Flex Ltd (NASDAQ:FLEX) prospects and sentiments in the market have turned sour in the wake of the company posting mixed Q2 financial results followed by weak Q3 guidance. Rating firm Moody’s raising the red flag about the company’s reduced revenue and cash flow expectations has all but continued to accelerate a sell-off of the stock.
Flex Price Analysis
After a period of consolidation, the stock is back to trading in a downtrend amidst soaring momentum. The stock has underperformed the broader sector depicted by a 50% slide from this year’s highs.
While the stock has pulled back from the $7 a share level, a lack of new catalysts to strengthen a bounce back could see the stock plunging further. The stock faces immediate support at the $7a share level, a breach of which could accelerate the sell-off.
After the recent sell-off, the stock faces immediate resistance at the $9 a share level on the ongoing bounce back. A rally followed by a close above the critical resistance level could give bulls a reason to push the stock to the $13 a share level, the next substantial resistance level. Flex needs to rise and stabilize above the $13 a share if it is to avoid a further slide.
Disappointing Q3 Guidance
Flex did report impressive Q2 financial results. Revenue in the quarter were up 7% to $6.71 billion but slightly below consensus estimates of $6.79 billion. Earnings were also up 7% to $0.29 a share beating estimates by a penny.
However, Q3 guidance appears to have spooked investors fuelling a sell-off of the stock. The company saying it expects earnings of about $0.31 a share on revenues of $6.8 billion did not go well with the markets. For starters, the guidance represents a 15% year over year drop in revenues. Analysts were expecting an earnings guidance of $0.36 a share on revenues of $7.3 billion.
India Capacity Concerns
The confirmation that the company will no longer make shoes for Nike at its facility in Guadalajara Mexico also did not go well with the market. The company is shutting down the operations on struggling to make it commercially viable. The shutdown is set to cost the company up to $30 million in exit costs. Flex could also incur additional costs attributed to the wind-down.
Flex finds itself in a precarious position when it comes to operational efficiency. The soft Q3 guidance has everything to do with limited manufacturing capacity in India with the shutdown of Mexico operations.
The company has had to turn its attention to investing in Indian facilities in the recent past as it looks to manufacture more products in the country. The investment comes on the Indian government imposing import tariffs on many types of goods all in the effort of encouraging local production.
Ramping up capacity to meet the growing demand has turned out to be a big challenge leaving most of Flex Indian business unserved. However, the management remains optimistic of solving the issue before the end of the year.
Bottom Line
Investors are taking a step back given the underlying issues that Flex is facing. The shutdown of Mexico operations could significantly hurt the company’s revenue base. However, it is the capacity issues in India, which raises serious concerns about the company’s prospects. Nike wind down and capacity issues in India will result in weakness on the consumer technology group, which could see revenue tank by 27%.
Moody’s warning that free cash flow for FY19 will fall below FY18 levels as a result of soaring capital expenditures has also not gone well with investors. That said investors are shunning the stock given the uncertain future. The stock looks set to remain under pressure until it sorts out its capacity issues in India.