Hi!
Some informal reflection:
Compared to the realized return on capital, organic growth, and M&A opportunities, I consider those historical valuation multiples to be low. In my opinion, this is also reflected in the long-term stock returns of the companies, which have been amazing, especially for Note, Incap, and Kitron.
I’ve been mulling over the following possible explanations:
- The market has constantly priced in a high risk that hasn’t happened to materialize.
- Growth and profitability have consistently surprised to the upside, meaning the market has continuously priced in slowing growth and/or weakening profitability.
In my view, the risk level doesn’t justify such low multiples and high required rates of return. Factors that come to mind as increasing the investor’s required return:
- Poor visibility into the end product and thus the demand drivers, which makes understanding and forecasting the business difficult.
- The resilience of an electronics contract manufacturer in a sharper recession is a question mark.
Your screenshots also match my perception that current valuations are slightly above the longer-term average, but not significantly (adjusting for the post-Covid boom).
How does the present differ from the past? The short-term organic growth outlook is more challenging looking at those 12-month revenue growth forecasts. Incap’s growth is based on a weak comparison period and an acquisition, and I assume Hanza’s growth also includes an acquisition.
Source: Bloomberg
There are still plenty of M&A opportunities in the market, but there are also many listed contract manufacturers operating with an active M&A strategy, which should limit the value creation potential of acquisitions. On the other hand, this has been true for some time, yet good acquisition targets still seem to have been found.
Profitability levels fluctuate with volume, and if organic growth continues at the 0–5% level, I don’t expect major changes in profitability compared to history.
Thus, the sector’s multiples still seem attractive to me, considering the drivers supporting long-term demand. I recall the reasons for the chronically low valuation levels being speculated upon in extensive reports, and the industry’s poor reputation has been one factor that has come up.
Compared to Elcoteq, which went bankrupt in the 2000s, the customer structures of Nordic contract manufacturers are clearly more diversified, which limits the companies’ risk profiles. Additionally, these companies focus more on industrial electronics (Elcoteq was consumer electronics). Perhaps the Elcoteq case, among others, has left some scars on investors.
Antti is on vacation this week and he knows the sector significantly more deeply than I do. He will certainly be happy to comment on the topic when he returns. 