ScanSource, Inc. (SCSC, $34.88): Investors Craving Organic
By: Andy Reed, AIM Student at Marquette University
Disclosure:
The AIM Equity Fund currently holds this position. This article was written by
myself, and it expresses my own opinions. I am not receiving compensation for
it and I have no business relationship with any company whose stock is
mentioned in this article.
Summary
ScanSource, Inc.
(NASDAQ: SCSC) is
a distributor of specialized technology hardware, including communications,
security and point-of-sale/barcode products. ScanSource sells its products
through partner vendors, such as Zebra and Honeywell. The company operates in
two segments, Worldwide Barcode and Security and Worldwide Communications and
Services segments, representing 67% and 33% of revenue, respectively.
SCSC
reported FY financial results on August 29, with revenue and EPS falling short
of street and company estimates.
Fourth
quarter gross margins faltered, falling to 9.4%, a 60 bp miss on guidance,
coming from increased costs and an unfavorable product mix in the company’s
Worldwide Communications & Services segment.
In
October 2015, management assembled a “search committee” to identify potential
avenues for building a recurring revenue business within the company. Announced
on the Q4 earnings call, the company acquired Intelisys, the market leader in
the telecom and cloud services market.
While
the company achieved 4% y/y increase in FY EPS at $2.71, the bulk of the growth
was driven by 1H strength, and should make for tough compares moving into
FY2017. With the stock taking a shellacking, faltering ~20% on earnings, I
still see numerous headwinds for the company moving forward. Due to an
uncertain market landscape and a growing reliance on acquisitions, investors
will likely continue to watch from the sidelines until further notice.
Key Points: ScanSource
reported disappointing fourth quarter sales of $877.5MM, vs street consensus of
$911.1MM. Most of the weakness came from the company’s inability to secure
deals within its barcode equipment business. After achieving a solid organic
growth profile in recent history, the previous two quarters have proven to be
tough from an organic growth standpoint. Fiscal third and fourth quarters saw
organic growth slide to (1%) and (8%) on a y/y basis. In addition, management
guided to another quarter of negative organic growth for the current quarter,
which assumes continued weakness in both of its segments.
As
organic growth appears to be a mixed bag, at best, moving forward, the company
has more recently focused on acquisitions to fuel near-term growth. ScanSource’s
acquisition of KBZ Communications in early 2015, which helped expand the
company’s videoconferencing capabilities, has helped drive top-line results.
The company expects near-term financial pressure from the integration of newly
acquired Intelisys, but with the growing popularity and expectance of lifetime
services, they are hopeful it can provide a much needed lift in the long term.
However, leaning on these acquisitions to fuel growth could prove to be a risky
bet, especially as KBZ prepares for a critical bid process for further
government business.
The
company’s barcode business suffered setbacks during the quarter, as retailers
began to delay their bigger spending projects. Driving the company-level
revenue disappointment, the barcode networking segment was dragged down by
smaller deals and fewer wins in North America within its key vendor space. With
a generally tough brick-and-mortar retail environment, its barcode and
point-of-sale technologies could potentially see a lift from retailers more
aggressively managing the supply chain. As such, management outlined its strengthening
expectations for the first half of the current fiscal year, as larger deals
could be achieved between ScanSource and its vendors.
What has the
stock done lately?
The
two largest shareholders, Fidelity and Blackrock, trimmed their positions in
the stock after the most recent earnings call. A good indication of recent
volatility, the Bollinger Bands on the company’s publicly traded equity have
widened significantly since the full-year earnings announcement. The stock
currently trades at $34.88 as of market close on 9/8, hitting a three month
low, but still significantly above its CY16 trough of $28.34.
Past Year
Performance:
The
past twelve months have been somewhat of a bumpy ride for investors, with the
stock approaching a five year high before a disappointing earnings announcement
in August. The stock also hit a three year low on January 15, 2016. Overall
return for the stock since the beginning of the company’s fiscal year is
approximately flat. SCSC completed a $120 million repurchase plan during the quarter
and approved a three-year plan for another $120 million repurchase over the
next three years. The company’s valuation appears to be quite fair, trading at
7.8x EBITDA, in line with a peer average of 7.7x.
Source: FactSet
My Takeaway
As
legacy markets have slowed for ScanSource, the next twelve months will be
crucial for investor perception. With nascent geographies, such as Brazil,
doing much of the legwork for the company’s business segments, it will be
important for the company’s North America business to regain some of its
luster. Organic growth will be paramount in regaining investor confidence. However,
the company’s footprint in the young 3D printing industry could provide investors
with incentive to jump back on the boat, but will almost certainly require a
wait-and-see approach after last month’s sell-off.
Source: FactSet
