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Moat Ratings Upgrades for Arrow Electronics and Avnet

Arrow Electronics and Avnet are two of the world's largest value-added distributors of electronic components including semiconductors, capacitors, interconnect products, and in Arrow's case, a provider of enterprise computing solutions. We believe both firms will maintain their places at the top of the distributor pile due to significant cost advantages over broadline distributors who may attempt to add their own value-added services and suppliers who may consider bringing such services in house. We believe this warrants an upgrade to a narrow moat rating for both firms.

Both companies have focused on improving their value-added services, such as component testing, design-chain support, supply-chain management, and other engineering-intensive offerings. However, the two firms have invested in maintaining their moats in different ways.

Arrow has used its strength in components and enterprise computing to become a "solutions provider." The firm has invested heavily in engineering expertise to become the central hub between semiconductor suppliers, software vendors, IT re-sellers and customers. We believe the firm's expansive offering of services and end-to-end solutions has it on target to generate excess returns over our forecast.

Avnet by contrast has doubled-down on components distribution, selling their own solutions business in 2016 and acquiring online distributor Premier Farnell. The firm is evolving as a value-added distributor by targeting makers, startups, hobbyists and other low volume customers via the additional acquisitions of and Dragon Innovation, as well as securing a partnership with Kickstarter. We think these moves will help Avnet capture customers at an earlier stage, growing with startups as they scale from ideation to full-scale volume production.

Both Avnet and Arrow have been caught in the middle of considerable supplier consolidation in the semiconductor industry, and we expect the threat of consolidation to remain a worry for both firms. That said, we think it unlikely that many suppliers will follow Texas Instrument's example and reduce Arrow and Avnet to fulfillment distributors due to the significant investment and time required. In the end, we believe the demand for increased electronic content will continue amid secular tailwinds such as the "Internet of Things," enabling long-term demand for the services and engineering expertise of both firms.

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