EMS stocks continue to oscillate wildly. The stocks are being buffeted by a teeter-totter of conflicting data. On one end is a stream of improving macroeconomic data: increasing durable-goods orders, lower inventories, resilient consumers, and growing optimism about improving corporate profits later in the year.
At the other end is the never-ending stream of negative data about the telecom industry: service providers with precarious balance sheets, always lower capex budgets, push-outs of new technology, and excess capacity. Year-to-date, the EMS sector is down about 5%, but only after a heroic rally in the past few weeks that brought the group up from about a 35% decline at the beginning of May. This follows a 27% decline in 2001. Does the price action suggest that investors are betting squarely against a recovery? Not really.
We believe that, currently, the trade in EMS shares is dominated more by investors playing short-term hunches about the status of major customers rather than betting on the long-term outsourcing trend. Share performance among printed-circuit-board makers has also been unexciting, even though a cyclical bottom appears to be at hand. Revenue and earnings performance likely bottomed in the first quarter, and we expect PCB makers to see modest sequential growth over the course of the year. True to past cycles, however, competition in the PCB industry always seems to be worse
than in other sectors. In the last 12 months, by our estimate, more than 3 million sq. ft. of PCB plant space has been closed in the United States. We believe that more closures are coming.
In the passive component sector, life is actually pretty good, measured by stock performance. Passives makers are up 12% year-to-date, handily beating all the major indexes. Why the increased confidence way back in the supply chain?
We believe that part of the reason is investor familiarity with passives makers from past cycles, as well as the diversified end-market exposure of passives providers. Book-to-bill ratios have also turned positive. Will this behavior continue? We expect so, but at some point there has to be a turn in demand for this performance to keep up. When this happens, look for a new friendship with EMS stocks to emerge as well.