Weak sales of some technology and consumer products is driving down an index of electronics- manufacturing-services companies, which is at a three-year low relative to the market.
Demand for networking and telecommunications gear -- a key tech-business segment -- has been “disappointing at best,” said Shawn Harrison, an analyst in Independence, Ohio, at Longbow Research. Investors also are skeptical about growth because slow orders for consumer products such as notebook computers, television set-top boxes and some smartphones “remain a headwind,” he said.
Spending on tech products may not show a typical “seasonal uptick” during the second half of the year, Harrison said. The customers of EMS providers -- including International Business Machines Corp. (IBM) and Cisco Systems Inc. (CSCO) -- have confirmed that “the world is still not firing on all cylinders,” he said.
The Bloomberg U.S. Electronics Manufacturing Services Index (BNUSEMSX) -- comprised of Flextronics International Ltd., Jabil Circuit Inc. and 11 other companies -- has fallen 24 percent since Feb. 23, compared with a 3.7 percent decline for the Standard & Poor’s 500 Index.
The index “broke a key support level” on May 10 when it traded below the point at which investors bought these stocks last year, said Jim Stellakis, founder and director of research at New York-based research company Technical Alpha. This was a bearish shift by investors, who “weren’t valuing this group the way they did in August and September of 2011,” he said.
Solaris Group doesn’t own any of these companies because the second quarter tends to be “a valley in terms of demand,” and the stocks are “dead money right now,” said Tim Ghriskey, who oversees about $2 billion as chief investment officer of the Bedford Hills, New York-based investment company.
Since production is outsourced to these companies, they are the first to see cutbacks in orders, and their stock performance tends to be very volatile, Ghriskey said. They began underperforming in mid-February, and the selloff intensified when some of their customers reported weaker-than-forecast activity, he said.
San Jose, California-based Cisco, one of the EMS customers, forecast fiscal fourth-quarter profit on May 9 that missed analysts’ estimates amid a “wait-and-see type of environment” Chairman and Chief Executive Officer John Chambers said on a conference call that day.
The world’s largest maker of computer-networking equipment said earnings before some costs for the period ending in July will be 44 cents to 46 cents a share. This compares with analysts’ estimates of 48 cents, data compiled by Bloomberg shows. These results aren’t a reason “to become more bullish about the industry,” Harrison said.
While Sanmina-SCI Corp. (SANM) executives are among those who have said demand probably will pick up in the second half of 2012, investors don’t have “confidence in that happening,” said Amit Daryanani, an analyst in San Francisco at RBC Capital Markets. Orders always can be reduced at the last minute, particularly when customers are concerned about the economy, he said.
Signs of Recovery
The “macro environment is unsettled, and the near-term performance of our network-communication sector remains uncertain” for Plexus Corp. (PLXS), even amid “early signs of recovery” in most of its business segments, President and Chief Executive Officer Dean Foate said on an April 19 conference call.
The Neenah, Wisconsin-based electronic and software designer anticipates performance among its top 10 customers will be mixed as they appear to be “struggling with forecasts,” Foate said. Juniper Networks Inc. (JNPR), the second-largest maker of networking equipment, represents 14 percent of its revenue, Plexus said April 18.
Demand has been “very spotty” for Celestica Inc. (CLS), which makes electronics for companies such as Research in Motion Ltd., Chief Financial Officer Paul Nicoletti said on an April 24 conference call. The Toronto-based company’s forecast for economic recovery in the second half of the year is “not as strong” as it “would have expected sitting here 90 days ago,” he said.
Such weakness in key markets has overshadowed cheap valuations, according to Harrison, who said this is one reason for his “neutral” recommendation on Celestica. The company is trading at a multiple of about seven times consensus 2012 earnings, near its historic low of six times, he estimates.
Even so, other markets, such as industrial, automotive and medical, have had “pretty good growth,” offering “pockets of strength” for diversification, Harrison said. Plexus and Jabil are among EMS providers that have “refined strategies to win new business,” which has helped cushion the slower demand from their tech customers, he said.
These companies have high operating leverage because of their large fixed-cost structure, so there’s a “double whammy” -- a decline in sales causes a disproportionate drop in profits, Daryanani said. They also have “massive global exposure,” particularly in Europe where their customers generate about 30 percent of revenue, he estimates.
The industry has been “extremely skittish” about business with Research in Motion, so Celestica and Flextronics (FLEX) “have put some guardrails” around their exposure to the maker of the BlackBerry smartphone, Daryanani said. The Waterloo, Ontario- based company forecast an operating loss May 29 for its fiscal first quarter.
If the EMS index can trade above the relative low that was “violated” in May, this will be the first indication investors are becoming more bullish about these stocks again, said Stellakis, a chartered market technician.
First, they will need to see signs of improvement as they await more robust demand, Ghriskey added.
“This is not the time to buy EMS stocks as investors are still very concerned about economic growth,” he said.
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