Sector Snapshot
Sector Snapshot
Contract Manufacturing Evolution
| Introduction |
 Multicellular organisms, composed
of eukaryotic cells specialized to perform particular functions, evolved
comparatively recently -- only about 750 million years ago. Similarly,
specialization in the business world has come about relatively recently as
well, manifesting itself in an outsourcing boom that has dramatically altered
the business landscape in the last decade.
Bum-bum-buh daah dum. Bum-bum-buh daah dum dee-dum-dum. As the "Wild Kingdom" music begins to fade one is left to ponder, all banal survival-of-the-fittest analogies aside, are these developments born of necessity? Is the business world in the throes of a natural evolutionary process engendered by a competitive environment? Well, the verdict may not be in on that, so instead let's turn our eyes toward a particular group of these "mutations." Contract manufacturers in the electronics industry stand at the top of the manufacturing hierarchy, employing cutting-edge manufacturing processes and technology. This dominant position among manufacturers has come about for a number of reasons. First of all, contract manufacturers of electronic components have proliferated largely due to their high-tech, glamorous nature (insuring that their genes will be passed on). Every country favors start-up electronics plants; likewise, they can be located, or relocated, almost anywhere. Being light in weight, electronics can be shipped anywhere on the globe without punitive transportation costs. In addition, extreme competition has forced this segment of the industry to be highly customer focused. Hence, contract manufacturers in the electronics arena rate highest in almost all the major qualitative manufacturing indices. Some have called it "vertical disintegration," but whatever you call it, many hi-tech companies have found that they can cut costs, gain flexibility, and respond more quickly to changes in the market by employing contract manufacturers. With names like Sun Microsystems, Cisco Systems and Cascade Communications among the converted, there seems to be no need to proselytize. Contract manufacturers in the U.S. and Canada are slated to do $25 billion in business this year, while worldwide revenues are forecast to top $59 billion. These manufacturers continue to pull in new business, growing 30% a year since 1992, with growth of 26% a year expected until 1999. Will in-house operators be able to keep pace with these specialized manufacturing powerhouses? There is ample precedent to conclude that they can't, however, you be the judge. Initially, contract manufacturers confined themselves almost exclusively to production of printed circuit boards. The next step came with the assembly of these boards and the addition of components. The process has now accelerated with customers outsourcing an increasing number of production steps. More and more contract manufacturers are making finished products and there is talk that system assembly will soon become the norm. Computer giant Hewlett-Packard plans to reduce its in-house production from 90% of systems value, down to 65% by 1999. In an attempt to realize these goals HP has sold a number of its plants to contract manufacturers, confident that their vision of the outsourcing landscape will come to pass. There are contrary voices, however -- Cabletron Systems currently manufactures printed circuit boards in-house that cost 10%-15% less than contract manufacturers they have benchmarked against. This, according to John Caruso, Director of Manufacturing for Cabletron, is largely a function of the company's significant capital investment in production and test equipment. The fundamental difference between the two views springs from point of entry. Many of the new electronics companies today start with no investment in manufacturing. This development is more important with respect to future trends in the industry than the positions taken by entrenched companies that have already made weighty capital commitments to manufacturing. Investors interested in the industry must be aware that many of the companies derive large portions of their revenue from significant individual customer contracts, which make them prone to dramatic revenue swings. In addition their operations are asset intensive, especially manufacturers that provide the raw materials necessary for product assembly, and margins can be narrow on many products. All these factors combine to create a volatile earnings setting that can turn very bleak, very quickly. If the 80's was the decade of "quality" in manufacturing, the 90's is shaping up to be the decade of value. Raising customers perception of a product's worth vis-a-vis its price will entail operations that are highly responsive to a changing market. Product cycles are getting shorter and shorter, and manufacturing operations tailored toward rapid ramp-ups will have a natural advantage. Transmitted: 9/27/96 5:54 PM (conman) |
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Definitions
