Time To Exit Arrow Electronics Stock?

Arrow Electronics stock (NYSE: ARW) is up around 25% since the beginning of 2020, but at the current price of around $105 per share, we believe that Arrow Electronics stock has around 15% potential downside.

Why is that? Our belief stems from the fact that ARW stock is still up around 2.5x from the low seen in March. Further, after posting mixed Q3 ’20 numbers, it’s evident that Arrow’s electronic components business is still struggling to get to pre-Covid levels. Our dashboard What Factors Drove 53% Change In Arrow Electronics Stock Between 2018 And Now? provides the key numbers behind our thinking, and we explain more below.

Arrow stock’s rise since late 2018 came despite a 2.5% drop in revenue from $29.7 billion in 2018 to $28.9 billion in 2019. However, a 4% drop in the outstanding share count saw revenue per share rise 2% over this period.

Arrow’s P/S (price-to-sales) ratio rose from 0.2x in 2018 to 0.25x in 2019, and has since risen to 0.3x, as Arrow stock has been riding the rally in technology stocks. However, given Arrow’s mixed performance in Q3 ’20, there is possible downside risk for Arrow’s multiple.

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So what’s the likely trigger and timing to this downside?

The global spread of coronavirus, has meant lower electronic semiconductor demand from the industrial sector, which has hampered demand for Arrow’s electronic components and computer products. This is evident from Arrow’s results for the first 3 quarters in FY ’20, where revenue came in at $20.2 billion, down from $21.6 billion for the first nine months of 2019. However, revenue in Q3 ’20 came in marginally higher at $7.2 billion from $7.1 billion in Q3 ’19, but a rise in raw material costs saw gross margins drop to 10.9% from 11.3%. EPS rose to $2.15 from $1.11 over the same period, but a closer look reveals that this was largely due to a high restructuring charge of around $45 million in Q3 ’19 which weighed down EPS. The impact of the pandemic on the company’s business can be gauged from its lower revenue for FY’20 so far and the fall in gross margins.

We expect Arrow’s business to struggle in the near to medium term, as demand for electronic semiconductor components is still far from pre-Covid levels. If there isn’t clear evidence of containment of the virus anytime soon, we believe the stock will see its P/S multiple decline from the current level of 0.3x to around 0.27x, which combined with a reduction in revenues and margins could result in the stock price shrinking to around $90, a downside of 15% from the current price of $105.

While Arrow Electronics stock may be overvalued, 2020 has created many pricing discontinuities which can offer attractive trading opportunities. For example, you’ll be surprised how counter-intuitive the stock valuation is for Intel vs Cisco.

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