$SNX Q3 2022 Earnings Report

$SNX Short

TD SYNNEX is an American IT distribution company with a workforce of 22,000 in over 100 countries. On September 1, 2021, Tech Data completed a merger with Synnex creating TD SYNNEX, a new company with $59.8 billion in revenue. Through the combination of both companies, TD SYNNEX became the largest IT distributor in the world with combined revenue of $60B Dollars. However, don’t let these numbers fool you as this is just the beginning of a messy story. As Li Lu, one of the top value investors and the founder of Himalaya Capital Management says “The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.” Implying the fact that a smart investor knows that debt, which is usually involved in bankruptcies, is a very important deciding factor on how risky a company is. The image below shows that at May 2022 TD SYNNEX had debt of $5.21b, up from $1.66b in one year. On the flip side, it has US$521.5m in cash leading to net debt of about US$4.69b.

According to the last reported balance sheet, TD SYNNEX had a debt of $14.7b due within a year, and a debt of US$5.42b due beyond 12 months. On the other hand, it had cash of $521.5m and $8.88b worth of receivables due within a year. So it has an approximate debt of $10.7b, more than its cash and near-term receivables, combined. When you consider that this deficiency exceeds the company's US$8.58b market capitalization, you might want to take a look at its balance sheet. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer from dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense. One big advantage of this method is the fact that we can both calculate the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses related to that debt (with its interest cover ratio). Using that approach, we come to the conclusion that TD SYNNEX has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 5.3 times. Or in simpler terms, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Additionally, TD SYNNEX grew its EBIT by 56% over the last twelve months, and that growth will have ease for them in handling their debt. However, these numbers don’t mean anything to an average day-to-day investor including myself. As we have seen countless times over the past previous months, the market has become much more sense considering that we are about to enter a recession. No matter how well you beat the estimates or how well your quarter was, people only look at one thing and that’s what you have in the future. If the expected guidance is poor, it will almost always have a negative impact on the stock’s price. So at this point, the main thing we should be looking at is not if TD Synnex will beat the estimates or not, but whether they will be able to decrease their debt for the future quarter or be able to keep the same future guidance without revising it to a lower number. One way of getting a rough idea and what we should be expecting would be through other companies’ reports from the same sector which would be Electronics Distributions in this case. We can start with Arrow Electronics, a very similar American Fortune 500 company that specializes in the distribution and value-added services relating to electronic components and computer products. After the company’s quarterly result that was released in early August, its stock fell by around 6% even though they were able to beat the numbers and post record revenues. However, as I mentioned before, these numbers don’t come into play anymore if the company posts poor guidance. As stated by the CEO “We’ve continued to build and deliver on our record performance for the past several quarters. While market conditions are challenging, they also provide ample opportunities to demonstrate Arrow's commitment to the success of our customers and suppliers.” This implies that while they are currently doing great, there is no guarantee that it will continue to be like this for the next quarter. On top of that, they are expecting changes in foreign currencies to decrease sales by approximately $350 million, and earnings per share on a diluted basis by $.25 compared to the second quarter of 2021 which was the nail in the coffin for them. The next company we will take a look at is Avnet, another giant in electronics distribution that released its report in August. While they were able to beat the estimates, they also dropped by around 6% as you guessed it, due to poor guidance. This was their statement “Lingering COVID-19 impacts from inflation and impacts from the conflict in Ukraine continue to have some ripple effects on supply chains. While supplies of some of the parts have modestly improved, we expect supply chain challenges to persist throughout the remainder of this calendar year”. Generally looking back at what this sector had to report, they are still dealing with supply chain issues that first started at the beginning of the year and now inflation too on top of that. One way we can back that up and confirm whether it will be an issue for TD Synnex as well or not would be by seeing if any investment firms have revised their estimates for the company. A number of analysts have commented on the stock recently. On Thursday, August 25th Barrington Research dropped their price target on shares of TD SYNNEX from $128.00 to $106.00, on Friday, July 1st JPMorgan Chase & Co. started coverage on shares of TD SYNNEX in a research note on Thursday, July 14th. They issued an "overweight" rating and a $119.00 price target for the company. Citigroup dropped its price target on shares of TD SYNNEX from $165.00 to $150.00 and set a "buy" rating for the company in a research note on Wednesday, June 29th. Finally, Credit Suisse Group dropped their price target on shares of TD SYNNEX from $115.00 to $110.00 and set a "neutral" rating for the company in a research note on Wednesday, September 14th. Taking all of this into consideration, I believe that TD Synnex will not post a very favorable report tomorrow. On top of winding ways to make sure their profit margins don’t decrease due to inflation, they would also have to make sure that not only does their debt not increase, but also decrease as well which would be a very hard task in today’s environment. Now let’s go to the opposite end of the spectrum and discuss the scenarios and factors that could make the earnings reaction to their report positive and why I believe the negative factors will outweigh the positive factors.

Taking a look at how often they beat the EPS estimates, they haven’t missed once since 2018 as marked by the green arrows. Taking this into consideration, it will most likely be the same for this quarter. However, as this is something that has become a norm for the company, it’s something that people would expect and are used to rather than them having a big reaction. This can also be outlined in their past four reports as the stock dropped for various reasons, even though the EPS beat. The increased demand for hardware and tools, which support hybrid working, is also expected to have boosted TD SYNNEX’s revenues during the quarter. The growing hybrid working trend has been a big factor in the sales of peripherals, software, communication, networking, and consumer electronic products. This impressive demand trend is likely to have been their biggest revenue maker. The increased usage of online and e-commerce services, along with the hybrid working trend, has been increasing the demand for cloud storage. This is likely to have aided TD SYNNEX’s data center servers and storage solution businesses in the fiscal third quarter. Additionally, TD SYNNEX’s fiscal third quarter performance is likely to have benefited from revenue contributions from the newly merged Tech Data Corporation business as well. However, with the new acquisition, the expected revenue is also increased and now it means they would have to make sure both the companies are creating stable profits rather than just one. As we also saw with other cloud companies, while they had an amazing quarter for user growth, their profit margins significantly decreased compared to last year. TD Synnex is also still very new in the cloud business and its profitability in this sector isn’t maximized.

Another factor concerning me is the amount of sell-offs that have happened during the past year by insiders. While there has not been any insider buying in the last three months, there has been selling. But the sales were generally small and nothing to keep an eye on. However, this still doesn’t change the fact that there hasn't been any buying recently, adding more to the fact that there is a possibility poor guidance will be true for this quarter as well.

Disclaimer: My opinion of this company is purely about this upcoming quarter and not about any long-term investments.

Market Cap: 8,113,549,114

P/E Ratio:14.18

Initial reaction: Short

Researched reaction: Short

Time: Tomorrow before the market opens

Estimate: -5%