Cash/Share: A measure of how much cash per share a company currently has. Current: The Current Ratio is a measure of liquidity. You just take the Current Assets and divide by the Current Liabilities. Ideally, this is 1.0 or greater in financially strong companies. DSO: Days Sales Outstanding measures the company's control on receivables. A company whose DSO is 50 takes 50 days to collect accounts receivable. Smaller numbers mean the company can use that money---a good thing. The figures herein use fiscal year receivable figures. EV/SR: The Enterprise Value/Sales Ratio is a better indicator than the PSR of the true value of a company. Where the PSR uses the company's market cap for the numerator, EV/SR looks at the Enterprise value. Both ratios use the denominator of trailing revenues. To get the company's enterprise value take the market cap (share price times shares outstanding), add the long term debt, and then subtract the cash and cash equivalents. GM: Gross margin, a measure of what percentage of each dollar of sales they get to keep after paying for the costs of manufacturing it. Market Cap = Market Capitalization. This is the number of shares outstanding times the current share price. Essentially, this is what the company is currently on sale for -- or at least what someone who acquired the company would have to pay. PEG: Price/Earnings Ratio over earnings per share (EPS) Growth Rate. This is a Foolish valuation that is also known as the Fool Ratio. It is detailed in our PEG area in Stock Research (Fool Main Screen --> Stock Research --> The Fool Ratio). Essentially, this is a short-hand for how underpriced or overpriced a stock is given the assumption that the Price/Earnings ratio should equal the rate of EPS growth. P/E: The Price/Earnings Ratio, this essentially gives you a ratio of how much you are paying for a dollar of earnings, allowing you to compare a stock to its peers on an apples to apples basis. PSR or P/S: The Price/Sales Ratio, this is dervived from dividing the last four quarters trailing revenues by the current market capitalization of the company. This gives a guide to how a company is valued relative to its peers when it does not have earnings to currently compare. PM: Profit margin, a meaure of what percentage of each dollar of sales a company gets to keep after paying for everything. RS: Relative Strength, a measure of how well the stock has performed relative to the market over the past two years. Scored on a scale of 1 to 99 with 99 being the best. Surprise: This ratio represents the latest quarter's EPS divided by the EPS that had been estimated. So, a 6% surprise simply means that EPS were 6% greater than expectations. WC/MC: Working capital is the difference between current assets and current liabilities. This is a measure of what percentage of the market cap is currently found in the working capital, signaling value. (WC-I)/MMC: Working Capital minus the Inventory divided by the Modified Market Cap. (Modified Market Cap. is the Market Cap. plus the company's long-term debt.) This ratio measures the working capital that's not tied up in inventory relative to its current market value. This is a measure of the working capital that can be used to growing the business. The inventory is subtracted from the working capital because in this industry the liquidation value of the inventory is lower than what the FIFO or LIFO value would indicate. YPEG: The Year-ahead PEG, this guy is also detailed in our PEG area in Stock Research (Fool Main Screen --> Stock Research --> The Fool Ratio). Essentially, this is a short-hand for how underpriced or overpriced a stock is given the assumption that the Price/Earnings ratio should equal the estimated long-term growth rate. |
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Inventory Turnover
Inventory Turnover Richard Schonberger, author of a series of books all under the heading World Class Manufacturing, argues persuasively that inventory turnover has been an accurate metric for telling the manufacturing story in the past and will continue to do so in the future. Charting industrial decline and ascendancy Schonberger states that manufacturing performance in the last half of this century has taken the shape of a V-curve. It declined for twenty five years and has been rising ever since. He argues that this twenty-five down, twenty-five up phenomenon is a global one, with variations by region. For instance, the bottom of the V occurred for Japan in the mid-60's. Their turnaround was sparked by Deming's total quality control and the blossoming of the Toyota system. Firmly entrenched players in the U.S. knew they were in trouble by the mid-seventies, with European manufacturers feeling the pain a decade later. Thereafter, all implemented the necessary changes to stem the tide of decline. Schonberger contends that historical charts of sales and market share as well as financial ratios of profitability like return on investment do not exhibit this V pattern. The metric that is consistent with the historical reality of manufacturing is inventory turnover. Schonberger cites a pattern of declining inventory turnovers that went hand-in-hand with manufacturing's precipitous decline, as well as the subsequent increases that marked manufacturing's return to health. Specific examples abound, Ford, Emerson Electric, Motorola, Whirpool, Eaton, Du Pont, Eastman Kodak, Cummins Engine's, Johnson & Johnson, and IBM, just to name a few that Schonberger