitabh Passi, an analyst at UBS Securities LLC in San Francisco, sees “moderating, decelerating year-over-year growth” in the next three quarters for makers of electronic equipment such as Jabil and Singapore-based Flextronics International Ltd. Even so, he rates the two companies as buys because “the biggest potential is with respect to margin expansion.”
Recent news from Cisco and International Business Machines Corp. shows how high-tech companies are weighing on manufacturers. San Jose, California-based Cisco said this month that revenue in the quarter ending Jan. 29, 2011, will be about $10.1 billion to $10.3 billion; earnings, excluding some costs, will be, at most, 35 cents a share. Analysts projected sales of $11.1 billion and profit of 42 cents on average, according to estimates compiled by Bloomberg.
Services signings at IBM declined 7 percent to $11 billion in the third quarter, the third consecutive quarterly decline in new contracts, the Armonk, New York-based company said in an Oct. 18 statement. Investors focus on the service business because it accounts for almost 60 percent of IBM’s annual sales and more than 40 percent of its profit.
At the same time, some of Cisco and IBM’s peers have boosted their profit projections. Hewlett-Packard Co., the world’s largest computer maker, forecast first-quarter earnings that exceeded analysts’ estimates on Nov. 22 as some corporations step up purchases of personal computers, printers, servers and networking gear.
The Palo Alto, California-based company said sales will be $32.8 billion to $33 billion in the quarter ending in January. Analysts had estimated $32.8 billion in revenue, according to data compiled by Bloomberg.
Makers of electronic equipment “should be able to generate better revenue growth than what we’ll see in broader tech, even though broader tech for 2011 might be at a modest level overall,” said Sean Hannan, an analyst at Needham & Co. in Boston, who lists Jabil and Plexus as strong buys. These companies “are kind of uniquely positioned right now. They don’t have to depend on robust GDP or organic growth in the underlying markets as long as some level growth exists.”
That hasn’t stopped several of these companies from saying customer orders are softening. Sanmina-SCI gave revenue guidance on Nov. 1 between $1.625 billion and $1.675 billion for the current quarter, below the consensus estimate of $1.71 billion. Benchmark on Oct. 26 said sales for the fourth quarter would be between $590 million and $630 million, compared with analysts’ estimates of $642 million.
“We saw a really broad-based decline in the demand from our customers except for one,” Chairman and Chief Executive Officer Cary T. Fu said on a conference call last month.
Plexus’s President and Chief Executive Officer Dean Foate also talked about weakness in demand on an Oct. 28 conference call: “Looking ahead to Q1, we currently expect our Wireline/Networking sector to grow in the mid-single digit percentage range, although the performance among the top 10 customers is a mixed bag of ups and downs.”
Jabil cut its revenue projections in September for the first time since the recovery began, citing fewer orders for communications equipment. Three months earlier the company boosted its forecast on stronger demand.
Looking ahead to 2011 and beyond, Jabil is optimistic about opportunities for growth, particularly outside the U.S.
“We’re actually pretty bullish about our prospects over the next several years,” Chief Executive Officer Timothy Main said in a telephone interview. Worldwide GDP is “outstanding and gives us more than enough headroom to allow us to grow our business aggressively. We’ll be able to capitalize on the global trends and then growth in emerging economies to supplement the growth that we have in North America and Europe.”
That outlook is too positive, Passi said.
“I’ve taken a more conservative approach,” modeling Jabil’s and Flextronics’s revenue “generally in line with a lot of the tech” companies such as Cisco and IBM, the USB Securities analyst said.
Sanmina-SCI said its growth is slowing, particularly as the U.S. economy lags behind emerging markets in Asia.
“We are moving into a position where we’ll be in more of an equilibrium” in the next few months, Chief Financial Officer Robert Eulau said in a telephone interview. “It’s a little too early to say what the impact of the Fed’s actions are going to be. I think our growth will moderate a bit.”
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