MOLX Molex Incorporated (MM)

Molex Inc’s (MOLX) earnings for the third quarter of fiscal 2011 missed the Zacks Consensus by a couple of cents, which management attributed to the natural disaster in Japan. Revenue for the quarter was in line, exceeding by 0.2%. The weak results and disappointing guidance caused shares prices to drop 2.4% in after-hours trading.

Revenue

Molex reported revenue of $874.5 million, which was down 3.0% sequentially and up 15.6% year over year, exceeding management expectations of $850-890 million, or up 1-6% sequentially. Molex generates the bulk of its revenue from the connector market, so results continue to be positively impacted by the secular growth in markets using these products.

Molex stated that although orders from Japan appeared to soften after the disaster, they started coming back toward the end of April. Moreover, other regions continued to enjoy normal seasonal demand, with orders increasing in January, slowing down in February and coming back again very strongly in March.

Revenue by End Market

Telecommunications remained the largest market in the last quarter, with an estimated revenue contribution of 23%. Segment revenues were down 10.0% sequentially and up 15.0% from the year-ago quarter. Molex stated that the infrastructure side of the business (typically lumpy) rebounded in the last quarter, as secular drivers, such as the increase in network traffic continued.

Management stated that one of its major customers expects mobile data traffic to grow at a 90% CAGR through 2015. While the overall cell phone business remained soft, the smartphone segment was very strong, with demand fueled by customers increasingly switching to smartphones, geographical expansion and the introduction of new products.

New technology and operating systems, specifically Google Inc’s (GOOG) Android and Microsoft Corp’s (MSFT) Win 7 are other positives for Molex’s smartphone business.

The second largest end market was Data or Infotech (estimated 23% revenue share), which increased 1.0% sequentially and 24.0% from the year-ago quarter. The segment’s performance was helped by a strengthening of the tablet, storage and service markets.

Moreover, inventory of Molex products were worked down in 2010 itself, not impacting results in the last quarter, according to management. New products from its customers and recent design wins are expected to drive demand through 2011.

Longer-term drivers in this market continue to be the migration to SAAS 2.0 and 16GB fiber channel networks in the storage market, as well as the popularity of tablets, notebooks and other MIDs.

Consumer Electronics, the third largest market, generated 19% of total revenue, representing a sequential decline of 8.0% and a year-over-year increase of 10.0%. While the sequential decline was in line with normal seasonality, Molex saw below-seasonal performance in the December quarter, indicating that revenue could have been stronger in the first quarter.

However, we think that performance was impacted by the disaster in Japan. Molex is optimistic about growth in this segment, as its customers continue to introduce new products targeting the BRIC countries, as well as Vietnam and Thailand, where growth is expected to be stronger that in other parts of the world. Higher disposable income and increased consumerism in developing countries are secular drivers of demand in this market.

The automotive market brought in 17% of total revenue, increasing 8.0% sequentially and 17.0% from the year-ago quarter. The strength in the last quarter was driven by the 10% global unit volume growth, with the strongest markets being India, Brazil and Russia. The overall strength offset the weakness in China (where government incentives were withdrawn in an attempt to slow down market growth) and Japan (which was impacted by the Tsunami).

Molex stated that roughly 3 million production units would be lost to the disaster, with a $2-4 million monthly impact on results in the next few months. The increasing electronic content in automobiles is a positive because it expands the market for Molex’s connector technology. This and Molex’s exposure to China (where a large amount of auto manufacturing has shifted) are secular drivers of demand in this market.

Industrial generated 14% of revenue, down 3.0% sequentially and up 12.0% from last year. The sequential decline was mainly because of softness in Asia. The rest of the markets were strong, due to capacity additions and ramp up of new products.

Molex generates a significant portion of industrial revenue through distributors and this section strengthened in the last quarter. Management appeared optimistic that the “focus account” strategy was working and stated that they continued to see new opportunities.  The business typically reflects global GDP growth rates.

The remaining 3% of Molex’s revenue came from medical/military markets, which were up 4.0% sequentially and 8.0% year over year.

