Dixon, KeynesTech, Silma SGS poised for growth, but beware of overvaluation

According to Kotak Institutional Equities, the total addressable market (TAM) for EMS operators in India is expected to reach $221 billion by FY2040, growing at an annual rate of 9% from $51 billion in FY23.

“Indian EMS service providers are well positioned to benefit from structural growth drivers, but high valuations are limiting meaningful investment in the sector,” said an April 12 Kotak report.

From a valuation perspective, most EMS companies, including Dixon Technologies, Kaynes Technology, Silma SGS Technology and Avalon Technologies, currently have higher price-to-earnings multiples than their five-year average price-to-earnings multiples, according to Bloomberg data, suggesting they are overvalued.

Syrma's price-to-earnings ratio is currently 73.88, above its five-year average of 67.47. Cyent DLM and Cain's are trading at 78.3 and 110.23, respectively, well above their averages of 82.97 and 103.64, respectively.

Dixon and Avalon's price-to-earnings ratios (PEs) of 151.21 and 113.0, respectively, are significantly higher than their five-year averages of 101.18 and 73.95.

High valuations deterring investment?

Analysts have warned that a repricing of valuations could outpace fundamentals and dampen investor optimism, but many fund managers are comfortable with premium valuations as they see robust growth potential in the sector.

What's comforting to investors is the company's historical growth trajectory, which has outpaced companies in other sectors such as consumer durables, said Amit Nigam, a fund manager at Invesco MF. “Furthermore, the expectation that these companies will continue to deliver consistently high earnings growth justifies the company's premium valuation.”

The Kotak report compares the Indian EMS industry with the US industry from 1995 to 2000. The US industry had a revenue CAGR of 72%, EBITDA margins of 10% and return on capital in the mid-teens.

Price-to-earnings multiples for US companies in the sector peaked at around 60 times forward earnings. But competition from Asian peers has since slowed growth and pushed margins down. With this in mind, the brokerage believes that maintaining margins and revenues may be tough for Indian companies as the industry shifts to lower-cost locations.

Drivers of growth

The Indian government has introduced Production Linked Incentive (PLI) schemes for sectors such as mobile, telecom, IT hardware, white goods and semiconductors, which are key growth drivers for the EMS industry.

These incentives, combined with tax cuts, rising exports and growing domestic demand for electronics, are brightening the sector's prospects.

Parth Gala, an analyst at HDFC Securities, said the Indian EMS industry accounts for just 2-3% of the global EMS market and has only begun to gain traction in the last six-seven years.

He believes that a combination of government initiatives, growing exports and robust domestic demand could help India's share of the global EMS market rise to 7%. Currently, imports account for about 30% of India's total domestic consumption, but Gala noted that this figure is projected to fall below 10% by FY28.

The share price movements of companies like Dixon Technologies, Kaynes Technology, Syrma SGS Technology, Avalon Technologies, and Cyient DLM over the past year reflect the underlying momentum. Not only that, mutual fund inflows into these stocks also highlight investor interest in the sector.

Dixon Technologies stock price now ₹9,268 each, up slightly from the previous day's close on the National Stock Exchange. KeynesTech and Silma SGS were down slightly. ₹3,256, and ₹Avalon Technology fell 1.3%. ₹481.

According to data compiled by Abhilash Pagaria, head of Nuvama Alternative and Quantitative Research, Cyient DLM has enjoyed inflows from mutual funds for four consecutive months since January 2024. Avalon Technologies has been attracting investments for the past five months. Dixon Technologies has seen steady inflows for three consecutive months since January, but some schemes booked profits in April, he explained.

Dixon is seeing an influx of mutual funds. ₹190 crore in January, ₹200 crore in February, Rs. ₹13.3 billion in March, while it declined by Rs. ₹12,800 crore in April. Cyient DLM and Avalon made MF purchases. ₹97 billion and Rs. ₹130 crore respectively in April.

“Dixon is likely to continue to perform well as it is likely to be included in the MSCI standard index,” Pagaglia added.

How did Q4 go for EMS players?

Dixon's mobile and EMS division's revenue surged 2.2 times year-on-year due to the signing of new mobile customers, according to company comments after announcing its March quarter (4QFY24) results. The division's return on invested capital rose to 59% in FY24 from 31% in FY23.

Kaynes has raised its EMS compound annual growth rate to 50% to 55% over the next two to three years. “We expect Kaynes to exceed approximately $1 billion in revenue by FY28, driven by high-growth EMS, OSAT (outsourced semiconductor assembly and test) and PCB (printed circuit board) projects,” analysts at Nuvama Institutional Equities said in a May 17 report.

Silma reported its highest quarterly sales ever. ₹Fourth quarter sales were Rs 1,149 crore, up 63% from the same quarter in FY23. Management maintained its FY25 sales growth guidance of 40-45%.

Sustainable growth

As the EMS industry reaches an inflection point, Gala believes the accelerated growth rate will continue to support its current strong valuation.

Market experts said that working capital management, competitive intensity, growth strategies, revenue visibility, collaborations, efficiency and execution will be key to monitor going forward as any disruption in these areas could spook investors.

Despite the sector re-rating, future growth will depend on continued revenue and profit growth, as well as margin expansion.