A recent Wall Street report suggests calendar 2009 first quarter financial performance will be tough for electronics manufacturing services (EMS) companies. Any glimmers of strength for this quarter’s EMS company performances can possibly be seen as product and customer specific.
The focus of EMS provider Jabil Electronics earnings call last month was more about whether the market has seen, or will see, the bottom in demand, versus specific details on business trends. It is believed this will be the case for many EMS companies reporting their earnings in April.
While the trend for electronics OEMs to outsource continues, however, with Nokia pulling its business in house (and it is expected trend to continue for a few more quarters as those OEMs with internal production strive to maximize their fixed-cost absorption) the overall trend for OEMs to further outsource will likely not be seen until later in 2009.
It is believed large telecommunications and networking customers are tracking below plan and corporate spending for new server and storage products remains on hold. Some in industry believe Cisco’s business is tracking below plan, which will be a damper on EMS companies.
As for server and storage demand being weak, with corporate reluctance to spend on new systems and holding off on upgrades in the current environment, this could be seen as possibly being offset by the Chinese government’s plans to stimulate technology spending – which appear to be working — thus driving good growth in China, which could will help EMS companies with exposure to electronics OEMs in the China market.
The financial market has largely priced in the weak economic environment however, and the report believes this earnings round will be more focused on determining a bottom, with investors focused on names of EMS companies that will outperform once demand resumes.
EMS companies highlighted in this writing include:
- Sanmina-SCI
- Celestica
- Benchmark Electronics
- Flextronics
- Plexus
EMS company 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 dependent on technology OEM sales, which are driven by the health of the overall macroeconomic environment.
The report by investment bank Deutsche Bank also list some potential risks specific to the EMS companies mentioned above. These risks are included below.
EMS company stock valuation
In general, EMS stocks have historically traded at similar P/E ratios. Deutsche Bank believe earnings coupled with a review of balance sheet and return metrics is the best way to evaluate EMS stocks.
Since 2004, EMS company profit-to-earnings ratios (P/E) have ranged from 3x to 20x, roughly tracking market multiples.
However, Deutsche Bank 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.
Sanmina-SCI risks and key customers
Potential positive risks to Deutsche Bank’s view of 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.
Potential negative risks to Sanmina-SCI include new losses in the components and enclosure businesses, deterioration in balance sheet metrics, the loss of one of its top customers (IBM, HP), a reduction in liquidity from current levels, and a breach of debt covenants due to lower-than expected cash flows.
Top customers at Sanmina-SCI include IBM and Hewlett-Packard.
Celestica risks and key customers
Potential positive risks to Deutsche Bank’s view of Celestica include a return to revenue growth which would drive operating margin leverage, further improvements in balance sheet metrics to improve cash, and increased business due to competitive deal wins.
Potential negative risks to Celestica include a deterioration in balance sheet metrics and the loss of a top 10 customer (Sun, IBM and Cisco).
Top customers at Celestica include IBM (~10% of business), Sun Microsystems, Cisco, Alcatel-Lucent, EMC, Hewlett-Packard, Honeywell, Juniper, Microsoft, NEC, Raytheon, and RIM.
Benchmark Electronics risks and key customers
Potential risks to Deutsche Bank’s view of Benchmark Electronics include increased business due to competitive deal wins, better business trends at Sun Microsystems, and improvements in the Company’s medical electronics segment.
Potential negative risks include the loss of a top customer (Sun Microsystems or EMC), higher-than-expected revenue declines in the medical electronics segment and ramp challenges of new facilities in China.
Top customers at Benchmark Electronics include Sun Microsystems (15%), EMC (<10%)
Flextronics risks and key customers
Potential risk to Deutsche Bank’s view of Flextronics include the loss of a significant customer like Sony-Ericsson, the failure or bankruptcy of a top 10 customer, further increases in distressed customers, a reduction in liquidity from current levels, and a breach of debt covenants due to lower-than-expected cash flows.
It should be noted by readers that VentureOutsource.com found no mention of potential negative risks to Deutsche Bank’s view of Flextronics other than the one paragraph above.
Top customers at Flextronics include Sony-Ericsson (~10%), Cisco, Ericsson, Hewlett-Packard, Kodak, Motorola, Microsoft, Nortel (~4%), Sony, and Sun Microsystems.
Plexus risks and key customers
Potential risk to Deutsche Bank’s view of Plexus include new deal wins with the newly ‘unnamed’ defense customer win, increased business due to competitive deal wins, and improvements in the medical electronics segment.
Potential negative risks include the loss of a top customer like Juniper or GE Medical, the loss of a new mechatronics customer and further slow-to-declining growth in the medical electronics segment.
Top customers at Plexus include Juniper (20%), GE (<10%).
Deutsche Bank, VentureOutsource.com, April 2009
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