Outlook: positive, but still guarded
David Parrish
Stock prices in the Advest contract electronic manufacturing (CEM) universe
have risen 16% on average in October, with much of that gain attributable to
top-tier manufacturers.
Flextronics, Jabil, and SCI are up between 35% and 40% in the past several
weeks, due, in large part, to bullish comments by several industry players.
Jabil noted in its recent conference call that demand firmed toward the end of
the quarter, and the company expects rising production levels in all segments
going into the fall. Some of Solectron's comments were just as favorable,
indicating the company continues to gain market share as larger OEMs
rationalize their supplier bases.
This trend, coupled with continued outsourcing initiatives, firmly positions
many of the larger contract electronic manufacturers to continue earnings
growth in excess of 20% annually.
But we are not without concern as we look to 1999. There is early evidence
of a slowdown in telecom spending and reductions in IT budgets.
Over the past couple of weeks, we have spoken with all of the Regional Bell
Operating Companies (RBOCs) and major long-distance carriers regarding
their capital-spending plans for 1999. Their budgets are down 2% for next
year, in contrast to a 10% increase in 1998 over 1997.
Furthermore, planned outlays at a dozen surveyed Competitive Local
Exchange Carriers (CLECs) are down 10% for 1999, after a 14% rise this
year, though many of these emerging service providers have indicated that
much of their infrastructure build-out is complete, which explains the declines.
Potential reductions in IT budgets also present a cause for concern. Several
networking companies are seeing a slowdown in customers' IT spending.
Economic concerns are causing many companies to rethink their level of
expenditures as we enter 1999. Additionally, Y2K expenditures could divert
funds away from networking-equipment purchases. In our view, projects that
are not "mission-critical" will go through a much greater level of scrutiny in the
current environment.
The poor visibility surrounding capital spending for next year clearly increases
the risk profile for CEMs that have heavy telecom and or networking
exposure. But the level of risk is moderate because much of the
manufacturers' recent growth is attributable to new program wins rather than
expansion of older programs. Over the next several years, the now firmly
established trend toward outsourcing, an ever diversifying menu of service
offerings, and continued penetration of offshore markets will provide a solid
foundation for meaningful earnings growth.
-David T. Parrish is an analyst at Advest Inc., Boston.
Copyright ® 1998 CMP Media Inc.
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