SGH (NASDAQ:SGH) has been a smart buy for the last two years or so and now the value is as compelling as it has ever been. The company just released Q3 earnings to beat expectations, announced a major acquisition that should be immediately accretive, and yet shares fell sharply in the pre-opening action. The reason, as best we can tell, is the company’s guidance was a tad on the weak side and it’s using a lot of cash to fund the deal. The takeaway is that this well-positioned player in the tech/digital components industry is trading about 5X its earnings with revenue growth, margin expansion, cash flow growth, and earnings growth all in the outlook.
SGH Beats And Guides Weak, So What?
SGH had a great quarter growing revenue 5.8% YOY to $463 million making it the 9th consecutive quarter of top-line growth. The revenue is nearly double the pre-pandemic level and beat the Marketbeat.com consensus as well. Internally, the gains were driven by a 10.7% increase in Memory Solutions offset by a small 0.5% and 0.4% decline in IPS and LED solutions. The decline in IPS and LED is worth noting but not a concern to us given the robust 55% increase in sales last year. In our view, the give-back is to be expected and much smaller than it could have been, and also supported by solid demand throughout the system.
Moving on to the margin, the news gets better with the gross and operating margins increasing versus last year. The gross margin expanded by 540 basis points on a GAAP basis, and 380 on an adjusted basis, while the operating margin improved by 100 bps and was aided by share repurchases as well. On the bottom line, the $0.44 in GAAP EPS reverses an operating loss posted in the prior year and the adjusted EPS of $0.87 grew by 24% and beat by $0.12.
The guidance came in a bit tepid but we say “so what?” because of two things. The first is that the Q4 guidance is favorable in that it brackets the consensus estimates with the consensus estimate at the high end of the range. That alone opens the door to outperformance if only slightly but there is more. We believe the guidance is cautious because the company has beaten its own guidance and the consensus estimate for the last 10 consecutive quarters and the margin of error widened over the past 3 quarters.
SGH To Buy Stratus Technologies In Cash Deal
SGH announced along with the Q3 report a definitive agreement with Stratus Technologies. The company is engaged in solutions for data center and EDGE computing and will be incorporated into the IPS segment presumably in the 2nd half of the year. The deal will expand SGH’s offerings in this arena as well as provide an expanded client base and ample opportunities for cross-selling and upselling too. The company says the deal should be immediately accretive to the top and bottom line including margin expansion which we view very favorably. The only downside is the company will eat up a lot of its cash and/or revolving credit facility but we see that loss recouped over time.
The Technical Outlook: SGH Falls To New Low
Price action in SGH took a dive on the results, guidance, and acquisition falling more than 12% to set a new low. This marks the lowest level the stock has traded in over two years and it could lead to lower prices but we don’t think much lower. The price action fell to just above a strong support zone put in place prior to and following the COVID-induced market correction in 2020 and we think this level will hold. Not only is the value compelling but the business is double what it was and should command a higher price for no other reason than that. The analysts, BTW, rate the stock a solid Buy but lowered their price targets in the wake of the report. The takeaway here is that analysts still see more than 50% of upside for this stock.
