There's finally a little good news for investors in electronic manufacturing services, a sector that has been hit hard by the prolonged slump in IT spending.
Several analysts are now expecting a modest uptick in business over the next few quarters, and
announced that it will begin outsourcing work for
( TLAB), a maker of telecom equipment. Nevertheless, pricing pressures are still hurting gross margins in the sector.
Lehman Brothers analyst Louis R. Miscioscia raised his ratings on
and Sanmina to overweight from even-weight, saying, "As each day goes by it becomes clearer that we are not going to slip back into another recession and the economy is making a slow, gradual, recovery. With that we would expect tech trends to eventually improve."
Miscioscia raised his price target for Celestica to $20 from $14, based on 25 times his 2005 earnings estimate of 80 cents. "We believe the stock should rally to those levels based on better q/q trends going intoDecember," he wrote in a note to clients Friday. Similarly, he raised his target price for Sanmina-SCI to $11 from $7, based on 25 times his 2005 estimate of 44 cents. Lehman Brothers does not have an investment banking relationship with either company.
As is often the case, good news for a contract manufacturer is bad news for employees of an OEM.
Tellabs, which like other makers of telecom equipment, has been struggling for several years, Friday announced that it will outsource manufacturing of its North American products to Sanmina, resulting in the layoff of about 325 employees. Beginning in the third quarter, Tellabs will record an estimated $90 million to $110 million in charges connected with the outsourcing move.
Although Sanmina-SCI obviously benefits from the agreement, Deutsche Bank analyst Chris Whitmore notes that the same economic forces that are forcing OEMs to outsource are pushing prices down and hurting margins throughout the electronics supply chain. "Despite significant restructuring, overcapacity is still a significant problem," he said.
Longer term, he said, the strongest players with the best cost structures, particularly
, will benefit. Deutsche Bank has a banking relationship with Flextronics and Celestica.
Gross margins in the sector dropped from 9.2% in the second quarter of 2001, to 7.4% in the second quarter of 2002, to 5.7% in 2003's second quarter, Whitmore said. But they should increase to 6.5% in 2004, Whitmore said.
Shares of Tellabs closed off 7 cents, or 1%, to $6.54 Friday; Celestica gained 31 cents, or 2%, to close at $15.64; while Sanmina-SCI dropped 4 cents, or less than 1%, to $22.61.