discusses. Why could this ratio be so valuable in understanding manufacturing performance? Let's take a look. To sell products a manufacturer must carry stock on hand, ready to deliver to customers. This stock, or goods being held for sale, is inventory. Inventory is recorded at cost on the Balance Sheet. When a sale is made cash is debited and sales is credited, both accounts increase in value. Making sales also causes Inventory to appear on the Balance Sheet, however it is not connected to the Sales Revenue account, but rather with the Cost of Goods sold expense. When a company buys or makes products its Inventory account is increased by the cost of the goods, not the sales value. This cost is kept in the Inventory asset account until the items are sold and delivered to customers when sales are made. At this time the cost is removed from the asset and charged to the Cost of Goods Expense account. The inventory balance is then the cost of products awaiting sale. Some of the companies goods may move rapidly out of inventory, while others may stay parked for extended periods. The company's average inventory is a measure of the average holding period for its mix of goods. The first step in arriving at a meaningful determination of a company's inventory turnover is the Inventory Turnover Ratio. This is determined by dividing:
Cost of Goods Sold Expense The result of this figure divided into 52 weeks gives an expression of the number of weeks worth of goods that are in inventory. This number multiplied by 7 (for the number of days in the week) will give a days figure. Just like the number of weeks figure, the number of days figure tells how many days of sales the company has in inventory. As mentioned previously, these figures show the number of weeks or days of costs of goods sold, not the weeks or days of sales revenue. Inventory turnover declines when the company manages its processes poorly and wastes in the form of inventory pile up. This is always a balancing act, the average inventory holding period should not be too high, for in this case too much capital is being tied up and capital has a high cost. Conversely, the holding period should not be too short for the result would be stock-outs, representing profit opportunities that are lost as a result of not having enough products ready for sale. Low turnover ratios mean that a lot of products are languishing in Inventory, tying up much needed capital. This is the mark of a poorly managed, financially distressed company. High turnover ratios indicate a company poised for growth. Transmitted: 9/26/96 3:48 PM (conschon) |
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Altron Incorporated
The Business Altron provides total design and manufacturing capability for interconnect products used in advanced electronic equipment. The company makes products in the mid-volume sector of the electronics interconnect industry, such as multi-layer high density printed circuit boards, custom designed backplates, and surface mount assemblies. Altron's OEM customers include a diversified base of manufacturers in the telecommunications, data communications, computer, industrial and medical segments of the electronics industry. Financial Information & Recent Developments Altron's second quarter ended June 29 yielded $44.3 million in sales, compared to $34.7 million for the previous year's quarter. Net income was $9,425,000, or $0.59 a share. This is a 33% increase over the previous year's net income of $6,304,000, or $0.46 a share. Altron's shares have faltered recently after their report to industry analysts at the beginning of the month warning of a slowdown in orders from some of its computer and semiconductor customers that have higher than expected inventories of Altron's products. Most industry watchers feel that this is a short term concern for the company. Transmitted: 9/27/96 6:04 PM (alrn0927) |
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Flextronics International Ltd.
The Business Flextronics offers printed circuit boards, multi-chip module design, materials procurement and management, advanced packaging fabrication, PCB assembly, final system build, distribution, and warranty repair. The company has facilities in North America, Asia, and Europe. Financial Information & Recent Developments During the end of fiscal year 1996, ended March 31 the company closed its Shekou facility in China, as well as a factory in Malaysia. The continuing operations of these facilities were moved primarily to the company's new 90,000 square foot facility in Xixiang, China. In February the company opened its third manufacturing facility in Silicon Valley and a sales and support office in Eidhoven, Netherlands. The new manufacturing facility in San Jose was opened to provide support for OEM's located in the Silicon Valley area. During the quarter the company also concluded its acquisition of Astron Group, a manufacturer of miniature gold-finished printed circuit boards, with facilities in Hong Kong and Doumen, China. In the first quarter ended June 30 FLEX reported $118.27 million in sales with net earnings of $4,954,000, or $0.35 per share. Transmitted: 9/27/96 7:22 PM (flex0927) |
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Jabil Circuits, Inc.