Orders

We estimate that orders were flat sequentially the second quarter running, after declining mid single-digits in the September quarter. However, slower sales enabled Molex to grow its backlog slightly in the last quarter. Orders were up around 5.0% from year-ago levels, after five quarters of double-digit increase.

Approximately 24% of Molex’s total orders were in the telecom market, 22% in data, 18% in consumer electronics, 18% in automotive, 15% in industrial and 3% in medical/military. The auto market saw the highest sequential increase (21.1%) followed by industrial, which was up 8.1%. Medical/military market orders were flattish, while other markets saw declines.

The order split between OEM/distribution/EMS was 55%-26%-19% in the last quarter, compared to 55%-25%-20% in the December quarter. Distribution was the only channel recording a yer-over-year decline (1%). EMS increased 17% and OEM 4%. All three channels were up low single-digits from the previous quarter.

Europewas the strongest region for Molex (up 15.3% in the last quarter due to strength in the auto and industrial markets), The Americas were up 9.7% driven by the same markets. Asia/Pacific North declined 12.8%, while Asia/Pacific South dropped 1.5% sequentially. The softness in Asia was partially on account of the Chinese New Year and partially on account of seasonal softness in the cell phone and consumer electronics markets.

Margins

Molex reported a gross margin of 29.8%, down 27 basis points (bps) sequentially and 137 bps year over year. Higher commodity costs (particularly gold and copper) and rising labor costs in Asia continue to plague the company, although price hikes announced across most product lines are offsetting these costs to a certain extent.

The earthquake and Tsunami in Japan also impacted the gross margins, as it lowered revenue on the one hand and increased costs (asset and inventory write-offs) on the other. Increasing volumes, new products and efficiencies will be beneficial for longer-term expansion.

Operating expenses of $159.4 million were higher than the previous quarter’s $159.0 million. The operating margin was 11.6%, down 86 bps from 12.4% recorded in the previous quarter. Operating expenses were flattish sequentially as a percentage of sales, so the primary reason for the decline was higher cost of revenue.

Net Income

Molex’s pro forma net income was $71.0 million or 8.1% of revenue compared to $81.0 million or 9.0% of revenue in the December 2010 quarter and $63.9 million or 8.4% of revenue in the March quarter of 2010. Our pro forma estimate for the last quarter excludes losses related to unauthorized operations in Japan.

Including the special item, the GAAP net income for Molex was $68.1 million ($0.39 per share) compared to an income of $78.3 million ($0.45 per share) in the previous quarter and income of $35.1 million ($0.20 per share) in the year-ago quarter.

Balance Sheet

Inventories were down 2.4%, with inventory turns flat at 4.5X. DSOs went up from 77 to around 81.

Molex ended with a cash and short term investments balance of $468.2 million, up $57.6 million during the quarter. Cash generated from operations was $144.4 million, up from $119.9 million in the fiscal second quarter.

Capital expenses were $64.2 million, or 7.3% of revenue, up from 6.8% of revenue in the previous quarter. The company also spent $18.8 million on acquisitions and $30.6 million on cash dividends in the last quarter.

Guidance

Molex expects revenue of $900-930 million in the next quarter, up 3-6% sequentially. The pro forma EPS is expected to be 42 to 48 cents a share, assuming a tax rate of 30%. The Zacks Consensus estimate for the fiscal fourth quarter at the time of the earnings announcement was 47 cents, at the high end of the guided range.

Conclusion

Molex is a leading player in the fast-growing connector market, with several secular growth drivers. Although there are some near term pressures on the business, such as conditions in Japan and China, channel inventories appear stable right now and the traditional North American and European businesses are showing signs of strength.

Additionally, Molex expressed optimism regarding its customers’ new products targeted at several emerging markets. We think the current softness in some of its served markets will not sustain. On the other hand, the secular drivers of the business remain in place. Consequently, our long-term (3-6 months) recommendation on the shares remains Neutral. 

However, considering the disappointing guidance and uncertainties in Japan, we think the shares could be under pressure in the near term. We have therefore allotted a Zacks #4 Rank to Molex shares, implying a Sell rating in the short term (1-3 months).

 
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