TD Synnex: Dividends, Buybacks, Capital Turnover, All Suggest Plenty Of Cash For Shareholders

Investment Briefing

There is opportunity to unlock risk capital in owning the equity stock of TD SYNNEX Corporation (NYSE:SNX) in my opinion.

SNX is a well-known tech distributor that offers a range of products sourced from original equipment manufacturers ("OEMs") and high-growth technology suppliers. Its catalogue covers several domains, including converged and hyper-converged infrastructure, cloud, security, and data/analytics to name a few. This positions it in the markets for IT hardware, software, and systems, such as personal computing devices, mobile phones and so forth.

In March 2021, SNX made the strategic move to acquire all outstanding shares of Tiger Parent Corporation, the parent company of Tech Data, for a $1.6Bn cash consideration. This was done to expand its market reach and capabilities, whilst capturing potential cost and growth synergies. After a challenging post-merger period, my analysis reveals the returns on this investment may be starting to pull through.

The market dynamics of IT products continue to trend towards a milieu of declining unit prices and shorter product life cycles. Much like the mining and makeup industries, it is borderline impossible to differentiate on product alone-you're all selling the same product. Some companies do possess consumer advantages and can differentiate on price and capture a higher margin-but for the most part, this doesn't exist. Of more economic value are production advantages-who can turnover capital the highest, with a cost leadership/lower pricing strategy.

SNX excels in this domain on my analysis. This appears to be a critical differentiator to the company's economics and ability to grow FCFs over time. This analysis will unpack all of these points and link back to the broad buy thesis. Net-net, I rate SNX a buy, eyeing $137/share.

Figure 1.

Risks to investment thesis:

Investors should also realize the following risks before proceeding:

1. Any tech distribution industry is tremendously competitive and margins are thin, which could crimp SNX's cash flows.
2. We can't ignore the broader macro-level risks which include the inflation/rates axis and tight money. This could hamper the credit cycle to a negative degree for SNX.
3. A bulk of SNX's economic value is in its capital efficiency and productivity. Should this falter, this could nullify the thesis.

Investors must understand these risks in full before proceeding to any investment decision.

Critical investment facts to buy thesis

1. Latest numbers

SNX posted its Q2 FY'23 numbers in July. It put up revenues of $14.1Bn, down 7% YoY. Global gross billings came to $18.7Bn, down ~400bps YoY. Looking ahead, management forecasts gross billings of $18Bn-$19.3Bn for Q3, which represents a 7% YoY decline at the midpoint. Top-line sales for Q3 are projected between $13.5Bn-$14.5Bn, also a 10% decline YoY. Despite the downsides, SNX is confident it will generate >$1Bn in FCF for FY'23 and I am aligned with this viewpoint. Critically, the company plans to return ~$340mm to shareholders in dividends and so forth in H2, bringing the total to $580mm for the year.

Back to the quarter, it pulled the $14Bn to gross profit of $969mm on a margin of ~ 7%, which was up 45bps YoY. The margin decompression came from a product shift towards its advanced solutions and high-growth technologies. Operating income for the period was $376mm, down 5.6% YoY, whereas SNX printed OCF of $708mm for the quarter. The geographic breakdown is observed in Figure 2 along with the YoY walkthrough.

Looking to the balance sheet, SNX trimmed NWX density sequentially to $3.8Bn from $4.2Bn in Q1. This reduction was seen in both the receivables account and inventories. The company also achieved post-merger synergy targets ahead of schedule. It realized $30mm of incremental savings in the quarter, and >$200mm cumulatively since completion. It also returned $93mm to shareholders through dividends and share repurchases, equating to $0.35/share.

2. Economic value

The company is still throwing off mountains of cash since the merger. Figure 3 shows the cash spun off to shareholders on a rolling TTM basis since 2020. It includes the acquisition effects and looks at FCF as a function of growth vs. maintenance capital. Only CapEx changes above the maintenance capital investment are considered, where maintenance capital is estimated at the level of depreciation each period. Dividends are also included in the definition of cash flow to owners.

Aggregate profitability is up and the company is still throwing off >$1.5Bn in FCF to shareholders including all buybacks and dividends paid up. On this, shareholders realized $16.90/share in the 12 months to Q2, ahead of levels seen back in 2020 and 2021. You can see the use of cash throughout '21-'22 in acquiring Tech Data and the corresponding rebound that ensued.

Capital density has increased markedly since the acquisition, up from $3.2Bn in 2020 to $13.6Bn last period, otherwise $146.30/share. The $146 produced $14.18/share in post-tax earnings last period, just 9.7% return on capital, as seen in Figure 4.

