January 22, 2017 | 9 Pages
CFA Report
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Fiscal Year Ends Dec
Rating: Hold
Price: $71.30
Price Target: $78.08
52-wk Range: $45.23-$73.15
Market Capitalization (M): 6,387.5
Shares Outstanding (M): 89.6
P/E: 11.56x
Enterprise Value (M) 8,840.2
EV/EBITDA
9
Arrow Electronics Inc.
DATE: 30-DEC-2016
TICKER: NYSE: ARW
GICS SECTOR: INFORMATION TECHNOLOGY
RECOMMENDATION: BUY (9.5% RETURN)
CLOSING PRICE: $71.30 TARGET PRICE: $78.08
INDUSTRY: TECHNOLOGY DISTRIBUTORS
Executive Summary
Investment Recommendation
We are initiating coverage with a BUY rating and 12-month price
target of $78. Our target price is calculated using a discounted free
cash flow valuation method. We validated our target price by using
comparative analysis with eight competitors. The target price
represents a 9.5% return on investment from the December 30th
closing price of $71.30, which implies an alpha of 0.9%. Arrow
Electronics Inc. is the leading global distributor of electronic
components by market share.
Evolution of the Internet of Things
The electronics equipment wholesaler industry is benefitting from the
evolution of the Internet of Things (IoT). According to Gartner, Inc
the IoT base will grow to 26 billion units installed by 2020,
representing a 28x increase from 0.9 billion in 2009. Due to Arrow’s
value add services we believe that it is well positioned to take
advantage of this explosive trend; however, the company’s ability to
maintain its market share will be a key component of future
performance.
Investment in Cloud Computing Services
Arrow has highlighted a fundamental driver of future growth to be
increased investment in Cloud Computing Services and Engineering
Consulting Solutions. The firm has expressed interest in pursuing this
business segment due to 100% gross margins and increasing demand
for Data Processing and Hosting services. Arrow Electronics has been
able to grow revenue in this segment by 121% in the past 5 years
alone. Reports from IBISWorld and the Bureau of Labor Statistics
project that this industry will experience rapid growth in the next 5
years.
Steep Growth in Asia
Roughly 21% of revenue for ARW is generated from Asia. Their
exposure to this region primarily stems from sales in China, India, and
Japan. Rapid GDP growth expectancies in these countries coupled
with increased demand for electronic components and consulting
services put Arrow in a great position to capitalize from overseas
expansion.
Financial Data 2011 2012 2013 2014 2015
Revenue Growth 14.1% -4.6% 4.7% 6.6% 2.3%
Gross Margin 13.8% 13.4% 13.1% 13.2% 13.0%
EBITDA Gross
Margin 5.1% 4.5% 4.5% 4.6% 4.5%
EPS 5.3% 4.4% 4.7% 5.6% 5.8%
ROE 17.3% 13.2% 9.8% 12.0% 12.0%
ROA 6.2% 4.9% 3.5% 4.1% 9.3%
Debt/Equity 53.4% 49.0% 53.8% 50.1% 57.8%
-20%
0%
20%
40%
60%
80%
100%
120%
5 Year Total Return
S&P 500 ARW
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Investment Risks
Key investment risks associated with Arrow consist of diminishing
margins in electronics equipment sales and increasing competition for
the Electronic Component Wholesale industry. This risk originates from
low barriers to entry and a lack of differentiation between products.
Component revenue for Arrow is primarily driven by global
semiconductor sales; Bank of America Merrill Lynch analysts estimate
growth in this sector to be stagnant in upcoming years. The firm also
relies on a concentrated group of vendors in the Enterprise Computing
Solutions space which exposes them to supply-side risk. ARW has
historically relied heavily on debt financing, so increasing interest rates
could potentially prevent lucrative investment opportunities including
stock repurchases and acquisitions.
