Dixon, Kaynes Tech, Syrma SGS are poised for growth but beware rich valuations

The total addressable market (TAM) for Indian EMS players is likely to reach $221 billion by FY40, a 9% compounded annual growth from $51 billion in FY23, said Kotak Institutional Equities.

“Indian EMS service providers are well-positioned to benefit from structural growth drivers, but expensive valuations limit any meaningful plays in the sector," said the Kotak report dated 12 April.

From a valuation perspective, the current price-to-earnings multiple of most EMS companies, including Dixon Technologies, Kaynes Technology, Syrma SGS Technology, and Avalon Technologies, is higher than their five-year average PE ratios, showed Bloomberg data. This suggests that valuations are stretched.

Syrma's PE multiple is currently at 75, surpassing its five-year average of 67.48. Cyient DLM and Kaynes are trading at 77 and 110.13, comfortably above their averages of 82.9 and 103.6.

Dixon and Avalon's PE multiples are at 154.7 and 112, significantly higher than their five-year averages of 101.19 and 73.94.

Rich valuations to deter investment?

Analysts caution that valuation rerating may outpace fundamentals, tempering investor optimism. However, many fund managers remain comfortable with premium valuations, recognizing the sector’s robust growth potential.

What offers comfort to investors, is their historical growth trajectory, which has outpaced that of companies in other sectors such as consumer durables, said Amit Nigam, fund manager at Invesco MF. “Additionally, the expectation that these companies may continue to consistently deliver strong earnings growth justifies their premium valuations".

The Kotak report compares the Indian EMS industry to the US industry during 1995-2000, which saw a 72% revenue CAGR, 10% Ebitda margins, and mid-teens returns on capital.

US companies in the segment peaked at price-to-earnings multiples of around 60 times forward earnings. However, competition from Asian peers later slowed growth and reduced margins. Keeping that in mind, the brokerage believes sustaining margins and returns could be challenging for Indian players as the industry shifts to lower-cost locations.

Growth drivers

The Indian government has launched production-linked incentive (PLI) schemes for sectors including mobile, telecom, IT hardware, white goods, and semiconductors are crucial growth drivers for the EMS industry.

These incentives, along with reduced taxes, increased exports, and rising domestic demand for electronics, have brightened the sector’s outlook.

Also Read: The evolution of Indian manufacturing as an investment theme

India's EMS industry, comprising a modest 2-3% of the global EMS market, has gained prominence only in the last 6-7 years, said Paarth Gala, analyst at HDFC Securities.

He believes government initiatives, coupled with rising exports and robust local demand, could elevate India's share in the global EMS market to 7%. Currently, around 30% of India's total local consumption is imported, and Gala pointed out this figure is projected to fall below 10% by FY28.

The share price movement of companies like Dixon Technologies, Kaynes Technology, Syrma SGS Technology, Avalon Technologies, and Cyient DLM over the past year is reflective of the underlying momentum. Not just that, mutual fund inflows into these stocks also underline the investor interest in this space.

Shares of Syrma, Avalon, Dixon, Kaynes, and Cyient DLM have soared between 18% and 153% over the past year. Dixon led the pack with a 153% rise, followed by Cyient DLM at 145%, and Kaynes at 141%.

Also Read: Dixon is becoming India’s Foxconn

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

Dixon saw mutual fund inflows of ₹19 crore in January, ₹200 crore in February, and ₹133 crore in March, but witnessed an outflow of ₹128 crore in April. Cyient DLM and Avalon saw MF buying of ₹97 crore and ₹13 crore in April, respectively.

“Dixon can continue to do well as it could be a probable MSCI standard index entrant," Pagaria added.

How was Q4 for EMS players?

Dixon’s mobile and EMS segment revenue surged 2.2 times year-on-year, driven by the execution of contracts with new mobile clients, as per corporate commentary post the March quarter (Q4FY24) results. The return on capital employed for this segment rose to 59% in FY24, up from 31% in FY23.

Kaynes raised its EMS guidance to a compounded annual growth rate of 50-55% for the next two to three years. “High-growth EMS, the OSAT (outsourced semiconductor assembly and testing) and PCB (printed circuit board) projects should catapult Kaynes to a top line of about $1 billion-plus by FY28E, in our view," said Nuvama Institutional Equities analysts in a report dated 17 May.

Syrma reported highest ever quarterly sales of ₹1,149 crore in Q4, up 63% from the corresponding quarter in FY23. The management retained its FY25 revenue growth guidance of 40-45%.

Sustaining growth

With the EMS industry at an inflection point, Gala believes accelerated growth rates will sustain going ahead, which in turn will continue to support the current rich valuations.

Market experts said monitoring working capital management, competitive intensity, growth strategy, revenue visibility, tie-ups, efficiency, and execution will be critical moving forward. Any disruption in these areas could potentially unsettle investors.

Despite the sector’s re-rating, future growth hinges on continued revenue and profit growth coupled with margin expansion.

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