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Avnet, because there is a shortage of chips

Today we have an extremely speculative idea: take shares of high-tech manufacturing services provider Avnet (NASDAQ: AVT) to make money on consolidation in that area.

Growth potential and duration: 17% over 15 months excluding dividends.

Why the stock could rise: The company could make money on the rising demand for its services.

Here’s how we do it: take the stock now at $39.29.

No guarantees

Our thoughts are based on an analysis of the company’s business and the personal experience of our investors, but remember: it is not a fact that the investment will work the way we expect it to. Everything we write is forecasts and hypotheses, not a call to action. Whether or not to rely on our thinking is up to you.

And what about the predictions

Studies such as this one and this one suggest that the accuracy of target price predictions is low. And that is normal: there are always too many surprises in the stock market, and accurate predictions are rarely realized. If the situation were reversed, then funds based on computer algorithms would perform better than humans, but alas, they perform worse.

That is why we do not try to build complex models. The return forecast in the article is the author’s expectations. We specify this forecast as a guide: as with investments in general, readers decide for themselves whether to trust the author and be guided by the forecast or not.

What the company earns from

The company provides services in the production of complex electronics. According to the annual report, the company has two divisions.

Electrical Components. The service cycle ranges from technical expertise in the creation of semiconductors, including staff training, to logistics services in this area and production management software. This represents 92.7% of revenue. The segment’s operating margin is 2.1% of revenue.

Farnell. Supplies of equipment and devices for prototyping and testing electronic products – 7.3% of revenue. The segment’s operating margin is 5.83% of revenue.

To summarize the company’s line of business: Avnet helps organize, manage and modernize the production of complex technological products. One of the company’s biggest customers, Texas Instruments, gives 10% of its revenue. That’s roughly the kind of company Avnet works for.

76.21% of revenue comes from semiconductor manufacturing services, 17.84% from integrated and electromechanical devices, and 3.24% from computer manufacturing. The rest comes from the mysterious “other.

The geographical distribution of revenues in the report is not quite correct – by region: 27% in the Americas, 32.6% in Europe, the Middle East and Africa, and 40.4% in Asia. We have to guess how much the company receives in France and how much in Egypt.

Arguments for the company

Semiconductor shortages. Toward the end of 2020, the world began to experience a shortage of semiconductors, and at the beginning of 2021, demand significantly outstripped supply – many manufacturers are working at full capacity and stocks are rapidly running low. The PC boom during the pandemic contributed in no small part to this. In the US some car manufacturers even put production at their factories on hold: there were not enough electronic components to assemble the cars, and the new ones were not delivered because of the shortage. After all, new cars need more and more of these components.

Avnet will be able to capitalize on this process as an expert in the management of complex high-tech production.

The company has a capitalization of $3.88 billion, and this makes it much easier for retail investors to pump up its stock. There is a good chance that when workers digest the information about the semiconductor shortage, they will start looking to see who stands to gain from it, and in the process pump up the company’s stock price.

The company could be bought. The semiconductor industry is experiencing a frenzy of activity these days. AMD bought Xilinx for $35 billion, and Nvidia decided to buy Arm for $40 billion. In total in 2020 have concluded agreements on takeovers in this sphere for 118 billion dollars – these are record figures for 10 years. Taiwan Semiconductor Manufacturing (TSMC) is going to build a new $28 billion plant in the United States.

The industry has been on its way to consolidation for a long time. If 20 years ago there were about 30 leading processor manufacturers, now there are only three: Intel, TSMC and Samsung. By the way, Intel is thinking about outsourcing some of its production to TSMC.

For the first time since 2010, semiconductor companies are spending more than 15% of their revenues on renovation of fixed assets, which in itself creates certain difficulties in terms of management and integration of new plants and facilities into the supply chain.

These trends, coupled with the tragic experience of logistics disruptions in 2020, may prompt some large technology company to buy Avnet, thanks to the company’s small capitalization. The likelihood of such a scenario materializing is very high, although it is impossible to say exactly when and on what terms it will happen.

What might get in the way

Dividends. The company pays $0.84 per share a year, which gives a nice yield of about 2.13% per year. That could help pump up the stock price at the expense of passive income enthusiasts. Except that the company is unprofitable, and the $83 million it pays to shareholders could be put to much better use. For example, this money could be used to pay off the company’s huge debts: out of $4.603 billion in debts, $2.766 billion have to be paid within a year. In theory, the company should have enough money for everything: it can count on about $3.3 billion at its disposal. But there is always the possibility of dividends being cut or cancelled, which could cause the stock to fall.

Competitors. Avnet has major competitors: Arrow Electronics, Future Electronics, World Peace Group, Mouser Electronics and Digi-Key Electronics. This is the reason why the company’s bottom line margin even in the best of times did not exceed3% of revenue. It will also be a drag on the company’s progress going forward.

Cost and loss. The company’s stock has already risen recently and is trading near historic highs, plus the company is loss-making. Together, this virtually guarantees that the stock will be volatile. It could even be the most unpleasant scenario: the stock will fall first, and then the company will get an offer to sell, which it will probably accept, because there is no reason for a loss-making company to trade. Arrow Electronics may wait for Avnet to drop in price in order to buy the company at a cheaper price.

Revenue and profit for the last 12 months in billions of dollars, bottom line margin as a percentage of revenue. Source: Macrotrends

What’s the bottom-line

On January 27, the company will have a report for the 2nd quarter of the fiscal year 2021 – the accounting departments of many companies, like ancient Greek polices, have their own chronology. Don’t expect supernatural results: the report will reflect the situation at the end of 2020, and the acute shortage of semiconductors began to be felt in January 2021. But the stock can be taken now at $39.29, and sold within 15 months at $47, just below its all-time high of $48.

This is not a very cheeky plan, given the objective difficulties and the wave of mergers and acquisitions in the semiconductor industry. Here we can expect at least an increase in demand for the company’s services and solutions. And at most, a purchase of the company by someone larger.

Just be sure to keep an eye on the Avnet website: there may be bad news about the reduction or cancellation of dividends. Then maybe you can dump the stock before the news gets digested on the St. Petersburg Stock Exchange.

This idea is very speculative, and those who do not like volatility, there is nothing to do here.

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