The Business Jabil Circuit is a designer and manufacturer of electronic circuit boards and systems for original equipment manufacturers in the international personal computer, computer peripheral, communications, and automotive markets. Jabil offers circuit design, board design from schematic, prototype assembly, volume board assembly and system assembly services. The company has automated manufacturing facilities in Florida, Michigan, California, Scotland, and Malaysia. Financial Information Jabil's credibility was hammered during the tech sell-off in January. Investors fleeing the sector were given fuel for the emotional fire in the form of Jabil's announcement that one of its major clients was withdrawing a portion of its business. Since then the stock has fought back into the teens by beating estimates. Transmitted: 9/27/96 6:39 PM (jbil0927) |
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Sanmina Corporation
The Business Sanmina is a provider of integrated manufacturing services to OEM's in the electronics industry. Sanmina's electronic assembly services primarily involve the manufacture of complex printed circuit board assemblies using surface mounting (SMT) and pin-through-hole interconnection technologies (PTH). The key ingredient in Sanmina's recipe for success is vertical integration. In addition to manufacturing and building multi-layer printed circuit boards, the company assembles chips and other components on those boards. Focusing on high-end quick-turn products Sanmina boasts "the more complex the job, the better." Acquisition News On September 26 Sanmina agreed in principle to acquire most of Lucent Technologies Inc.'s custom manufacturing operation assets in Greensboro N.C. The factory makes wide area network switches, integrated circuit testers, video-conferencing equipment and high-security phones and modems. Most of the equipment will be relocated to Sanmina's Raleigh, N.C. facility. On September 20, Sanmina announced that it had entered into an agreement to purchase all of the assets of Comptronix Corporation, which had filed for bankrupcy protection back in August. Through a financial formula which determines the price of fixed assets, inventory and accounts receivable, a final figure of $20 to $22 million was churned out. However, the final purchase price will be determined by asset totals at the time of closing. The assets include Comptronix's plant and equipment located in Guntersville, Alabama as well as its operations in Guaymas, Mexico. The completion of the transaction is subject to fulfillment of "due diligence" by Sanmina, in addition to bankrupcy court approval and completion of the "pre-transaction notification process" required by Hart-Scott-Rodino. The company promises that all of these hurdles will be surmounted, but it chooses to remain mum until they are. Financial Information Sanmina went public in November of 1993, selling 2.5 million shares at $22 a share. During the company's IPO investors were told that the company hoped to grow at 18% the first year. Instead, the growth was 33% and Randy Furr, Sanmina's CFO, recently reported that the company hopes to grow it business 22% by the end of this year. Transmitted: 9/27/96 4:58 PM (sanm0927) |
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SCI Systems, Inc.
The Business SCI Systems is the world's largest electronics contract manufacturer. SCI builds computers and hundreds of other electronic products and parts for a long list of mostly anonymous customers. The company runs one of the world's largest surface mount technology operations (SMT fixes components to both sides of a circuit board). The company designs, manufactures, markets, distributes, and services electronic products for the computer, aerospace, defense, telecommunication, medical, and entertainment industries. SCI conducts its operational activities through a Commercial Division and a Government Division. Although the company derives a majority of its revenues from hardware manufacturing, it is primarily a vertically integrated engineering and manufacturing services provider. The company has plants in Canada, France, Hong Kong, Ireland, Mexico, Scotland, Singapore, Thailand, and the US. Financial Information & Recent Developments Sales for the third quarter of fiscal year 1996 increased 88% to 1.113 billion form $591 million in the previous year's quarter. Similarly, the first 9 months of 1996 yielded sales of $3.193 billion compared with $1.831 billion for fiscal year 1995's corresponding quarter. Results for the year ended June 30 boosted totals for the year to record heights. Sales for the year were $4,545 billion, a 59% improvement over the previous year. Transmitted: 9/27/96 5:28 PM (scis0927) |
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Smart Modular Technologies
The Business Smart Modular is an independent manufacturer of specialty memory modules, standard memory modules, embedded processor modules and PC Cards with memory and communications functionality. SMOD offers over 400 products to OEM's and distribution channels in the computer, networking and telecommunications industries. SMOD has manufacturing facilities in the U.S., India, and Puerto Rico. Financial Information & Recent Developments On September 11, SMOD announced plans to open a manufacturing facility in East Kilbride, Scotland. SMOD hopes to have the facility up and running by November and will initially manufacture approximately 75% of its product offerings there. The European marketplace represents 32.7% of the worldwide marketplace for DRAM SIMMs. SMOD hopes to capitalize on the tripling in the number of personal computers estimated to be manufactured in Europe by the year 2000. Results for the third quarter ended July 31 included net sales of $101 million, compared to $70.6 million for the third quarter of the previous year, an increase of 43%. Net income for the first nine months of fiscal 1996 was $18 million, or $0.87 per share compared to $7.7 million or $0.44 per share for the same period in 1995, representing an increase of 98%. Transmitted: 9/27/96 7:02 PM (smod0927) |
