October 20, 2008
Investment bank Deutsche Bank recently released a report on the EMS industry relative to analysis of the credit crisis. Given the issues in the credit markets, and the concern about corporate balance sheets, Deutsche Bank felt it would be a helpful exercise to examine its EMS group of companies the bank follows to assess available liquidity and near-term debt obligations.
Per the report, Deutsche Bank’s EMS universe of companies includes the following EMS providers:
- Benchmark Electronics
- Celestica
- Flextronics
- Jabil Circuit
- Plexus
- Sanmina-SCI
Deutsche Bank seems to feel its EMS universe of companies appears well-funded, with ample liquidity in place for upcoming debt payments. With stocks trading at historically low valuations, the bank also examined its EMS group based on tangible book and cash multiples, with 3 EMS companies trading below tangible book and 2 trading below cash.
In general, EMS companies appear well funded, with interest coverage ratios at 6x, or greater, for all but one of the EMS companies the firm follows. Sanmina-SCI has the lowest coverage ratio at 2x, it should be no surprise this is based on its high level of debt (55% debt-to-capital ratio) and high interest rates.
Only two of the bank’s EMS companies in its universe have debt coming due before the end of 2009 (Flextronics and Jabil Circuit), however Deutsche Bank feels both of these companies appear to have ample liquidity to cover these payments without having to access the capital markets.
Trading below book value, cash value
While each of the stocks of companies in the firm’s EMS universe are trading at low valuations relative to historical norms, 3 EMS providers are trading below tangible book value and 2 EMS providers are trading below cash value.
Within the firm’s coverage, EMS providers Celectica, Sanmina-SCI, and Benchmark Electronics are each trading below tangible book value, which suggests to Deutsche Bank the market expects some form of restructuring at these companies.
Meanwhile, Sanmina-SCI and Celestica and both trading below cash value, although neither is trading below net cash.
The Deutsche Bank reports states the firm believes that in today’s market EMS stocks should trade at a discount to the overall market, due to ongoing concerns about the economy, the higher volatility of EMS shares, and EMS companies’ more limited visibility on demand.
EMS commentary / risk
EMS provider stocks have historically been volatile, due to the high fixed-cost nature of the business which can lead to significant swings in profitability. In addition, the industry is also dependent on OEM sales, which are driven by the health of the overall macro-economic environment.
Based on this, Deutsche Bank comments on the possible ‘good’ and the potential for ‘bad’ among the following EMS provider stock prices and financial performance:
Benchmark Electronics: Circumstances the firm believes could impact Benchmark Electronics, should they occur, include additional business due to competitive deal wins, better business trends at Sun Microsystems, and improvements in the company’s medical segment. Negative risks could surface should Benchmark Electronics lose one of its top customers (Sun Microsystems or EMC), experience higher-than-expected revenue declines in the medical segment and difficulties related to the ramp of new facilities in China.
Celestica: Circumstances the firm believes could impact Celestica include a potential return to revenue growth which would drive operating margin leverage; faster-than-expected returns to profitability in Europe, better-than-expected management of balance sheet metrics to improve cash, and increased business due to competitive deal wins. Negative risks could surface should there be further losses in Mexico and Europe, deterioration in balance sheet metrics, and the loss of one of its top 10 customers (Sun, IBM, or Cisco).
Flextronics: Circumstances the firm believes could impact Flextronics include difficulty integrating the Solectron acquisition; an inability to return to previous operating margins due to higher material costs and a slower economy. Negative risks could surface should there be a loss of a significant customer such as Sony-Ericsson, and a faster-than-expected decline in the global demand.
Jabil Circuit: Circumstances the firm believes could impact Jabil Circuit include faster-than-expected return to 4% operating margins, and significant deal wins to offset the loss of Nokia and Philips business. Negative risks could surface should there be a greater-than-expected decline in mobile business, increased losses in displays, deterioration in balance sheet metrics which would impact cash generation, and the loss of one of its top customers (Cisco, Philips, or HP).
Plexus: Circumstances the firm believes could impact Plexus include new deal wins with the so far , unnamed defense customer, increased business due to competitive deal wins, and improvements in the company’s medical segment. Negative risks could surface should there be the loss of a top customer like Juniper or GE Medical, and further slowing-to-declining growth in the medical segment.
Sanmina-SCI: Circumstances the firm believes could impact Sanmina-SCI include increased profitability in the components and enclosure businesses; better-than-expected management of balance sheet metrics to improve cash, and increased business due to competitive deal wins. Negative risks could surface should there be new losses in the components and enclosure businesses; deterioration in balance sheet metrics, and the loss of one of its top customers (IBM, HP).
Source: Deutsche Bank
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