Value Line assigns Financial Strength ratings across a spectrum from A++ (Highest) to C (Lowest). Generally speaking, the largest companies with the strongest balance sheets get the highest scores. Factors considered in making a rating determination include balance sheet strength, earnings performance, market capitalization, stability of returns, and business outlook, among others.
The Financial Strength rating and a stock’s Price Stability rank are the two main components used to determine Value Line’s proprietary Safety Rank, which measures the total risk of a stock relative to the approximately 1,700 other stocks under Value Line review.
Although a company’s Financial Strength rating is just one factor among many that investors should consider, it is an important one. Moreover, shareholders should take particular note of changes in this rating—both up and down. Value Line subscribers have access to our complete list of Financial Strength upgrades and downgrades each week in the Selection & Opinion section of The Value Line Investment Survey. Noted here, however, are recent upgrades awarded to Avnet, Inc. (AVT) and Sanmina Corp. (SANM).
Avnet, Inc. is the top distributor of semiconductors and computer and peripheral equipment to resellers and end users, based on sales (which were $25.7 billion in fiscal 2012). The company operates through two segments, the Electronics Marketing division (58% of sales) markets semiconductors, connectors, and passive components; and the Technology Solutions unit (42%), which sells servers, computing, and data storage products.
Value Line recently upgraded the financial strength of Avnet from a score of B++ to A. Although the debt to capital ratio has stayed at a fairly constant rate of around 25% for several years, the company’s market cap has risen over 12% year to date. Avnet also saw earnings per share rise by 3% year over year in the fourth quarter of 2012, the first positive advance in over a year. Its customers appear to have worked through an inventory glut that arose last year. High component revenues in Asia and improvement in the book to bill ratio has also brightened the outlook.
Elsewhere, the company has further diversified its product portfolio and customer base through the acquisitions of Genilogix (optimizes the quality, performance and availability of mission-critical applications) and USI Electronics (distributes discrete semiconductor, passive and electromechanical components). Genilogix adds a significant contract with Hewlett-Packard, for public safety products. This market is generally resilient to adverse economic trends. Along the same vein, USI boasts strong ties to dependable military and aerospace customers.
Despite the fact that the company’s financial strength has improved, Value Line analyst Kenneth DeFranco believes its stock’s price appreciation potential is not overly impressive. Also, conservative investors may be turned off by the risk that comes with companies that generate revenue from volatile demand for electronic goods.
Sanmina Corporation provides integrated manufacturing services to original equipment manufacturers in the electronics industry. Services include: manufacture of printed circuit board assemblies, custom-designed backplane assemblies, multi-layer printed circuit boards, testing and assembly of completed systems, and cable assemblies. In fiscal ’12, the ten largest customers accounted for 50% of sales.
The primary justification for the recent increase in Sanmina’s financial strength from a C+ to a C++ is its reduced debt load. Indeed, at this time last year, the company had nearly $1.2 billion in fixed income obligations or 60% of its capital, a figure that has since been lowered 38% to $735 million or 43% of capital. Management recently moved to redeem about $250 million in debt due in 2014. With this out of the way, the company will have only a minimal amount of long-term debt coming due until the final year of the decade. The improved balance sheet will reduce future interest expense, and has contributed to the stock price rising nearly 46% since May of 2012.
Despite the improvement in the balance sheet, the company still has a relatively weak financial strength rating. The near-term outlook for Sanmina’s fundamentals is far from sanguine. Its customers continue to exhibit caution in their buying patterns. A solid pipeline of new project should help get revenues moving in the right direction. Although the company has solid long term price appreciation potential, the shares have exhibited extreme volatility in the past and should only be considered by risk-tolerant investors.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.