Arrow Elec Core Business Strains

Arrow Electronics, Inc. (ARW - Analyst Report) reported revenues of $4.35 billion in Q2:08, above our estimate of $4.05 billion, while non-GAAP diluted EPS of $0.84 beat our consensus estimate of $0.77.

For the September quarter, ARW guided to revenue and EPS in the $4.1-4.4 billion and $0.73-0.78 ranges. We were expecting $4.05 billion and $0.75. Component sales are expected to be in the range of $2.85-3.05 billion. Computing sales are expected to be $1.25 billion -1.35 billion, slightly above our expectations on an absolute basis, but weaker on a q/q comparison. The company claims a change in business mix (from acquisitions) has introduced more pronounced seasonality, though our analysis of organic growth implies slightly worse-than-normal trends for the core business.

In the meantime, we are likely to see margins under pressure, as the core business continues to deteriorate and the need for successful acquisition integration becomes all the more acute. We are reiterating our Hold rating with a revised target price of $35.00 (10.5x our FY2008 earnings estimate).

We analyzed the ROE [return on equity] by splitting it into its three components net margin, asset turnover and equity multiplier. The TTM [trailing twelve-months] net margin has been relatively steady at around 2.5% for the last four quarters (2.3% in Q2:FY08). This may be the result of management’s cost reduction efforts, which have been offsetting the negative impact of lower-margin acquired business lines.

The management also increased its fixed assets base, which further reduced the asset turnover ratio in the last quarter. Arrow has around $1.4 billion in long-term debt. The equity multiplier has been steady over the last three quarters, as equity has been coming in line with the increase in total assets. This is another metric to watch, given the company’s already large total debt position.

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