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Recovery in sight; to be repositioned for growth

Avalon Technologies (AVALON) stands out in the EMS landscape as the only player with a significant manufacturing presence in the US. While this has historically been a competitive advantage for the company, recent economic headwinds in the region have posed challenges. However, the company is successfully navigating these issues with a well-defined recovery plan for its US business, alongside continued growth in its domestic operations.

* The US business is witnessing recovery with a shift in stance from destocking to restocking. Further, various strategic steps taken by the company during the leaner period are yielding results as the company is securing new orders and onboarding new clients.

* AVALON’s domestic business is expected to thrive with significant wins in the aerospace, defense, EV, and industrial sectors. The company is expanding into new areas such as solar and servers while preparing to meet increasing demands with two new facilities in Chennai.

* Overall, we expect that majority of the pain is behind the company. AVALON’s domestic as well as US businesses are expected to ramp up over 2HFY25 and FY26, leading to strong growth for the company.

Light at the end of the tunnel for the US business

* AVALON witnessed a decline in revenue (down 16% YoY in FY24) and losses in its US business, driven by macroeconomic challenges that led to inventory destocking among several customers.

* However, the company believes that the destocking phase has now bottomed out, with signs of a shift toward restocking. Several customers are already nearing 100% of their original demand levels. Accordingly, the company’s order inflow is expected to improve going forward.

* During this lean period, AVALON has taken several strategic steps to strengthen its US business for long-term growth. These include cost rationalization, relocating labor-intensive production to India, increasing the wallet share from existing clients, and acquiring new customers.

* The company has made significant inroads into the clean energy space and expects to benefit from the Inflation Reduction Act (IRA). A key customer in this segment has also received product compliance certification, leading to strong supplies from 2HFY25, which will be further ramped up in FY26.

* Sunrun – one of the key clients of Lunar Energy, which is a major customer of AVALON within the clean energy segment, in its recent concall, highlighted a stronger outlook for 2HFY25 with materially higher net subscriber value and positive cash flow generation.

* Further, Avalon has onboarded two auto-component companies as well as secured significant contracts with two major industrial companies. Additionally, the company has expanded into cable harnesses and lighting products within the aerospace sector, signing a 15-year master term agreement with a major global aerospace player.

* Factoring the momentum within the US business, going forward, we expect the company’s US business to clock ~25% revenue CAGR over FY24-FY27 with margins to improve, led by favorable operating leverage.

Indian business to spearhead growth ahead

* While AVALON addressed challenges in its US operations, it remained focused on scaling its Indian business and strengthening its presence in the domestic market.

* The company has reinforced its foothold in established sectors such as industrial, rail, and automotive while expanding into high-growth areas such as solar, defense, and servers.

* Its concentrated efforts in the domestic market have led to major new wins in the aerospace, defense, and EV sectors, securing contracts with large multinational companies. Additionally, the company has secured new business from leading players in the industrial and energy sectors.

* AVALON is collaborating with key industry leaders in the rail sector on anticollision Kavach systems, a development that could significantly boost its domestic rail business.

* To meet the rising demand, AVALON is set to launch two new facilities in Chennai, India. With prototyping orders already secured, we expect a ramp-up in domestic operations starting in 2HFY25, with further expansion in FY26.

* We anticipate AVALON’s Indian business to clock ~32% revenue CAGR over FY24-FY27, contributing ~50% to consolidated sales by FY27 (v/s ~41%/46% in FY23/FY24).

Valuation and view

* We believe that going forward, AVALON will be well-positioned for growth on account of: 1) recovery within the US business led by restocking from existing customers and new orders from recently onboarded clients; 2) continued growth within the Indian business led by new order wins and ramp up of upcoming plants; and 3) an increase in the mix of box build through new orders or increasing the wallet share from existing customers.

* We estimate AVALON to clock a CAGR of 28%/54%/78% in revenue/EBITDA/Adj. PAT over FY24-FY27. We reiterate our BUY rating on the stock with a TP of INR690 (40x Jun’26E EPS).

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