Company Description
Arrow Electronics Inc. (ARW) was founded in 1935. It is now a global
corporation that is listed as a fortune 150 company. Arrow is divided into
two primary business segments, Global Components Retail and
Enterprise Computing Solutions. The primary target market for Arrow
consists of industrial and commercial consumers of electronic
components. Arrow specializes in supply chain logistics and serves as an
intermediary between producers and consumers of electronic equipment.
The firm partners with over 100,000 manufacturers and industrial clients.
Arrow is headquartered in Colorado; however, the company has over 460
locations in 85 different countries.
Products and Services
Enterprise Computing Solutions (ECS)
Arrow ECS is a “comprehensive portfolio of IT solutions” that accounts
for 38% of total revenue. ECS consists of 5 parts:
1) Comprehensive Distribution Services including everything from
engineering and integration support to warehousing.
2) Advanced Solutions Lab for resellers to design, test, build and demo
solutions for their customers.
3) Global Training Services with more than 1,000 vendor authorized
training courses available on-site, online and in 42 Arrow training
classrooms in North America.
887.6, 7%
5,858.3, 48%
1,686.5,
14%
443.8, 4%
3,384.0, 27%
FY 2015 Global ECS Revenue
Storage
Software
Standard
Servers
Proprietary
Servers
Other
Products and
Services
Numbers in Millions USD
Source: Bloomberg Finance, LP and ARW FY '15 10K
11,721.5
50%6,788.7
29%
4,771.8
21%
ARW FY'15 Revenue by
Geography
North America
Europe
Asia/Pacific Source: Bloomberg Finance LP
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4) Business Intelligence Services for solution providers to help them
better understand the current/future industry environment and support
business growth opportunities.
5) Financial Solutions for both solution providers and their end-users.
Global Components Retail
Arrow is the largest global distributor of electronic components. This
segment of the business currently makes up 62% of total revenue. Within
the global components business segment about 66.0% of the company’s
sales consist of semiconductor products and related services; about
19.0% consist of passive, electro-mechanical and interconnect products
(capacitors, resistors, potentiometers, power supplies, relays, switches
and connectors); about 10.0% consist of computing and memory, and
about 5.0% consist of other products and services.
Competitive Positioning
Enterprise Computing Solutions (ECS)
Arrow’s ECS prospects can be viewed in the context of Data Processing
& Hosting Services and Enterprise Software Publishing. According to a
2016 report from IBISWorld, total revenue of Data Processing & Hosting
Services was $144.4 billion and expected to grow at a rate of 4.8%
through 2021. The industry’s growth is characterized by the trend of
businesses outsourcing their IT storage to capitalize on the dependability
and integration offered by cloud-based solutions. While Arrow does not
engineer or host the platforms that increasingly house industrial
information, its role as an intermediary allows the company to bridge the
gap between smaller to medium-sized value added resellers (VAR’s) that
do not have the capital or expertise to engineer the design-chain of their
own data systems. ECS also consists of the distribution of enterprise
software, the total market of which saw revenues of $37.9 billion in 2016
and forecasted to grow at 4.5% through 2021. The products delivered by
this industry consist of customer relationship management (CRM) and
enterprise resource planning systems (ERP). Vertical integration in this
segment may pose a threat to Arrow’s foothold; the company recognizes
this and attempts to proactively offer its customers leading-edge
solutions that easily fit into their supply chains.
Electronic Components
No major players currently have an influential position in the global
electronic parts and equipment wholesale sector. 13,261 businesses
compete for $361.7 billion in revenue worldwide. Forecasts from
IBISWorld predict annual growth between 2016-21 will average
3.2%. In a mature life-cycle industry with a significant number of
competitors, success is driven by strategic acquisitions that increase
geographic reach and effective customer relationship management. Over
the past several years, distributors such as ARW have flocked to the
developing world where rising incomes and increased usage of
electronics have given way to higher demand. Meanwhile, prices for
semiconductors and other components have declined as a result of
manufacturing improvements. Due to the high concentration of
competitors, distributors have not been able to realize the increased
margins that would otherwise be brought about by these two factors, and
many, including ARW, accept lower operating margins as a cost of
higher volume.