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Solectron Corporation
The Business Solectron's sales are derived from supplying customized manufacturing services to original equipment manufacturers in the electronics industry. The company's primary services include materials procurement, materials management, and the manufacture of printed circuit board assemblies. Other manufacturing services include system assembly, flexible cable asssembly, disk duplication and packaging. The pre-manufacturing services that the company provides include consultation on product design and manufacturability. Post-manufacturing services such as repair, refurbishment and upgrades are also extended to customers. In its manufacturing services Solectron offers both turnkey and consignment options. In the first case the company provides the materials necessary for product assembly, while consignment allows the customer to secure the needed inputs. Solectron has three manufacturing operations in the U.S., two in Europe, and one in Malaysia. At the end of 1995 Solectron executed definitive agreements with Hewlett Packard GmbH (HP's German subsidiary) to acquire HP's printed circuit board assembly operation in Boeblingen, Germany. The company competes within the electronics manufacturing services (EMS) segment of the electronics industry, a segment that has been growing at a faster rate than the overall industry to which it's attached. In addition, companies evaluate the services provided by Solectron in comparison to the estimated costs of manufacturing the products themselves. Along with many others in the industry, Solectron feels that its primary competitve focus should be on quality, responsiveness, value-added services and the development of cutting edge manufacturing technology. It is in this fashion that Solectron hopes to capitalize on the outsourcing trend that has experienced accelerated growth over the last couple of years. Solectron is highly visible within its industry due to an extremely rigorous customer service focus, which entails weekly customer appraisals of Solectron's performance. This constant feedback contributes greatly to their responsiveness, problems and concerns do not go unchecked for long. Financial Information & Recent Developments Outsourcing by OEM's greatly improved Solectron's bottom line in 1995. Net income was a record $79.5 million, which represented a 43% increase over prior year's net. Recently reported net income for fiscal year 1996 was a well received $114.2 million. Solectron recently announced that it will acquire Force Computers Inc., an electronics manufacturer, for about $187.5 million. Force will become a subsidiary of Solectron, contributing greatly to SLR's manufacturing capability. Transmitted: 9/27/96 5:36 PM (slr0927) |
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Zycon Corporation
The Business Zycon's strategy as a contract manufacturer of printed circuit boards and other electronics equipment is to capitalize upon its significant capital expenditures on modern facilities and equipment. Since April 1988, Zycon has invested over $95 million in these two areas, and as a result hopes to accomodate incresing domestic capacity up to the $300 million level. In addition to its corporate headquarters and manufacturing facilities located in Santa Clara, California, Zycon is building an advanced printed circuit board manufacturing facility in East Malaysia. Zycon hopes to be shipping products from this facility by the end of the year. To minimize the financial impact of adverse market conditions affecting any one customer or sector Zycon has sought to diversify its customer base. In 1995 Zycon manufactured printed circuit boards for nearly 150 customers. Financial Information & Recent Developments In the first quarter of 1996 the Company had net income of $3.9 million, or $0.35 per share. This represented a 456% increase in net income on a 44% in revenues over the same quarter in 1995. As is evident from the numbers, the surge was due to a gross profit margin increase of almost nine percentage points. The company attributed the increase to a spreading of fixed costs over a large sales base and a trend toward higher margin circuit board products. For the six months ended June 30 sales were $103.47 million and net income was $5.5 million, or $0.50 a share. This compares favorable with the previous year's 6 months of $0.26 a share. Transmitted: 9/27/96 5:16 PM (zcon0927) |
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Financial Rations
Contract Manufacturing Ticker PEG YPEG PSR Inv.T DSO Csh/S Altron ALRN 0.85 0.54 1.18 7.29 36 16% Flextronics FLEXF 0.70 0.47 0.78 9.81 64 1% Jabil Circuits JBIL NA 1.40 0.29 7.14 31 3% Sanmina SANM 1.33 1.23 3.09 8.64 42 17% SCI Systems SCIS 1.08 0.98 0.45 6.03 23 1% Smart Modular Technologies SMOD 0.92 0.56 1.50 7.62 28 7% Solectron SLR 0.91 0.60 0.97 7.02 37 42% Zycon ZCON NA 0.26 0.55 28.89 43 2% |
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Sector Snapshot is our attempt to help Fools the world around generate new investment ideas. Whether a legitimate industry or a group of random stocks we have decided to link together under a hip moniker, Sector Snapshot aims to deliver serious research content that will allow any Fool to begin their journey to financial excess. Our short examinations of the companies in Sector Snapshot come from a multitude of sources. In no particular order, we look at press kits, Value Line, EDGAR, First Call estimates, Zacks Investment Research Estimates, Daily Graphs, Hoover's Online, Morningstar Stock Reports, Nelson's Investment Research, Investor's Business Daily, Dow Jones Retrieval, Disclosure Financial Reports and our own common sense.
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