Ingram Micro Inc. (NYSE:IM) may be the biggest distributor of technology products in the world, but it certainly is not the most profitable. Companies like ScanSource, Inc. (NASDAQ:SCSC) and Avnet, Inc. (NYSE:AVT) have carved out niches that allow them to be more profitable. However, only one of the three companies is a good investment at the moment.
Same industry, different strategies
Ingram Micro Inc. (NYSE:IM)’s offerings are vast; its product base has unparallelled breadth that generates industry-leading revenues. Meanwhile, ScanSource, Inc. (NASDAQ:SCSC) is a specialty distributor that focuses on point-of-sale, communications, and security devices. Its niche provides it access to a smaller total addressable market, so its revenue base is naturally much smaller than Ingram Micro Inc. (NYSE:IM)’s. Meanwhile, Avnet, Inc. (NYSE:AVT) carved out a market at the high end of IT products, which is a smaller market but provides higher margins.
Despite Ingram Micro Inc. (NYSE:IM)’s lead in total revenues, Avnet and ScanSource, Inc. (NASDAQ:SCSC) out-earn the company on each unit sold. Ingram Micro sells its products at an average gross margin of just over 5%, while ScanSource, Inc. (NASDAQ:SCSC) and Avnet, Inc. (NYSE:AVT) sell products at double the gross margin.
Ingram Micro’s lower profitability is the result of trying to cover the entire industry; it operates in a number of lower-margin markets that ScanSource and Avnet, Inc. (NYSE:AVT) avoid. As a result, it earns lower margins and lower returns on capital.
ScanSource, Inc. (NASDAQ:SCSC), on the other hand, operates in higher margin markets similar to those of Avnet, Inc. (NYSE:AVT). The company grew revenues and profits at a double-digit pace over the last year and has deep relationships with premium vendors. In addition, ScanSource is focusing on expansion in Asia, which could provide even more upside to revenue growth.
Meanwhile, Avnet, Inc. (NYSE:AVT) operates in many markets by distributing high-end products that fetch above-normal profit margins. As a result, the company earns higher margins than many of its specialty distribution peers.
Avnet and ScanSource, Inc. (NASDAQ:SCSC) grow primarily through acquisitions; ScanSource has averaged a little over one acquisition per year over the last two decades, and Avnet recently added Access Distribution to its long line of acquisitions. Fortunately, both companies have proven adept at bidding for and integrating acquisitions into operations.
However, only ScanSource earns outsized returns on invested capital. Ingram Micro Inc. (NYSE:IM) and Avnet target such a broad market that capital efficiency is lost in the process.
However, Avnet should boost its return on invested capital through additional cost-cutting. At the same time, Ingram Micro Inc. (NYSE:IM) maintains a below-average return on invested capital despite excellent working capital management. This is due to the company’s precarious position as the largest company in an industry that offers no sustainable competitive advantages.
Investment Case
ScanSource is the most attractive of the three given its high margins, niche markets, and low price-to-earnings ratio — it currently trades at just 12.5x trailing earnings.
Meanwhile, Avnet and Ingram Micro both trade at 10.5x trailing earnings, but their businesses are not as attractive as ScanSource’s. ScanSource offers reliable earnings and revenue growth due to its niche positioning, but Avnet and Ingram Micro are more susceptible to competitive pressures due to the breadth of their product offerings. As a result, neither company is an attractive investment option at a 10% earnings yield during a good year for the industry.
Bottom line
Over the long run, it pays to stick with the best company in the industry. Consider an investment in ScanSource and toss out Avnet and Ingram Micro.
The article This Tech Distributor is a Bargain originally appeared on Fool.com is written by Ted Cooper.
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