1,440.6,
10%
9,507.8, 66%
2,737.1, 19%
720.3, 5%
FY 2015 Global Components Revenue
Memory
Products
Semiconductors
Interconnect
Products
Other Products
and Services
Numbers in Millions USD
Source: Bloomberg Finance, LP and ARW FY '15 10K
-20%
-10%
0%
10%
20%
30%
40%
50%
60%
70%
80%
FY '06 FY '07 FY '08 FY '09 FY '10 FY '11 FY '12 FY '13 FY '14 FY '15
Total Global Components Global Enterprise Computing Solutions
Source: Bloomberg Finance LP
ARW YOY Segment Revenue Growth
0
5,000
10,000
15,000
20,000
25,000
FY '06 FY '07 FY '08 FY '09 FY '10 FY '11 FY '12 FY '13 FY '14 FY '15
ARW Total Annual Revenue by Segment
$Millions USD
Source: Bloomberg Finance LP
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Porter’s Five Forces
Threat of New Entrants - LOW-MEDIUM
The high concentration of small electronic components distributors is
emblematic of the sector’s low barriers to entry. Ease of entry is made
possible by the sector’s low capital intensity and light regulatory
qualifications. Conversely, the resulting market saturation may be a
deterrent to prospective distributors that lack the client base or supplier
agreements needed to withstand the competition. As noted above,
shrinking operating margins and increased consolidation may reverse the
industry’s high fragmentation, potentially benefitting larger value-added
distributors (VAD) such as Arrow or manufacturers targeting end-
users. In the scope of ECS, distributors seeking to offer such solutions
require sophisticated supplier networks and higher levels of capital and
logistics expertise, making the shift to a VAD of cloud-based industrial
solutions less attainable for smaller participants.
Power of Suppliers - MEDIUM-HIGH
The electronics components industry is characterized by a large number
of supplier firms (Circuit Board & Electronic Component Manufacturing
consisted of 2,740 businesses in 2016), little differentiation, and few
switching costs which result in low supplier power in this industry. With
regards to ECS, supplier power is somewhat higher; the Enterprise
Software Publishing and Data Hosting industries were each comprised
of 1,628 and 63,762 businesses in 2016, respectively. While these
numbers sound large, it is important to note that each industry has several
players that maintain at least 10% of market share. As a percentage of
COGS, ARW’s top three suppliers provide over 26%. In aggregate,
supplier power faced by Arrow is medium-to-high when considering that
no single supplier accounted for Arrow’s 2015 revenue, but the company
notes its ECS segment relies on a limited number of suppliers.
Power of Buyers - MEDIUM-HIGH
For reasons similar to Arrow’s components supplier power being low,
the company finds itself on the opposite side of the relationship with
respect to its buyer power. The high concentration of competitors in
electronic components distribution and lack of product differentiation
affords buyers many options when purchasing components. It is
important to note, however, that the bulk of competing firms are small
regional businesses except for Arrow’s major global competitors such as
Avnet, Ingram Micro, and Tech Data. The company historically notes in
its 10K’s that no more than 2% to 3% of sales are attributed to any one
customer; however, outsider estimates for 2016 put some larger clients
at 3% or more. When targeting small-to-medium buyers, Arrow aims to
differentiate itself by “selling the enterprise” through offering integrative
hardware and software solutions to its existing clients in addition to
consultative customer support.
Availability of Substitutes – LOW
As all users of electronics transition from locally hosted storage to
integrative cloud-based offerings, Arrow is capitalizing on the growing
substitute to components by penetrating the cloud computing
segment. For this reason, availability of substitutes for Arrow’s total
offerings is low.
