Mixed sentiment on EMS sector

The electronics manufacturing services (EMS) sector is one where Malaysian enterprises have built notable businesses, with a number of them listed on Bursa Malaysia. These companies get a fair bit of attention from investors and analysts due to their stable earnings and growth potential.

But it is a sector that has its fair share of challenges.

The EMS business involves manufacturing and assembling electrical and electronic products for brand owners. Due to its high labour requirements, some issues arose in the past.

A few years ago, ATA IMS Bhd lost a key client after allegations of bad labour practices surfaced.

Last year some consumer-focused EMS stocks were downgraded due to lowered sales projections from key customers.

And this year came the Cape EMS Bhd saga, involving a promising EMS player with superior margins that listed on Bursa Malaysia last March.

It not only failed to deliver on growth targets, the company’s major owner also saw the bulk of her shares being force-sold, leaving a bad taste with investors.

For fund managers like Tradeview Capital Sdn Bhd chief executive officer Ng Zhu Hann, this is why the EMS sector is a tricky one to invest in.

“The sentiment around the EMS sector is very low,” he says.

He says this is because of the series of events that hit the sector, beginning with ATA IMS’ labour issue in 2022, followed by brand owners such as Dyson moving some their EMS contracts to lower-cost countries such as Vietnam, right down to the latest saga involving Cape EMS.

But not all observers seem to think so.

Year-to-date, the two bellwether stocks in the EMS sector – VS Industry Bhd and SKP Resources Bhd – are up by around 40%, beating the FBM KCLI, which is up by 14%.

“The average year-to-date return for EMS counters is 33.6% if we exclude Cape EMS. We think the overall sentiment is still positive on the sector, but of course it boils down to the fundamentals of the respective companies,” says Danny Wong, the chief executive of Areca Capital Sdn Bhd.

Bloomberg data also shows there are mostly “buy” calls on EMS companies widely covered by analysts.

For example, all nine analysts covering SKP Resources have a “buy” rating on the stock, giving it a 12 month target price of RM1.35, indicating a 22% upside.

Still, one persistent challenge is the move by EMS clients to lower-cost markets such as Vietnam.

A good example is Dyson, the global consumer electronics brand that had previously been outsourcing a lot of its manufacturing to Malaysian EMS players.

“The consumer EMS sector’s overall reliance on Dyson-related orders is very much lower now. The competition is from other markets in South-East Asia which have much lower labour costs,” points out Loh Yan Jin, an analyst for Maybank Investment Bank Research.

Another challenge is slowing demand as some analysts had been pointing out since last year the cooling demand for consumer electronic products.

However, the quarterly results of some local EMS players this year have proven that demand is recovering.

Maybank’s Loh also points to a more recent development – manufacturers rushing to ship their products to the United States to avoid the possible imposition of fresh tariffs after the November US presidential election.

“US postal inventories have reached a record high in the past one year, but consumer spending has not caught up. A slowdown in consumer spending will definitely hit demand,” she says.

EMS firms that focus on industrial products opposed to consumer goods enjoy higher valuations and that valuation gap is likely to grow even bigger, points out Maybank’s Loh.

This is because of the higher entry barrier for industrial EMS, with more stringent technical know-how demanded from clients.

These firms normally deal with jobs related to complex industrial equipment, critical infrastructure, and specialised electronics used in sectors like telecommunications, automobiles and industrial automation.

In contrast, consumer EMS players are more susceptible to economic slowdowns which dictate consumer sentiment.

Loh also points out that consumer focused EMS players like VS Industry and SKP Resources have been trading below the average forward price-earnings multiple in the high teens in the past one year, whereas industrial-focused players such as PIE Industrial Bhd, Nationgate Holdings Bhd and Aurelius Technologies Bhd are trading well above that mean.

So can consumer-focused EMS players try to move into industrial products?

Some have made the attempt but face challenges due to the technical and other skill sets needed.

Tradeview’s Ng says, “The market has yet to see any notable results from this. It is not that straightforward, especially when the consumer EMS companies have specialised in their particular area for a long time. They have to repurpose production lines and retrain their workers,” he says.On a more positive note, Areca’s Wong adds: “The China+1 strategy continues to favour local EMS players as multinationals shift orders from China to Malaysia. Consequently, companies like Nationgate, PIE Industrial and EG Industries have experienced increased orders from both existing and new clients.

“Additionally, horizontal expansion through diversifying product offerings and customer base is proving crucial.

“For instance, EG Industries has boosted earnings by moving into higher-margin products like 5G optical modules, while Nationgate’s collaboration with Nvidia on the original equipment manufacturing of artificial intelligence servers has significantly contributed to its revenue and earnings growth in the second quarter of FY24.”

As for any impact on the sector caused by the occurrences at ATA IMS and Cape EMS, Maybank’s Loh says: “These are separate cases and are not sector-related issues. It does not really impact investor sentiment.”