Motilal Oswal identifies 5 stocks to ride the India EMS wave

Motilal Oswal Financial Services has come out with a list of five stocks that can help investors ride the wave of growth as India emerges as a derisking option to China in the manufacturing supply chains of American, Japanese and Korean companies. These companies have been forced to look for an alternative to China after China decided to flex its muscles on the international scene and started intimidating its smaller neighbors, including Japan, Philippines, Vietnam and Taiwan.

Motilal Oswal is only one of several brokers who have highlighted the EMS opportunity in India and come out with a list of stocks to ride this wave to prosperity. The first to do so was Morgan Stanley, nearly a month ago.

Unlike MS, the Indian brokerage firm has initiated coverage on five EMS stocks – Kaynes Technology, Avalon Technologies, Syrma SGS Technology, Cyient DLM and Data Patterns. It has placed a ‘buy’ rating on the first four stocks and assigned a ‘neutral’ rating for Data Patterns. These companies are gaining share driven by strong order flows, execution track record and presence across the value chain, noted the broker.

Overall, Motilal Oswal Financial Services is bullish on the growth prospects of the EMS industry in India. It believes the sector could soon replicate the success stories seen in IT, specialty chemicals, auto parts and textiles. However, investors need to watch out for downside risks such as supply chain disruptions, high working capital requirements and delay in order execution. The stocks are also trading at premium valuations currently.

Rapidly growing industry
The global EMS market was valued at around $880 billion in CY21. India formed a small part at just 2.2% share or $20 billion. However, the Indian EMS industry is expected to clock the fastest growth at 32% CAGR over CY21-26, the report said.

In comparison, the EMS industry in China, US, and South East Asia is forecast to grow at 5%, 4.4% and 6.7% respectively during this period.

The Indian EMS market is projected to reach Rs 6 trillion by FY27, up from just Rs 1.2 trillion in FY22. Its share in the global market will expand to 7% by CY26 from 2.2% in CY21.

“We strongly believe EMS to be a sunrise sector in India propelled by growing electronics market, government’s support, evolving electronics ecosystem and global shift such as China+1,” the Motilal Oswal report said.

Domestic drivers
Several factors will drive growth of the EMS industry in India. The country’s electronics market itself is expanding at a rapid pace at around 18% CAGR during FY21-26.

Government policies like the production linked incentive (PLI) scheme, electronics manufacturing clusters (EMC) scheme, and the Semiconductor Mission are giving a thrust to local manufacturing.

The report sees a clear shift happening from China to India because of the government push and low labour costs.

While China pays $35.5 per hour of labour, the rate is $10.48 in Vietnam and just $6 in India, it pointed out.

Execution the key
Motilal Oswal is betting on four EMS stocks to ride the industry tailwinds—Kaynes Technology, Avalon Technologies, Syrma SGS Technology and Cyient DLM.

The brokerage initiates coverage on these four stocks with a ‘buy’ rating as it believes they are well placed to gain market share and deliver robust earnings growth.

Strong order pipelines, healthy traction in end-user industries, improving profitability and execution track record make these stocks Motilal Oswal’s top picks in the EMS space.

However, the stocks are not without risk. Supply chain disruptions, delay in order execution and high working capital requirements could impede growth.

Kaynes Technology

Kaynes Technology is engaged in end-to-end and IoT-enabled integrated electronics manufacturing. It caters to automotive, industrial, aerospace, defense, outer space, nuclear, medical, railways, IoT and IT sectors.

The company has seen exponential growth in order books at 96% CAGR over FY20-23 across key verticals such as automotive and industrial. Automotive and industrial accounted for nearly 65% of its orders in FY23.

Kaynes is developing a niche across the value chain – design, prototyping, PCBAs and box builds. The company gets the bulk of its revenues from the high margin OEM-PCBA (62%) and OEM-Box Build (30%) segments.

Motilal Oswal sees Kaynes expanding margins as these high margin segments grow further. It is also backward integrating into bare PCB manufacturing and outsourced semiconductor assembly and test (OSAT) to boost profitability.

The brokerage forecasts Kaynes to deliver a strong 41%/46%/55% CAGR in revenues/EBITDA/PAT over FY23-26 driven by 32% CAGR in order book and improving profitability.

Motilal Oswal has initiated coverage on Kaynes Technology with a Buy rating and set a price target of Rs 3,100. The stock currently trades at Rs 2,669.

Avalon Technologies

Avalon Technologies is a vertically integrated EMS provider catering to clean energy, mobility, industrials, telecom and medical sectors. It has manufacturing facilities in India and the US.

The company has transformed into an end-to-end box build solutions provider over the years. Box builds accounted for 47% of its revenues in FY23 and their share is expected to increase further with recent order wins.

In FY23, Avalon generated around 76% of business from clean energy, mobility and industrials. Motilal Oswal expects the mix to tilt further towards high-growth clean energy and aerospace verticals which have longer life cycles.

It estimates Avalon to deliver 23%/27%/45% CAGR in revenues/EBITDA/PAT over FY23-26 led by 24% CAGR in order book.

Motilal Oswal is bullish on the growth prospects and has placed a Buy rating on Avalon Technologies with a price target of Rs 730. The stock is currently trading at Rs 529.

Syrma SGS Technology

Syrma SGS Technology provides engineering and design services to automotive, healthcare, consumer goods, industrial, IT and railways sectors.

The company has been delivering 33% revenue CAGR over FY20-23 backed by robust growth in consumer electronics and electric vehicles verticals.

Syrma’s order book stood at Rs 35 billion as of June 2022 quarter. Motilal Oswal expects the healthy pace of growth to continue given strong order book, increasing focus on exports and higher ODM products.

It forecasts Syrma SGS to register 37%/45%/42% CAGR in revenues/EBITDA/PAT over FY23-26.

Motilal Oswal is optimistic about the company’s prospects and has initiated coverage with a Buy rating and price target of Rs 775. Syrma SGS is currently trading at Rs 639.

Cyient DLM

Cyient DLM has over three decades of experience in electronics manufacturing with a focus on defense, aerospace, industrial and medical technology verticals.

The company’s order book has jumped nearly 64% CAGR over FY21-23 to Rs 24.3 billion in FY23. It is seeing continued traction in the medical technology and aerospace verticals which will boost growth.

Cyient DLM enjoys long-term relationships with marquee customers like Honeywell, Thales, ABB and Bharat Electronics. Its promoter Cyient brings rich domain expertise in design capabilities.

Motilal Oswal expects Cyient DLM’s revenues/EBITDA/PAT growing at 40%/46%/83% CAGR over FY23-26 led by healthy order book and flows.

It has initiated coverage on Cyient DLM with a Buy rating and set a price target of Rs 870 based on its strong growth outlook. The stock is now trading at Rs 687.

Data Patterns

Data Patterns is one of the fastest growing electronics solutions providers in the defense and aerospace verticals with expertise across land, air, sea and space.

But Motilal Oswal has initiated coverage on the stock with a ‘Neutral’ rating because of high working capital requirements.

It appreciates that Data Patterns has a strong track record (36% CAGR over FY19-23), large addressable market and capabilities across different domains.

The company is also ramping up investments in new product development and expanding manufacturing capacity. Its order book has been growing at a robust pace.

However, net working capital days stretched to a high 628 in FY23 which remains a concern. Motilal Oswal sees the company delivering a healthy 33%/37%/40% CAGR in revenues/EBITDA/PAT over FY23-26 though.

It has placed a Neutral rating on Data Patterns with a price target of Rs 2,270. The stock is currently trading at Rs 2,028.