EMS in recession: What’s different this time?

October 22, 2008

The worsening macroeconomic environment and evolving global recession will undoubtedly impact all companies throughout the tech supply chain as investment bank J.P.Morgan writes in a recent report. EMS, in particular, is not immune.

However, it's important to keep in mind the overall structure of the tech supply chain industry and the positioning of individual companies are vastly different from the last tech recession that occurred in 2001.

Being attuned to these differences can present interesting challenges for companies and opportunities for investors based on many of the compelling risk / reward profiles that now exist.

So, what are these vast differences? Specifically, 4 important areas, including:

business mix and diversification
new business wins/backlogs
debt profiles / liquidity
capacity utilization / footprint positioning.

Business mix and diversification

Today, electronics manufacturing services (EMS) companies generate 31% less revenue from networking and telecom than they did back in December 2000 when it peaked at 53% of sales. During the same time, less volatile and less penetrated areas such as medical, industrial, instrumentation, defense, aerospace, and automotive electronics have expanded from 11% to 20% of total sales.

New business wins / backlogs

Plexus led the group of EMS companies in J.P.Morgan's universe with new wins over the past year accounting for 28% of its calendar year ‘08 expected revenue followed by Benchmark Electronics at 16%, Flextronics at 9%, and Jabil Circuit at 8%.

Debt profiles / liquidity

The average debt / total capital for the group is less than 30%, with the highest being Sanmina-SCI at 55%. Overall liquidity is also very strong at ~$11B for the industry (cash plus unused revolver balances), which is almost twice the $6.6B level from 2000.

Capacity utilization / footprint positioning

Capacity utilization has improved over the past few years as have operating margins, which are now as high as they have been since 2001. An improved footprint has been a big part of this turnaround with low-cost capacity more than tripling since 2000 and high-cost capacity shrinking from 79% of the total to 38%.

Are all tech recessions the same?

While Wall Street is clearly pricing in a very bleak outlook for tech stocks, J.P.Morgan believes this tech recession won't be as bad as the last one in 2001 for 3 reasons:

inventories are fairly lean
an M&A or, capacity expansion, binge does not currently exist - which could delay the recovery, and
companies are much more diversified

The report goes on to state that, while the bank wishes it knew how long this tech recession would last, J.P.Morgan does take comfort in the fact that the most severe recessions post World War II lasted 16 months, on average, which would put the end to this current recession around mid 09.

Source: J.P.Morgan