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SED International: Concerns over Margins and Leverage
Posted by: Mark Lin (IP Logged)
Date: December 18, 2012 09:35AM

Founded in 1980, SED International Holdings Inc. (SED) is a multinational, preferred distributor of leading computer technology, consumer electronics, and small appliance products. The company also offers custom-tailored supply chain management services ideally suited to meet the priorities and distribution requirements of the e-commerce, Business-to-Business and Business-to-Consumer markets. Headquartered in the Atlanta, Ga., area with operations in the U.S. and Latin America, SED offers products and services to more than 10,000 customers and 200 vendors.

Valuation

SED is a net-net trading at a P/NCAV of 0.70 and P/NTA of 0.57. Its current P/B valuation represents a 8% discount to its five-year average P/B of 0.60. In terms of earnings-based valuations, it is valued at a trailing 12 months EV/EBITDA of 16.70. SED achieved a 0.7% ROE for the past 12 months and a five-year average ROE of 1.7%.

One of the tell-tale signs that a net-net is a value trap or a perpetual net-net is the fact that the stock has never traded above its net current asset value through out its trading history. It is therefore worth noting that SED's share price exceeded its net current asset value from February through May 2012, and prior to November 2011.

Take note that GuruFocus calculates NCAV using the traditional Graham Net Current Asset Value definition of 100% of cash, 75% of receivables and 50% of inventories, while I simply deduct total liabilities from total current assets. In SED's case, receivables and inventories each account for about half of current assets, while the remaining current assets comprises cash and other current assets related to an insurance claim for warehouse theft.

SED NAV, NTA, NCAV Comparison


SED has a patchy earnings track record with losses in six out of the last ten years. SED is in a low-margin business with gross margins hovering in the 5-6% range and operating margins below 1% historically. SED's recent financial performance raises fresh concerns, with operating and net margins dipping into negative territory and a spike in inventory days above 40 days.

SED Profit Margins Comparison


SED Inventory Days, Receivables Days Comparison


Financial and Business Risks

SED is heavily geared with a gross debt-to-equity ratio of 164% and a net gearing of 148%. This is not helped by a low interest coverage ratio of 2.2. SED has no long term debt on its book, but finances working capital with a significant amount of revolving credit facilities.

SED Cash-Debt-Market Capitalization Comparison


The risk of inventory write-downs is increased by the nature of its business selling a wide range of products subject to fast technological obsolescence and the difficult economy. The spike in inventory days above 40 days in the last fiscal year and the trailing 12 months is reflective of this.

SED has limited bargaining power with suppliers, as a large proportion of revenues is derived from products it purchases from a few manufacturers. In bad times, suppliers are likely to tighten credit terms and exert price pressure on SED. In good times, SED could be unable to purchase a sufficient quantity of popular products from its suppliers and be forced to purchase from wholesalers at the expense of reduced margins.

SED, or its subsidiaries, may have to secure additional financing in future, if it is to continue to expand its operations in Latin America. SED is restricted by the terms of its U.S. bank credit facility from funding its Latin American subsidiaries. This will potentially further weaken SED's balance sheet.

Business Quality and Capital Allocation

SED claims that its quality of service is a key differentiator, with 60% of its customers identifying service and support as the primary reason they do business with SED. SED caters to SMB resellers and assigns a primary salesperson to every customer, regardless of size, in contrast with most competitors which are diverting resources to larger low-margin business.

SED positions itself as a niche player, focusing on under-served markets such as housewares, small business segments and Latin America markets. It claims to have a unique customer base with minimal competitor overlap, targeting reseller customers in retail, e-commerce, VAR, system builder, OEM and custom install.

SED has a diverse customer base spanning multiple product categories and multiple geographies. It has little or no customer concentration risk, with no single customer accounting for more than 10% of its sales. SED meets the demands of 10,000 customers and 200 vendor partners with over 17,000 products across major technology and electronics categories. The U.S. accounted for 60% of SED's fiscal 2012 revenues, with exports and Latin America operations making up 16% and 23% of fiscal 2012 revenues, respectively.

SED does not pay a dividend.

Conclusion

While SED claims to compete on service, not cost, its margins and ROEs suggest a different story.

Disclosure

The author does not have a position in any of the stocks mentioned.


Stocks Discussed: SED,
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