EMS industry headed for another round of belt-tightening
By Claire Serant / EBN (11/06/2002 12:09 PM EST)
Weak end-market demand is placing EMS providers on a subsistence diet involving a new wave of restructuring charges aimed at preserving, if not improving, operating margins. Sanmina-SCI Corp. last week became the latest contractor to tighten its belt another notch, disclosing that it will undertake a 12-month retooling to prop up soft capacity utilization rates.
"We'd like to see our EMS and enclosure divisions operating at 60% capacity and our printed-circuit-board (PCB) fabrication [division] at 50% capacity," said Randy Furr, Sanmina-SCI's president, speaking to analysts. "For the next four to five quarters, we're going to take between $225 and $250 million in restructuring charges."
Sanmina-SCI's cuts are smaller than the huge budgetary adjustments generally made in 2001. Last year contract manufacturers sliced about $2.3 billion from their operations, while they are expected in 2002 to cut $1.3 billion through layoffs and plant consolidation. Some analysts predict additional restructuring charges later this year of $500 million as EMS providers scramble to rid themselves of excess plant capacity.
"The magnitude of the restructuring will be smaller [going forward], but it's not over," said Shawn Severson, an analyst at Raymond James & Associates Inc., St. Petersburg, Fla. Severson sees EMS providers absorbing additional restructuring charges next year of $500 million to $1 billion.
Cost-cutting
Sanmina-SCI's crash diet was precipitated by a $2.6 billion loss in its fourth fiscal quarter ended Sept. 28. In the year-ago quarter, Sanmina reported a net loss of $167 million, although that was before last December's merger with SCI Systems Inc.
Revenue in the just-ended quarter was $2.6 billion, compared with year-ago pre-merger revenue of $600.7 million. Sanmina-SCI also recorded pretax charges of $2.7 billion linked to goodwill impairment.
"I think Sanmina-SCI was holding out on the hope that there would be a market rebound [for communications infrastructure]," said Michael Schneider, an analyst at Baird/US Research, Milwaukee. "They're taking another aggressive attack at their cost structure, which will ultimately benefit the business."
According to the plan, about half of the restructuring costs will come from Sanmina-SCI's EMS division, another 45% from its PCB division, and the remainder from its enclosure business, according to a report by Jerry Labowitz, an analyst at Merrill Lynch & Co. Inc., New York.
At the same time, the company will increase the number of production lines in low-cost locales, from roughly 25% of total manufacturing capacity now to 40% in the next several quarters, Labowitz said.
While additional restructuring entails new charges that will hurt net earnings, the move is not without its potential upside, said Kevin Kane, an analyst at IDC, Framingham, Mass.
"The short-term earnings of EMS providers will be suppressed, but improved margins will be the result as capacity utilization rates increase," Kane said. "Long term, business to EMS vendors will increase as cost of production continues to decrease."
Sanmina-SCI is not alone. Analysts also expect top-tier EMS companies like Flextronics International Ltd. and Solectron Corp. to undergo further restructuring.
PCB weakness
In releasing its earnings two weeks ago, Flextronics chairman and chief executive Michael Marks expressed frustration at the performance of Multek, the company's PCB division, though he stopped short of saying whether any action would be taken.
To date, the company has reported restructuring charges of $209 million, which represents 2% of its year-to-date sales, according to Bear, Stearns & Co. Inc., New York.
"Flextronics took their hits early on," said Raymond James' Severson. "As they transferred production [to low-cost sites like China] they gave up pricing and margin in the near term and had to absorb it as they transferred production overseas.
"The company could decide to close down their Germany PCB operation [sometime next year] and transfer production to Asia, which could give them restructuring charges in the range of $100 million to $200 million," Severson said.
Jim Sacherman, Flextronics' chief marketing officer, said no decision has been made regarding the fate of the company's PCB sites.
"[Marks] stated that we may be forced to close some unnamed PCB facilities if the market doesn't show some improvement," Sacherman said. "But we're hopeful the PCB market will improve and we can avoid closures."
Meanwhile, Solectron, based in Milpitas, Calif., has taken restructuring charges so far this year of $543.1 million, which represents 6% of the company's sales, according to Bear, Stearns. Solectron has closed sites in Milpitas and Fremont, Calif.; Hillsboro, Ore.; Everett, Wash.; and Calgary, Alberta, and will auction off the properties Nov. 7.
"The company is consolidating sales offices and [certain] plants to have less overhead," a Solectron spokesman said.
Schneider of Baird/US Research said such continued cost-cutting is a sign that contract manufacturers see no relief on the horizon and are preparing for a long period of slack demand.
"They've taken a final look at their cost structure and probably have another 10% to 15% to take out," he said. |
