Alex Brown is pounding the table on the sector.
Yesterday morning Jim Savage from Alex Brown had a conference call for the firm's clients. I got to listen to taped version of the call last night. The following comments are my interpretations, and since he talked fast and moved quickly through the info, I may not always have it quite right. I'm also sensitive to the fact that Alex Brown has done a great deal of terrific work surveying OEM customers on outsourcing plans, and I don't want to too freely distribute that info, so I'll post more in terms of generalizations. I guess I'll also throw a plug in for Jim Savage; he's one of the best analysts in the sector. With those caveats, here goes:
Jim essentially pounded the table for the ECM sector leaders, SCI, JBL, SANM, and said FLEXF, DIIG, and SLR were all strong buys/buys at this point as well.
Jim started by talking about the ridiculous valuations the stocks reached last Wednesday. He said the forward PEs on these stocks ranged from 12 for SCI and JBL to 17 for SANM based on his estimates, and considered these valuations as an 'opportunity' considering the fast growth the sector, and particularly the leaders, will see over the next several years.
He then went through the bear case for the sector. He thinks the market believes that ECM companies only get overflow work from OEMs, and therefore the slowdown in the electronics biz hurts ECM disporportionately. He believes this is not true; that more and more companies are outsourcing core programs. Five years ago this may have been somewhat true, and ten years ago, even more true, but today OEM customers rely on the ECMs. Also there may be a fear that in a slowdown, OEMs will bring some of the assembly biz back inhouse. Although there has been some minor moves by Compaq and Apple, maybe 3Com, to do this, it doesn't represent a significant amount of biz compared to the new divestures and outsourcing contracts being awarded and being considered at this time.
He quickly raced through a set of divestitures in the sector in the first half, that involved a total of $2B in new divestures, including Nokia deal to SCI, IBM deal to Solectron, and a Nortel deal. He also mention the HP deals to Celestica, SCI, SLR, and JBL where HP is outsourcing core programs.
Then he moved into outsourcing contracts. He mentioned outsourcing plans among semi-equipment makers like Applied Materials and Teradyne, and 'white goods' manufacturer Whirlpool. He mentioned outsourcing among PC makers like Gateway and Dell. But the biggest outsurcing growth will come in the telecom area, and in increased outsourcing in Europe. Nortel, with $8B worth of annual Cost of Goods Sold (COGS), is planning major outsourcing and has already awarded a number of contracts to the likes of SLR, SCI, and SANM. Lucent will become the second largest ECM user (behind HP?? - my guess), if they proceed with their plans to outsource as much as 40% of their manufacturing. They have virtually no outsourcing currently. Also Ericsson has moved toward outsourcing, and will continue, but still does 80% of their manufacturing, so there is lot more potential biz in the works. He expects there will be some major contracts over the next year. Nokia is just beginning, but is planning to outsource work this year. Alcatel will announce at least one divestiture this year, and more in the future. Finally there are signs that Phillips is moving rapidly to outsourcing. The expected beneficiaries of this outsourcing, are the largest ECM players: SCI, SLR, Celestica, FLEXF, JBL, SANM, and AVEX.
In the first half of 98, ECM sector total revenue growth will probably come in at somewhat less than 25% over 1997, but Jim expects a rebound and that second half growth will exceed 30% as these deals kick in. He feels that last week we possibly hit the bottom for these stocks, and "If we haven't, we're pretty damn close!" The inventory adjustments we saw at existing customers like Compaq should be almost complete at this time, and HP has forecasted that they will see a much stronger second half.
He commented about pricing pressure, and drops in ASPs, and indicated that the material costs are the biggest costs in the structure for ECMs, not depreciation or labor. Since the component costs are dropping, ASPs are declining in some sectors. But he feels that ECM margins won't be impacted much. Question to SCI's Olin King "Will ECM margins decline?" Answer: "Can't get blood from a turnip."
He then went through a stock by stock review super quick. It is apparent he was really pounding the table for SCI and JBL at last week's fire sale prices. He felt SANM had hit a bottom and had great growth potential. I don't know if I heard this correctly, but a 1% move to outsourcing by Lucent, if it goes to SANM (my comments- This is likely since SANM specializes in the backplanes and panels that go into telecom gear.), would add 25% to SANM's annual revenues (Wow!!). He upgraded FLEXF recently because of positive earnings growth, we may get a modest upside surprise next Q, and EPS including noncash goodwill amortization should be above $2.60 for the current fiscal year. SLR has great growth prospects, but since its valuation is much higher than the others, he isn't pounding the table as hard at this time. And among smaller caps, he favors DIIG, which he said is trading at 9 times his calendar 99 EPS.
All in all, he was extremely positive on the sector over the next 18-24 months.
For my part, I agree with everything I heard. The rundown on OEM outsourcing jives with my analysis and contacts. The next year is going to be interesting.
Paul |
