The economy is slowing down for most businesses, but it’s just right for this outsource manufacturer to succeed
The economy has changed a lot since the pandemic began. While rising interest rates, tight labor, and still-present inflation are all slowing things down.
That said, the supply-chain supercycle is here with increasing investments in supply chains and infrastructure. Aerospace and defense spending is also surging with the U.S. helping its allies, but a recession is still likely to come.
Plexus (PLXS) stands at the crossroads of all three trends and captures increasing demand as an outsource manufacturer.
The business is pretty stable and is poised to be better as investments in end markets ramp up.
The market fails to recognize this and thinks the company’s returns will fade to the cost of capital levels. This results in the undervaluation of the stock.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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There are three big themes converging on the U.S. economy today. Understanding these helps us focus on the correct areas and find opportunities in the market.
One is the supply-chain supercycle you have heard us talk about many times.
After a decade of underinvestment in supply chains and infrastructure, the pandemic has been an eye-opening experience for the U.S.
Lead times got extended, orders got canceled, and manufacturers saw increasing supply chain costs. The U.S. needs to rebuild its infrastructure and enhance its manufacturing capacity, and fast.
Companies are now bringing their manufacturing facilities back home, benefiting from incentives like the Bipartisan Infrastructure Bill. In its first year alone, the bill has allowed over $185 billion in funding of projects for new roads, bridges, facilities, and other infrastructure.
The second big theme is the reinvestment cycle we are experiencing in the aerospace and defense industry.
With the ongoing war in Ukraine, the U.S. has been sending more aid and equipment to our European allies. At the same time, we are replacing our stockpiles, increasing the need for aerospace and defense production.
Finally, we have the unfortunate truth of a recession on the horizon. Inflation is still high, interest rates have been rapidly increasing, and several industries already feel the declining demand.
This means the cost of capital for projects is a lot higher, and we are likely to see growth subside. This might result in higher unemployment and a decline in consumer demand.
Plexus (PLXS) manages to be at the crossroads of all three trends.
It is an outsource manufacturer of industries. With its positioning, it captures the supply-chain supercycle, aerospace and defense investment cycle, and spending on healthcare and life sciences, which is a more stable end market if we enter a recession.
The business is pretty stable. Its Uniform return on assets (“ROA”) has been around 8% for the last two decades. Even around the great recession of 2009, the business performed very well.
Plexus has proved that it is a very balanced business with exposure to rising trends and stable end markets.
It could even see a bit of a boost over the next few years as the supply-chain supercycle ramps up.
And yet, the market is pricing its profitability to decline to levels not seen in the last two decades.
We can see this through our Embedded Expectations Analysis (“EEA”) framework.
The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.
In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.
At the current stock price, the market expects the company’s ROA to fade to its cost of capital, which would be the lowest in the last two decades.
The market does not seem to realize there are two big tailwinds driving the business, that are only going to get bigger in the next decade. Additionally, it is exposed to another big defensive end market.
As these trends play out, Plexus will see demand for its services skyrocket. That means higher profitability and a potential upside.
SUMMARY and Plexus Corp. Corporation Tearsheet
As the Uniform Accounting tearsheet for Plexus Corp. (PLXS:USA) highlights, the Uniform P/E trades at 16.9x, which is around the corporate average of 18.4x and its historical P/E of 16.0x.
Average P/Es require average EPS growth to sustain them. In the case of Plexus Corp, the company has recently shown a 1% growth in Uniform EPS.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Plexus Corp.’s Wall Street analyst-driven forecast is a 9% EPS growth in 2023 and a 19% EPS growth in 2024.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Plexus Corp’s $96.62 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to shrink by 2% annually over the next three years. What Wall Street analysts expect for Plexus Corp.’s earnings growth is above what the current stock market valuation requires through 2024.
Furthermore, the company’s earning power is 1x its long-run corporate average. Moreover, cash flows and cash on hand are 1.3x its total obligations—including debt maturities, capex maintenance, and dividends. Also, the company’s intrinsic credit risk is 120bps above the risk-free rate.
All in all, this signals average credit risk.
Lastly, Plexus Corp.’s Uniform earnings growth is in line with its peer averages and its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research