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Competitive Rivalry – HIGH
The components distribution industry is characterized by a mature life-
cycle stage with low market share concentration. No single company
accounts for more than 5% of industry sales. Small regional distributors
who hire four or fewer employees comprise over 50% of the industry’s
13,261 players. Industry trends of consolidation caused by acquisitions
and vertical integration initiated by manufacturers are expected to
increase market share concentration among larger participants. Different
conditions exist in the Enterprise Software Publishing and Data Hosting
industries in which Arrow exists as a VAD; both sectors are
characterized by high growth with the former experiencing medium
competition and the latter high. While industry figures are more
representative of developers for these two sectors, Arrow’s role as an
intermediary enables it to capitalize on increased utilization of such
products and services. Arrow’s major components competitors such as
Avnet, Tech Data, and Ingram Micro are also exploiting the IoT by
offering solutions similar to those of Arrow’s ECS. Additionally,
vertical integration on the part of application providers increases the level
of competitive rivalry in this segment.
Investment Risks
Political/ Legislative
Serving customers in over 85 countries and realizing over 50% of
revenue from outside of the United States, Arrow faces numerous
potential challenges related to varying sovereign and municipal
regulations and international agreements. Such risks include import and
export regulations and taxes, funds transfer restrictions, labor laws, and
environmental laws with particular regard to disposition and use of
hazardous materials. Additionally political upheaval in developing
countries could threaten Arrow’s customer relationships or ability to
conduct business. Arrow’s reliance on international sales requires strict
compliance with US Export Administration Regulations with regards to
products manufactured in the US. Failure to comply can result in denial
of export privileges, inventory seizure, fines, or criminal penalties. The
changing political landscape in the US has brought rise to the potential
of a decrease in corporate taxes. Arrow, as compared to its competitors,
receives a greater share of its revenue from the US making it better
positioned to take advantage of the decrease in corporate taxes.
Supply
Arrow engages in short-term non-exclusive distribution contracts with
its suppliers that do not guarantee long-term stability of its supply
chain. Vertical integration, specifically within the components
distribution sector, threatens to upend Arrow’s position as a value-added
intermediary. Additionally, certain verticals (particularly those of ECS)
involve a limited number of suppliers, increasing the magnitude of
adverse material effects on Arrow’s role in the supply chain should any
disruptions occur.
Execution
In its components segment, Arrow aims to maintain a cost-leadership
strategy which requires that it sell components at prices which are
proportionately less than the value they contribute to the finished
products sold by Arrow’s customers. This emphasis on price opens the
potential for possibly defective products to be distributed to Arrow’s
customers which could result in litigation. Arrow attempts to mitigate
Top 10 Suppliers as a % of COGS
Supplier % of COGS
Cisco Systems Inc 14.56%
HP Inc 6.09%
NetApp Inc 5.97
VMware Inc 4.87%
NXP Semiconductors 3.45%
Texas Instruments Inc 2.99%
Linear Technology Corp 2.33%
Samsung Electronics Co Ltd 2.24%
Source: Bloomberg Finance LP
United States Revenue Exposure
Company US Rev. as a % of
TOT Rev.
Arrow Electronics Inc 46.20%
Avnet, Inc 36.00%
Tech Data Corp. 35.30%
WPG Holdings Limited 3.60%
Source: FactSet
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these risks through the use of liability insurance (which has maximum
claim payouts) and supplier agreements which shift liability to the
manufacturers. Attempts at managing these risks are further complicated
by differing legal standards across the countries in which Arrow operates
and possible qualitative damages to Arrow’s reputation and client
relationships. Furthermore, the company faces the risk of inventory
impairment given the rapidly evolving nature of its offerings. This risk
is mitigated by agreements with suppliers that compensate Arrow for loss
in inventory value or the option to return goods at cost, but these
agreements are limited in duration and do not exist with all of its
suppliers.
