NEW YORK & CHICAGO--(BUSINESS WIRE)--Three evolving trends have the potential to strengthen EMS companies' credit profiles over the long term, according to Fitch Ratings. These include electronification of everything, design collaboration with customers and internally across businesses and product agnostic strategies.
Momentum in these three areas would be significant because they address several key credit concerns for investors around the EMS sector - cyclicality, customer concentration and low margins.
As automobiles, glucose monitoring devices, washing machines and other non-traditional products add electronic content, the addressable market for electronics manufacturing rises. These products often involve longer lifecycles, helping to reduce the volatility associated with handsets, PCs, servers and other traditional electronics products. EMS providers are often able to extract higher margins from non-traditional products due to the increased complexity required to manufacture them.
Revenue diversification improves from exposure to new end markets (aerospace & defense, medical, auto, industrial and retail) and from the increase in the number of products and programs. Industries such as medical and A&D bring unique regulatory, compliance and geographic location requirements that increase already steep barriers to entry for larger players.
Traditional EMS services involve manufacturing, assembly, distribution and repair of electronics for technology original equipment manufacturers (OEMs). Today, EMS providers invest in design capabilities, adding engineers and sleek Silicon Valley innovation centers, where cutting-edge technologies are on display for customers, and capabilities are shared across business units.
Larger EMS providers with diverse industry exposure have a greater opportunity to leverage technologies across seemingly unrelated end-products (e.g. cell phone camera technology used to create a less stressful feeding tube for patients), bringing a level of design capability that customers would not have on their own. Embedding themselves into the design process elevates EMS providers from contract manufacturer to strategic partner. This deeper engagement model provides an opportunity for long-term margin enhancement and stickier customer relationships.
EMS providers are finding that their manufacturing and supply chain expertise can be leveraged to any product, even ones without any electronic componentry (hence Flextronics dropping the "tronics" from its name). This expanded addressable market is largely due to increasingly sophisticated manufacturing capabilities and data capture, opening the door for EMS providers to accelerate time to market and reduce cost for virtually any product company in the world.
For example, Flex's engagement with Nike involves sneakers with no electronic content. Flex's value proposition with Nike is based on: time to market - setting a record for the fastest new Nike factory ramp of 150 days from start to first ship; manufacturing capability - complex weaving design; and regionalization and customization. Leading with innovation and prioritizing deeper engagements with blue chip customers irrespective of the underlying product's electronic content should help reduce customer concentration and provide high-quality revenue streams.
Fitch believes that the largest, most reputable EMS providers with capabilities across a variety of traditional and non-traditional industries are primed to benefit from higher growth and margins, reduced cyclicality and lower customer concentration over the long term. Fitch publicly rates two of these companies - Flextronics International, Ltd. (rated 'BBB-'/Positive by Fitch) and Jabil Circuit, Inc. (rated 'BBB-'/Stable by Fitch). We expect the effect of these trends on Flex and Jabil's financials to be gradual given the measured pace of adoption of EMS services by non-traditional customers. However, with their massive scale, a small change in margins can have a vast impact on FCF.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
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