Near-term growth & margin worries for EMS players Dixon and Amber

Brokerages prefer Amber Enterprises to Dixon Technologies in the sector

The stocks of electronic manufacturing service (EMS) players such as Dixon Technologies (Dixon) and Amber Enterprises (Amber) have seen a sharper correction than the broader markets and benchmarks, shedding 18-37 per cent since the start of May.

Lower growth in their customer segments, cost pressure, and valuations weighed on the stocks. While both have been multi-baggers over the past three years, with Dixon rising 7.5 times and Amber gaining 2.5 times during this period, the Street has a mixed view on the returns potential of the two EMS companies.

Among the near-term worries are demand and cost pressure, visible in the March quarter performance of Amber, though Dixon’s financials were more resilient.

Amber’s room air-conditioner (RAC) segment performance was weaker than expected, given the longer winter, coupled with higher Covid infections in the early part of the quarter. This resulted in lower offtake by channel partners, which, coupled with supply-chain issues in China, affected the segment.

Standalone profitability at gross level was down 320 basis points to 10.5 per cent while at operating level it was 360 points lower due to higher employee costs. Consolidated margins were down about 200 basis points. Weak margins, higher depreciation due to capital expenditure over the past year, and increased interest cost led to a 24 per cent y-o-y hit to the bottom line.

While Q4 performance was disappointing, Ambit Capital analysts believe it was a blip in an otherwise decadal growth story for the company. The brokerage expects 28-38 per cent revenue and operating profit growth annually over FY22-25 and anticipates the returns on capital employed to improve by 10 percentage point to 17 per cent in FY25. A large part of the growth is expected to come from the doubling of the RAC market to $10 billion by FY26, implying 14 per cent annual growth.

Analysts led by Pulkit Patni of Goldman Sachs Equity Research, which has a buy rating on the stock, said: “Through acquisitions, Amber has backward integrated into components and other AC applications. Import substitution and Production-Linked Incentives (PLI), coupled with export opportunities, provide strong growth prospects for the company.”

What could, however, hit near-term return ratios are investments of Rs 1,100 crore over FY20-23 with a view to de-risk from RAC assembly towards making components. Further valuations after a steep 45 per cent correction since May mean it is available at a 35 per cent discount to Voltas.

The country’s largest EMS company, Dixon Technologies, had a steady March quarter showing. The performance on revenue, which was up 40 per cent year-on-year, was driven by strong growth in the mobile and home appliances segments. Its gross margins improved on a year-on-year basis. The operating profit margin grew 65 basis points to 4 per cent year-on-year due to higher operating leverage, cost improvements across segments, and price increases, which offset the rise in raw material costs.

Given that it is the largest EMS player in electronics, lighting, mobile phones, security systems, and washing machines, the PLI scheme and import substitution are key growth drivers. Goldman Sachs estimates the company’s addressable market size of $36 billion to grow by 12 per cent annually to hit $73 billion by FY26. The brokerage, however, has a neutral rating. “We believe Dixon’s strong growth and returns profile (annual revenue growth of 42 per cent over FY20-26E and return on capital employed of 30 per cent plus) warrants premium multiples to sustain, but we see limited upside from current levels,” said the brokerage in a note last month.

Morgan Stanley has an underweight stance, highlighting that the consumer electronics volumes (TVs are the company’s largest segment) have been sluggish, despite new customer wins. Domestic lighting volumes continued to disappoint and exports are yet to see traction. What has offset this weakness are semi-automatic washing machines and mobile volumes.

Investors should await clarity on near-term demand/margins as well as further correction before considering the stocks.