Wired for growth: Strong outlook fuels EMS players' success circuit

The sector saw a dual dynamic in Q2 - revenue growth acted as a current of strength, yet profit margins faced resistance

Led by Dixon Technologies (India), stocks of listed electronics manufacturing services (EMS) companies saw robust gains in trading on Friday. The two largest players in the sector, Dixon and Amber Enterprises India, saw gains of 8 per cent and 2.7 per cent, respectively, while other players also ended in the green.

The launch of a cellphone manufacturing facility by Dixon and a strong outlook led to a positive sentiment for the sector.

Dixon and Kaynes Technology have been the best performers on the returns front, posting a rise of 17–22 per cent over the past three months, while returns for other stocks in the space have been modest over this period.

While the outlook remains strong, the operational performance of the major players in the 2023–24 (FY24) July–September quarter (second quarter, or Q2) was subpar. Although revenue growth was robust, margins went south on account of higher costs. The companies in the sector posted 28 per cent revenue growth over the year-ago quarter and 17 per cent on a sequential basis.

While Cyient DLM (Design-Led Manufacturing), Syrma SGS Technology, Kaynes, and Dixon were the table-toppers on the revenue growth front, the laggards were Elin Electronics and Avalon Technologies. Kaynes and Syrma reported the highest order inflow in the quarter, registering a growth of 2.2–2.4 times over the year-ago quarter. Although the top line was robust, the same was not reflected in the operating performance.

Analysts at Systematix Research, led by Ashish Poddar, say, “Despite healthy sales growth, companies could not see margin expansion due to elevated raw material costs and other expenses. The working capital cycle also remained stretched, with a likely reduction by the end of the January-March quarter.”

Among the key players that witnessed margin pressure were Cyient and Avalon, which saw a contraction of 580 basis points (bps) and 540 bps due to lower raw material costs in the base quarter and adverse operating leverage. Data Patterns (India) registered the highest margin expansion of 340 bps year-on-year.

Brokerages, however, expect the sector to see an improvement in the second half of the financial year.

Analysts at Motilal Oswal Research, led by Sumant Kumar, say, “The growth momentum is expected to pick up pace in the second half of FY24 (seasonally better half), led by strong execution of the large order book at the end of September, coupled with continued order inflows from the existing and newer end-user industries.”

Led by an improvement in high-value product mix and increasing order flows from high-margin industries, the revenues of its coverage companies are expected to rise 38 per cent annually over 2022–23 (FY23) through 2025–26 (FY26).

While operating profit should improve by 40 per cent during this period, operating profit margins are expected to inch up to 14 per cent, says the brokerage, which has a ‘buy’ rating on Kaynes, Avalon, Cyient, and Syrma.

Systematix Research, too, remains structurally positive about the industry. Despite a mixed Q2, companies remained bullish on their growth outlook. The government’s Make in India, Make for the World, backed by various schemes and incentives, has aided India’s growing acceptance as an alternative manufacturer to China.

Import substitution and India’s rising penetration in the domestic market provide a large opportunity for the Indian EMS industry, says the brokerage. It has a ‘buy’ rating on Dixon, Elin, Syrma, and Avalon. The brokerage has a ‘hold’ rating on Amber due to the low return on capital employed of 15 per cent for 2024–25 (FY25) and fair valuation of 41 times FY25 earnings estimates.

Both brokerages are positive on Avalon and Syrma.

Avalon is a top pick on account of strong order inflows, with the clean energy and industrial segments accounting for 60 per cent of the order book, which, coupled with a higher India manufacturing mix (75 per cent), are expected to drive revenues and margins.

Given the structural growth factors in electronic system design and manufacturing, Syrma is expected to be a key beneficiary. This, coupled with strong order book and revenue growth, should see Syrma’s revenues, operating profit, and net profit rise 34–40 per cent annually over the FY23–26 period.