Interest Rate
Arrow’s MRQ debt-to-equity ratio of 0.63 is largely in line with industry
averages and has remained relatively stable over the past several
years. While Arrow’s management is comfortable with its current
leverage ratio and BBB- credit rating, these factors could increase the
cost of borrowing in light of the Federal Funds Rate projected increase
of up to 100BPS in 2017. Rising interest rates, while uncertain, may
result in less attractive financing options when considering ARW’s
upcoming maturity of $500 million of long-term debt in 2018, $300
million of which is locked in at the lowest coupon rate (3%). While not
significant, the company may incur higher borrowing costs within the
next few years. The company’s predominant use of fixed-rate debt (88%
of total debt at the 2015 fiscal year-end) and use of interest rate swaps as
cash-flow hedges help to mitigate the risk of rising rates. Management
notes in the 2015 10K that a one percent rise in average rates would not
materially impact its bottom line.
Foreign Currency Exchange Rate
Given Arrow’s significant exposure to foreign markets, it is susceptible
to foreign currency translation effects which decreased operating income
by $41.8 million and sales by $1.2 billion in 2015. The company aims
to mitigate this risk through the use of foreign currency contracts and
natural hedges in which international transactions are dollar
denominated. Natural hedges are commonly realized in Asia which is
also ARW’s fastest-growing international market. Currency exchange
rate forecasts for 2017 are mixed, but overall dollar strengthening trends
are expected to continue mildly in the short-term and weaken in 2018.
Since Arrow only hedges cash flows against currency risk, and not
currency translations, this could generate Other Comprehensive Loss in
2017 and income in 2018.
Management and Governance
Michael J. Long was appointed Chairman, President, and CEO in May
2009. Prior to being named Chairman, President, and CEO Long served
as COO for Arrow. While do not agree with the role of Chairman, CEO
and President being granted to one individual, Long does have sufficient
knowledge of the industry and the company having been with ARW
since 1991. The combination of all three positions, creates a conflict of
interest for the board. For the board to remove an underperforming CEO
they have to turn against their chairman. The combination of the
positions also forces the CEO/Chairman to split their time between
running the board and the company.
ARW has recently seen a change in CFO with Paul Reilly announcing
his retirement back in May. Christopher Stansbury has since been named
the new CFO. Prior to being named CFO, Stansbury served as Chief
Returns Over Michael Longs's Tenure
Comparables
Total Return
(%)
Cumulative
Arrow Electronics, Inc. 210.00
S&P 500 200.38
Electronics Distributors -IND 104.98
Source: FactSet
Board Diversity
Execs. on the Board 1
Non-Execs. on the Board 8
Source: Bloomberg Finance LP
0.0
100.0
200.0
300.0
400.0
500.0
600.0
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 > 2026
ARW LT Debt by MaturityMillions USD
Revolver
LT Bonds/Notes
Source: FactSet
Arrow Electronics Baa3 62.9% 1.66 2.54x 7.13x 18.4%
Average 61.4% 1.75 3.16x 9.55x 21.8%
Median 44.3% 1.41 2.34x 9.38x 20.6%
Avnet Baa3 56.5% 2.82 2.97x 8.88x 4.0%
Ingram Micro A -- 32.0% 1.44 1.72x 9.87x 25.6%
Tech Data Baa3 17.5% 1.38 0.97x 13.51x 42.0%
WPG -- 139.7% 1.34 6.98x 5.93x 15.6%
Total
Debt/EBITDA
EBITDA/Interest
Expense
FCF/Total
Debt
Source: FactSet
ARW Credit Ratios vs Competitors
Company Name
Moody's
Issuer Rating
Total
Debt/Equity
Current
Ratio
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Accounting Officer for ARW. Reilly has agreed to stay on and work with
Stansbury until the end of January 2017. Going forward it is important
to pay attention to this transition with Stansbury only joining ARW back
in 2014 and Reilly having served as ARW’s CFO since 1991.
