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Avnet Downgraded to Underperform

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We have lowered our long-term recommendation on Avnet, Inc. (AVT - Free Report) to Underperform from Neutral following the company’s disappointing results in the fourth quarter of fiscal 2012. Moreover, with the prevailing macro economic uncertainty, Avnet may face more headwinds going forward.

During the fourth quarter of fiscal 2012, the company’s earnings declined 18.9% annually and missed the estimates by 9 cents. Management stated that lower sales and adverse impact from foreign currency translation had adversely impacted the company’s business during the quarter.

Asia undoubtedly remains one of the largest growth drivers for the company. However, it must be noted that while this region is profitable, it also contributes largely to the lower margins of Avnet. The company has been taking extensive measures to increase operations in its Asian markets in order to avail of lower costs, but this attempt might also prevent the company from achieving higher margins. The Technology Solutions is expected to be hit the most in this regard, which is evident from management’s current three-year operating margin projections of 3.4%–3.9% for the segment.

Avnet’s domestic and foreign operations are subject to significant competitive pressures. It faces stiff competition from Arrow Electronics Inc. (ARW - Free Report) , which remains a fiercely formidable rival. Arrow’s recent acquisitions of ALTIMATE Group, Global Link Technology and Redemtech can turn out to be highly profitable, thereby posing a serious threat to the future of Avnet.

Further, Avnet is a global company with operations in around 70 countries. Approximately 61% of total revenue came from international operations in 2012. Although this is highly laudatory, it does make the firm vulnerable to foreign currency fluctuation.

Additionally, the company earns a huge portion of revenue from the semiconductor industry, which is highly cyclical in nature. Hence, we believe, any fluctuation in this industry would surely affect the company’s business going forward.

However, we have identified few prospective silver-linings under the strong downbeats, which might neutralize these negatives. These positives include the company’s strong product line and share buy-back initiatives, which provide Avnet with a high competitive edge in this industry, thereby improving its credibility ratings even more.

The company’s steady acquisitions are expected to be a good contributor to its revenue stream going forward. Avnet has been assiduously expanding its market share, especially in Europe, the Middle East and Asia through its acquisition strategy. During fiscal 2012, the company completed acquisitions of eleven businesses with total annualized revenues of $900 million.

Moreover, the company has taken several effective cost-saving initiatives through its restructuring actions. This strategy is expected to encourage the company’s margins moving ahead.

Even though a few upsides prevail owing to the tremendously precarious conditions clouding the company’s growth lines, we lowered our recommendation on Avnet to Underperform from Neutral. Our recommendation on the stock is backed by a Zacks #5 Rank, which translates into a short-term (1 to 3 months) ‘Strong Sell’ rating.

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