A few points are relevant to this discussion:

1. The first is that the rate of return on invested capital is stretching higher each period. It climbed from 5.5% in '21 to 9.7% last period (TTM values), tracking back to the previous range of 13-19% (see: Figure 4 and Figure 6).
2. The source of these returns is important too. As mentioned earlier, it's near impossible to differentiate by product or price in the tech distributors business. Post-tax margins are borderline atrocious. Companies don't necessarily enjoy consumer advantages. So no growth at the margin, and cost differentiation is absent. They do enjoy production advantages, however. The low-cost producers combat the margin pressures through capital efficiency. You see this in two ways for SNX:
   • Attractive rates of capital turnover, at ~4.5x last period. This correlates to each $1 of capital at risk pulling in ~$4.50 in sales.
   • Working capital efficiency (which relates to the point above). As seen in Figure 5, the company is recycling cash tied up in NWC back to cash in around 1 month, give or take a few days. Sales outstanding has come down from 82 days in '21 to 58 days in Q2 as well.

With these points in mind, the trajectory of returns on capital is something to heavily consider here.

3. Forecasts and expectations at steady-state

The drivers of SNX's value for the past 3 years are noted in Figure 7. The impacts from all M&A are folded into NWC, intangibles and fixed assets. Critically, sales growth has been a standout, growing 11.8% geometrically over the period. This, on tight, but stable operating margins.

Most of the capital allocation has gone to working capital and intangible assets. This is important to the debate because it illustrates fixed asset density is low for the company, and we saw earlier SNX's working capital efficiency. Each new $1 in sales required $0.06 in NWC, and ~$0.1 in intangible investment.

It's unreasonable to expect SNX to compound sales at 12% going forward in my view. Consensus has it to do ~4.5% in '24 ad I am aligned with this view. Figure 8 carries the incremental value drivers from above forward albeit at the 4.5% sales growth to see what the capital requirements might be (to keep its competitive position).

Critically, should it achieve this, I'd estimate SNX to require $320-$390mm quarterly investment ($1.28Bn-$1.56Bn annualized) with the bulk of this heading to NWC. This would equate to ~24% of NOPAT reinvested each period. Again I'd see ~4-5x capital turns to throw off ~10-11% trailing ROIC and for SNX to compound its intrinsic value at an average of 4.5% into '24. Most critically, SNX could still through off >$1Bn in FCF each rolling TTM period under these stipulations. Moreover, if growth were to slow to ~2%, I'd see a lift in FCF to $1.3-$1.4Bn.

4. The technical take

There is technical support for SNX as well. On the daily chart in Figure 9, both price and lagging lines are positioned above the cloud. You're bullish on this time frame, which looks to the coming weeks, with support at $100 all throughout November.

Figure 9.

The weekly chart is most compelling to me. It looks to the coming months. The price line crossed in late August, and we've now got the lagging line (in blue) at the precipice of the cloud top, ready to cross to the upside. Should it do so, this is a bullish confirmation on the long-term chart.

Figure 10.

Added to this, we've got upsides to $107.5 on the daily point and figure chart below. These studies have eyed the move from mid $80's tremendously well, capturing the $95 and $97 levels well in advance. I'd be looking for a move to $107.50 as the next short-term target based on this setup.

Figure 11.

Valuation and conclusion

The stock sells cheaply and is trading at 9.4x forward earnings and 7.9x forward EBIT. It also sells at 7.2x NOPAT and is priced at a 0.94x discount to invested capital.

The last two points here are critical in my opinion. Consider that:

1. SNX has more in EV than it does in invested capital. The market doesn't believe these assets will produce a meaningful rate of return, or throw off piles of cash.
2. The return on new capital deployed was 5% last quarter. At the current market cap of $9.55Bn it is priced at 7.2x P/NOPAT as mentioned, or 9.7x EV/NOPAT (9,550/1,318 = 7.2x; otherwise 12,810/1,318 = 9.7x). The 5% incremental return grew profits by that much, and assuming the same 7.2x multiple, the company warrants a $9.96Bn market value, $13.4Bn EV.

Compounding the firm's implied intrinsic value at the function of its ROIC and reinvestment rates to date, I get to $10.5Bn in market value. Extending the calculus out to '24 using the steady-state numbers in Figure 8 gets me to $12.85Bn in market value. In my view, the market may be under-reflecting this economic value.

Extending the numbers out to FY'28 and discounting at the 12% hurdle rate used here, and taking the average of this and the $12.85Bn from above gets to an implied value of $202/share. As a reminder this assumes a 4.5% growth rate into FY'25, then fading to a long-term GDP range of 2-3% by FY'28. In my view, this supports a buy rating.

In short, there are economic tailwinds building for SNX and these are inflecting positively on its market value in my opinion. Capital turnover is high, more than compensating for the margin challenges and retaining SNX's competitive position. Cash conversion from NWC is at a high pace and supports the route to $1Bn in FCF each period into FY'24. Technicals are equally as supportive. Net-net, I rate SNX a buy, eyeing an initial valuation band of $137/share.