ARW’s capital allocation strategy is based around investing organically,
M&A, and returning excess cash to its shareholders in the form of share
repurchases. Recently the board approved up to an additional $400
million worth of share repurchases, this is on top of $1.4 billion dollars
the firm has already spent since 2012. ARW does not have a dividend,
and management has told us they have no future plans on initiating one.
Since 2005 ARW has spent over $3.8 billion dollars to acquire 43
companies. This has allowed ARW to increase sales, geographical reach
and services capabilities. The electronics wholesaling industry has a low
barrier of entry so ARW active acquisition strategy is also a way for them
to consolidate competition. Going forward we believe that ARW will
continue to improve its business mix through M&A.
ARW has an overall ISS Governance QuickScore of 5. The pillar score
of 10 for audit and risk overview scores raise a big red flag. EY stated in
their audit report for the 2015 10-k that they had an adverse opinion of
Arrow’s internal controls. On top of that ARW was involved in criminal
fraud in which hackers impersonated an ARW executive and was able to
transfer $13 million dollars to outside bank accounts in Asia. When we
questioned management regarding the adverse opinion and fraud, they
responded as follows “We have already implemented the necessary
changes to address auditor’s concerns over our controls and to prevent
future fraudulent events like the one that occurred at the beginning of
2016. We are now in a period where the auditors much observe these
controls to conclude the material weakness has been properly
addressed.” We will be keeping a close on eye on their 2016 10-k audit
report and ISS Governance QuickScore to make sure the right changes
have actually been implemented.
Valuation
We used a DCF, a comps analysis, and a Monte Carlo simulation to
estimate a price target. The DCF results in a price target of $79, the
comps analysis gives a target of $77, and the Monte Carlo has a median
of $78. When avearging the results, we arrive at a price target of $78.08
for a return of 9.5%. Since the return is higher than our calculated
required return of 8.6%, it implies positive alpha and warrants a BUY
recommendation. Assuming fundamentals stay the same, if the share
price rises above $72.79, our recommendation would be less
constructive, because the return implied by our target price represents
negative alpha.
Discounted Cash Flow
We base our implied share price on our estimated free cash flow through
2021 and a long-term growth rate of 3%.
The WACC is the discount rate for our DCF. The cost of equity is
estimated using CAPM. The risk-free rate is the yield on 10-year treasury
bonds (2.4%), the beta is the raw beta as calculated by Damodaran Online
(1.37), and the market risk premium is also calculated by Damodaran
(4.5%). This outputs a cost of equity of 8.6%.
The pre-tax cost of debt is the weighted average of the given interest rates
on short-term borrowings, asset-securitization borrowings, a revolver
facility, and the marginal cost of bonds. The marginal cost of bonds is
Insider Ownership
% of Shares Held 0.67%
% Change in Last 6 mo. -7.65%
Source: Bloomberg Finance LP
ISS Governance QuickScore
Quick Score 5
Audit & Risk
Overview 10
Board Structure 4
Shareholder Rights 4
Compensation 4
Source: ISS
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found by approximating a best-fit mathematical function of the bonds’
yield curve. The average years left to maturity of bonds issued in the past
seven years is 8.9, which is plugged into the function and outputs the
likely yield on the next bonds Arrow will issue, giving a marginal cost
of bonds of 4.1%. The weighted average of all debt gives a pre-tax cost
of 3.9%, and a marginal tax rate of 28% gives a post-tax cost of debt of
2.8%.
Since Arrow intends to maintain its current capital structure, its marginal
weights are equal to its current weights. Using market values, these are
71% equity and 28% debt. Less than 1% is attributed to non-controlling
interests, which are included in the model, but are immaterial. The
resulting WACC is 6.9%.
When discounting free cash flows to the end of 2016, the DCF results in
a valuation of $72.88 per share. When discounting to the end of 2017,
the DCF results in a price target of $79.
