I wrote up Tech Data (TECD) last August 2018, when the stock was trading just under $85 per share. Since then, the stock is up 12.1% (vs the S&P up 4.7%). But despite the outperformance, the stock has actually gotten cheaper. A year ago it was trading at 8.2x 2018 earnings. Today it’s trading at an historical low valuation at 7.6x earnings (for the fiscal year ending January 2020).

Put differently, TECD likely will grow EPS at a 31% growth rate this year. And yet, it suffers at a multiple that suggests a business model either in serious secular decline or likely to see a major negative earnings drop soon. Even at the company’s trading low in late 2008 (at roughly $20 per share during the panic of the Great Recession), TECD traded at an 8.0x P/E multiple. The downside appears quite limited.

A more typical trading level is 10-14x earnings, and 5-8x EBITDA. Below is a chart of the average P/E ratio going back to 2017.

Summary

Quarter Overview

For the July quarter announced last week, Tech Data earned $2.69 per share, up an eye-popping 34% year over year. Management beat guidance handily, and offered $2.85-3.15 October quarter EPS guidance (vs Street at $2.85). Street expectations have to be raised (again), and while the company generates usually 40% of annual earnings in the 4th quarter, it appears that barring an instant recession, the company will earn in the $11.75 -$12.75 range for the full fiscal year (ending January 2020).

Sales growth was impressive at 5% excluding currency impacts in the quarter. The America’s segment grew 7% yoy, while Europe continued to remain weak with growth down 2%, although up 2% adjusting for the Euro.

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Margins improved as well, as management continues its $70-80mm cost cutting plans. The company also seeks to optimize their portfolio, increasingly focusing on higher margin products and higher margin services per the Avnet TS acquisition business they purchased back in 2017.

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Source

Lots of questions on the call had to do with tariffs. The company reiterated that the issue with tariffs is that when a vendor raises prices, then Tech Data simply passes along the higher price. To state the obvious, they are simply a distributor. To an extent, higher prices and at similar margins, imply higher DOLLAR gross margins. From that perspective, tariffs could be deemed a benefit.

But the reality is that tariffs are a tax to the international trade system. And that acts as a deterrent to growth. Management left out any impact from the potential September 1st tariffs out of guidance. It’s unclear to me that it would be anything but a negative to growth.

Another minor concern that management addressed was the company’s exposure to Huawei phones. At the end of the first quarter, Huawei phones totaled 4% of inventory. Today that figure is 2%.

Finally, management raised their share buyback plan by $200mm, taking their total authorization to $275mm. That is 8% of the outstanding market cap, and if done in the next year, adds a substantial tailwind to EPS growth for 2020 and 2021. The Street is forecasting $12.60 in EPS in 2021 (next year), and given management’s ability to continue to outperform, I wouldn’t be surprised to see EPS in the $13-14 range.

Valuation Appears Quite Attractive

I re-ran Tech Data’s valuation relative to its peer group, and it appears substantially cheap at a roughly 30% discount on both an earnings as well as an EV/EBITDA basis. This is despite the fact that TECD generates the highest ROE’s in the industry at 15% in the latest quarter, and an EPS growth rate that over time has trounced is competitors.

As an investor, I am continually impressed by management and their skill in allocating capital, cutting costs and optimizing their portfolio to generate higher margins.

Should TECD simply get a multiple near ARW, which I deem to be the best comp to TECD, then the shares would be worth 9.67 x $12.25 (my 2012 earnings estimate) = $118 per share. That is upside of 34%.

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The difference in valuation here is truly inexplicable. ARW is a well-run company, but has only grown EPS at a 5% rate over the past five years, compared to TECD at 19%.

AVT is a component distributor who (according to insiders I have spoken to in the space) really focuses on low margin and high volume product. Their EPS growth rate has been quite unimpressive, with 2019 EPS expected to be lower than what they did 5 years ago. Despite that, the stock garners a 12.5x earnings multiple and even on forward 2020 numbers is trading at 9.4x earnings. At 8x EBITDA, AVT trades at a 55% premium multiple to Tech Data.

Note that one private name in the industry is owned by Berkshire Hathaway; TTI purchased about a decade ago. Here is a good video describing why these are good businesses.

The only negative to the TECD story, per management’s tone at least, was that Q4 2018 was a very solid quarter. With global growth slowing and a stronger dollar, Q4 2019 will be a tough comp. To that end, I modeled the first two quarters of 2019 using actual results, added $3.00 for Q3 which is the midpoint of their guidance, and assumed a flat Q4 vs the year before ($4.55 in EPS). That gets me to $12.28 in EPS.

Currency headwinds also are a drag, with the dollar 6% higher today than it was in Q4 last year. In any case, $12.28 should be a doable number for 2019, a very solid result, and conservative relative to current Street estimates. Look for positive momentum near term. Any trade relief or GDP growth acceleration in the next few months, and the stock should continue to re-rate higher.

The downside appears to be limited, but perhaps real on a mark to market basis. Missed quarters are treated quite poorly by the market. That said, EPS in 2009 was only down 3%. The biggest draw down in EPS since 2005 was 32% in 2007, followed by EPS growing by 82% in 2008. A 30% decline in EPS would imply $8.62 in earnings for TECD, and a P/E multiple of 11x. While I originally viewed $75 as the downside, perhaps it is more likely a mid $80s level. That is down $10, and up $30-50 depending on one’s investing horizon.

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Conclusion

From the time of its IPO, TECD has generated substantial returns for shareholders. From its listing date June 30, 1986 to June 30, 2018, Tech Data has provided 13.5% annual returns to holders. Over the past 5 years however, TECD has underperformed. While EPS has doubled (from $5.18 in 2018 to $10.46 in 2018, and likely over $12 this year), the stock has continued to re-rate lower. It is a cash flow machine however, and a well managed one at that. I recommend a long position; Tech Data is a high quality Compounder.

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Disclosure: I am/we are long TECD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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