The only way is up for this electronics distributor as earnings per share hit bottom

Declining industry trends appear to be reversing

The secret to making money from shares in companies that are sensitive to business cycles is to buy when times are tough. The hard bit is knowing when and if fortunes will turn.
Following smart money can be very helpful in identifying cyclical plays that are down on their luck but well positioned to enjoy the sunny uplands of a recovery.
A case in point is Arrow Electronics, a US-listed global distribution and IT company that’s expected to report earnings per share (EPS) for 2024 more than 50pc below their pandemic peak. Many of the world’s best value-focused fund managers are betting this will be as bad as things get, and EPS is forecast to double over the following two years.
There are 12 elite fund managers who hold shares, all ranked among the top 3pc of over 10,000 equity managers monitored globally by financial publisher Citywire. This results in Arrow having Citywire’s top Elite Companies rating of AAA based on the high level of smart-money backing.
One of these elite investors is Larry Pitkowsky, manager of the GoodHaven fund. He told Questor: “It strikes us as a very well-run distributor that’s a very important part of the ecosystem it operates in.
“It appears to be selling at a very attractive price to depressed earnings and it has repurchased enormous amounts of its own shares.”
Arrow’s importance to its customers is rooted in the scale of its operations and the expertise of its staff, which includes many engineers. These staff help increase the stickiness and value of its client relationships by involving it at early stages of product design and development.
Arrow generates 77pc of sales from distributing a huge range of components from 180 sites in 85 countries. The rest of its business involves setting up complex IT systems and managing transitions from in-house computers to the cloud.
It serves diverse markets and thousands of customers. However, by product type, it has a big focus on semiconductors, which account for four fifths of component sales.
While soaring demand for AI chips has captured headlines, the wider semiconductor industry has been in a slump since the pandemic. So too have markets for many of the other components and services Arrow offers.
Arrow’s sales have also slowed because its customers have been working through substantial inventory built up in response to Covid supply-chain disruptions. This has been unwinding since 2022.
The seized-up post-pandemic market also caused Arrow’s own inventories to balloon relative to sales along with money owed by customers. Financing this contributed to a doubling of net debt excluding leases from $1.8bn to $3.6bn between the end of 2020 and 2022. The figure sat at $3.3bn at the end of last year.
But negative trends have gone into reverse. A fall in inventory and outstanding invoices is freeing cash and net debt is forecast to fall to $2.1bn by the end of 2024. Strong cashflows also support Arrow’s long-term track record of buying back its own shares, which has reduced the share count by nearly 60pc since 2007. A bonus for Brits from Arrow returning cash this way rather than through dividends is that it removes the hit from dividend withholding tax.
The company believes both its own and its customers’ inventories will be back to normal by the end of the year. Trading also appears to have stopped deteriorating with chief executive Sean Kerins describing Arrow as “bumping along the bottom” at the time of second quarter results. All this helps provide foundations for a recovery.
Meanwhile, major economic stimulus announced by China last month could help get sales moving upwards given sluggish activity in the country has been a key cause of weakness in Asia, where Arrow generates 28pc of revenues. While faltering, green shoots are emerging in the semiconductor industry. Many of Arrow’s end markets are also showing early signs of recovery, too.
Brokers’ EPS forecasts have been holding steady for several months following a long period of downgrades. This steadies hopes that 2024 will indeed be the low point in the current cycle and the profit recovery currently being forecast prices the shares at just 6.7 times 2026 EPS.
With trends and fundamentals finally turning in Arrow’s favour, this column believes it is worth following the lead of the smart money betting a recovery is coming.
Questor says: buy
Ticker: NYSE:ARW
Share price: $132.39
Algy Hall is editor of Citywire Elite Companies.
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