How Will The European Debt Crises Affect The EMS And The Connector Industry? How Will Manufacturing Trend As The World Moves Toward More Electronics Consumption?

Wall Street Transcript

67 WALL STREET, New York - July 10, 2012 - The Wall Street Transcript has just published its Electronic Components Report offering a timely review of the sector to serious investors and industry executives. This special report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online.

Topics covered: Electronics Manufacturing Supply Chain - Secular Connector Demand Growth - Automotive, Data Center and Mobile Spending - Component Price Erosion

Companies include: AVX Corp. (AVX); Arrow Electronics (ARW); RELM Wireless Corporation (RWC); T-Mobile (DTE.DE); Amphenol (APH); Anixter International (AXE); Apple (AAPL); Avnet (AVT); Belden (BDC); Celestica (CLS); Flextronics (FLEX); Jabil Circuit (JBL); Molex (MOLX); Multi-Fineline Electronix (MFLX); NetApp (NTAP); Plexus (PLXS); Research in Motion (RIMM); Sensata (ST); TE (TEL); TTM Technologies (TTMI) and many more.

In the following brief excerpt from the Electronic Components report, an expert industry analyst discusses the outlook for the sector and for investors.

Amit Daryanani, CFA, is a Research Analyst at RBC Capital Markets, covering electronic equipment manufacturers and electronic manufacturing services companies. He holds a B.S. in chemical engineering and an MBA from Northeastern University in Boston, Mass.

TWST: You mentioned the crisis in Europe. How specifically does the European crisis impact this sector?

Mr. Daryanani: In terms of the connector companies, the correlation is fairly straightforward. Companies like TE Connectivity (TEL) and Sensata (ST) have somewhere close to a third of their revenues coming directly out of Europe. So to the extent that demand starts to slow down over there due to the macro situation, you would not only see the demand headwind, but you also will end up having some translation impact as well for these companies. For the connector companies, those two are the ones with highest exposure, TEL and Sensata, on a demand and FX basis.

On the EMS companies, they don't have a whole lot of direct exposure than the manufacturing footprint in Europe. Their headwinds will come from the fact that their customers, which are the Ciscos (CSCO) and EMCs (EMC) and IBMs (IBM) of the world, typically tend to get about 30% of their revenues from Europe. So as their revenue shrinks due to lessening demand in Europe, so goes the demand for EMS companies.

TWST: Let's talk about connectors for a minute. Who do you like in that subsector and why?

Mr. Daryanani: The name that we like a lot in this space is Amphenol (APH), and their story is that for about the last decade, they had been able to do 11% revenue growth, 18% EPS growth on a fairly consistent basis. The way they get to that 11% revenue growth is about 7.5 points is organic growth, four points or so is acquisition driven. Our belief is they can sustainably do that dynamic which is 11% sales, 18% EPS for the next 10 years as well. And to the extent they can execute on that potential, we think the multiple will work back to the 18, 19 range which should put their stock in the $67, $68 range versus trading at $57 today. So that's the name in the connector space really broadly in the tech supply chain space that we like.

TWST: Any other company you like?

Mr. Daryanani: TEL, TE Connectivity, is probably the other name that I think is a fairly attractive value play. They are a three to five year proposition, and they are sustainably doing about seven points of revenue, 13 to 14 points of EPS growth, and you get a 2% dividend yield as well with that. What's interesting is the way they get to that seven point revenue growth - this 2% growth from overall production going higher, but five points of that really comes from increasing content. So the basic belief that almost everything is using more electricity than it used to, so the vast majority of products will have a whole lot more electronics in the future than what they have today. So to the extent that story continues to work in that 7% sales, 13%, 14% EPS growth, I'd argue the multiple will start to improve from 10 times to hopefully 13, 14. And in that scenario, stock would go from $33 today to north of $45 over the next six to 12 months.

Another thing that is going to be a good catalyst for TEL is that their buyback has been paused for the last six months or so, but I believe they will restart the buyback program starting with the September quarter, and they could target about a $13 buybacks annually, but should give that 7% of the market cap. So I think that should be a very good catalyst that could help offset some of the Europe-centric headwinds should Europe get worse than the 7% declines that we are modeling for right now.

TWST: What are the major positives happening for the components?

Mr. Daryanani: Yes, the positive in the EMS space right now is the nontech companies, the industrials, the health care companies, the aerospace companies strongly look at outsourcing as a more real solution now, and I think that largely reflects the fact that manufacturing is truly not a core competency for any of those verticals for the most part. So that is going to become a big growth driver for a lot of these companies.

The question will be, which one of the six existing EMS companies can be successful in it, and at least our analysis would suggest it's Jabil (JBL) and Plexus (PLXS) are the two that should end up being more successful versus the other four. That to me is probably the one positive theme.The other part is, the industry navigator has gone through about 10 years of restructuring since the dot-com buzz. I think the manufacturing footprints and the cost structures are much better aligned today than that has been historically.

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