Comparable Companies Analysis
The comparable companies analysis is based on the market ratios of
Arrow’s competitors. In order of their weighting in the analysis, the
competitors are Tech Data, AVNet, Anixter, Ingram Micro, WPG
Holdings, Jabil Circuit, Flextronics, and Celestica. When applying their
market ratios to Arrow’s forecasted 2017 financials, and applying
weights to each company and ratio, we arrive at an implied target price
of $77.
Monte Carlo Simulation
Our Monte Carlo simulation runs 1M experiments, where each generates
a share price at the end of 2017 based on the DCF model. The simulation
assumes a standard deviation of 27.5%, which is the implied volatility of
Arrow’s call options with a strike of $72.50. Scenario analysis is run to
randomly generate the drift parameter based on the multinomial
distribution. The scenarios are external events that could impact Arrow’s
target price. The first scenario is a decrease of the American corporate
tax rate to 15%, a development the incoming republican administration
has intends to achieve. The other three scenarios are a hard landing in the
Chinese economy, Frexit, and worst-case forecasts of the results of
Brexit. The first scenario improves profitability, and the other three
depress macroeconomic forecasts, which reduces forecasted sales in
relevant segments.
The mean of the resulting distribution is $83, and the median is $78. Of
the simulations, 51% result in performance that warrants a BUY rating,
and 38% result in negative returns, which warrants a SELL rating. The
weighting toward outperformance strengthens our confidence in our
BUY rating.
Since the distribution is skewed, higher price outcomes affect the average
more than lower outcomes do. Therefore, the median is more
representative of the likely one-year return, so we use the median, of
$78.20, to inform our target price.
Price Target
When averaging the target prices implied by the DCF, the comparables
analysis, and the Monte Carlo, we arrive at our final target price of
$78.08.
0
50
100
150
200
250
$3
5
$4
6
$5
8
$6
9
$8
1
$9
2
$1
04
$1
15
$1
27
$1
38
$1
50
$1
61
$1
73
$1
85
$1
96
$2
08
Outc
om
es (
00
0s)
Stock price
Share Price Distribution
y = 0.010ln(x) + 0.019
R² = 0.937
0%
1%
2%
3%
4%
5%
0 2 4 6 8 10
YT
M
Years left to maturity
Arrow's Yield Curve
9 | P a g e
Financial analysis
Gross margins remain stable through the forecast, as pricing pressures in
the Components segment are offset by a shift in product mix toward ECS,
in which the sale of some products is reported net of costs, giving them
a 100% gross margin. Profit margins are also stable through the forecast.
Accounts receivable and payable, have been growing much faster than
revenue in recent years. Arrow has told us this is happening because of
the ongoing shift toward ECS products that only report net sales. Arrow
collects payments for these products, so while their share of the product
mix increases, accounts receivable will grow faster than revenue. To
maintain their leverage, they are growing accounts payable along with
accounts receivable.
Arrow has historically used higher leverage than its competitors. It has
told us they are comfortable with their current leverage, and that they
plan to maintain their net debt to EBITDA ratio between 2 – 2.5. We
forecast the ratio will stay in the middle of this range. This leads to a slow
decrease in interest coverage and a stable debt to equity ratio.
We forecast that Arrow will spend $294MM on acquisitions per year,
which is its seven-year average. This spending is reflected in the growth
of balance sheet accounts, primarily goodwill. Arrow has spent
approximately $1.4B on share repurchases and recently expanded its
program to allow for an additional $400MM. We expect it to spend its
free cash flow mainly on repurchases and forecast that these will grow
through 2021. Arrow does not have a dividend program and has told us
that it has no plans to initiate one.
-10%
0%
10%
20%
30%
2016 2017 2018 2019 2020 2021
Gro
wth
Rat
e
Income Statement Accounts
SG&A D&A
Restructuring & other Operating profit
0
200
400
600
800
2016 2017 2018 2019 2020 2021
Cash Flows in $M
Operating cash flow CAPEX
Acquisition spending Investing cash flow
Treasury buybacks Free cash flow