Reality Check for EMS Stocks

Jabil, the sector's consistent stalwart, posted a rare earnings miss in June and announced plans to cut jobs and close plants. It is also undergoing an options probe.

Plexus(PLXS Quote), which soared earlier in the year, disappointed investors in July with weak guidance.

"There's excess capacity in the industry," Daryanani says. "What I wonder is, given the excessive competition, if OEMs have a stronger leverage position, EMS companies are holding the extra inventory to keep the current business in place." (His firm seeks to do business with the companies it covers.)

After the second quarter, excess inventory at EMS firms was up about 16.5%, on average, while companies guided revenue to grow about 7% or 8% sequentially, Daryanani says. Inventory and revenue should build at about the same pace.

"If demand doesn't live up to expectations for the second half of the year, you're more likely than not to have an inventory correction in the supply chain," Daryanani says.

Part of the reason for the inventory build-up is also due to restructuring, as companies move from high-cost to low-cost regions, he says.

While closing plants should -- in theory -- pay off in the long run, it also hurts margins because firms are stuck with fixed assets and depreciation, Seligman's Lu says.