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From strength to strength: Emerging as a global powerhouse!

* India's Electronics Manufacturing Services (EMS) industry is experiencing a robust growth trajectory, driven by a surge in global orders and blossoming export prospects. Key catalysts of this momentum include a growing influx of orders in railways and aerospace, along with a reinforced global positioning. The sector is poised to benefit from integration into high-value global supply chains, establishing Indian EMS companies as pivotal contenders on the international stage. In this report, we delve into the promising revenue growth potential within the sector, fueled by export-driven opportunities and a healthy order pipeline. Our coverage universe consists of Kaynes Technology (KAYNES), Avalon Technologies (AVALON), Syrma SGS Technology (SYRMA), Cyient DLM (CYIENTDL), Data Patterns (DATAPATT), Dixon Technologies (DIXON), and Amber Enterprises (AMBER).

* EMS companies are seeing increased orders from railways and aerospace, driven by the government’s focus on infrastructure. These long-term contracts, which offer higher margins, ensure sustainable growth and revenue visibility for these sectors. The industry’s aggregate order book jumped 24% YoY to INR147b in 2QFY25 (excluding DIXON and AMBER), with notable order inflows in the railways and aerospace sectors.

* Indian EMS companies are rapidly expanding export opportunities, driven by global investments and partnerships. With swift project execution, strategic acquisitions, and growing order books position, these companies are well-positioned to increase their global market share, reinforcing India’s emergence as a leading EMS export hub.

* Accordingly, we believe that the earnings growth momentum for the EMS industry will accelerate, driven by expanding global opportunities for EMS companies and a robust growing order book. We expect our EMS coverage companies to achieve a revenue/ EBITDA/adj. PAT CAGR of 42%/46%/51% over FY24-27.

Promising demand in Railways and Aerospace fuels the sector momentum

* EMS companies are experiencing increasing order flows from the railways and aerospace sectors. The railways segment, driven by the Indian government's focus on infrastructure, witnessed an allocation of INR2.4t in the Union Budget 2024-25, reflecting an 11% CAGR over the last five years. This was much higher than the 6% CAGR for defense and 10% CAGR for the overall Union Budget. The sector is likely to gain momentum in 2HFY25, post-election, boosting order inflows for EMS companies involved in interlocking, braking systems, and cables.

* Similarly, aerospace and critical industrial production, including railways, are benefiting from higher work content, leading to improved margins and growth potential.

* The longevity of contracts in railways (five to seven years) and aerospace (up to 15 years) ensures sustainable growth and long-term revenue visibility for EMS companies, creating a stable growth trajectory.

* The growth rate of order inflows slowed to 12% YoY in 2QFY25, compared to 38% YoY in 1QFY25, while the aggregate order book grew 24% YoY in 2QFY25, a deceleration from the 28% YoY growth in 1QFY25. Despite this slowdown, the strong momentum in the railways and aerospace segments continues to provide healthy growth drivers for the sector.

* KAYNES received a major aerospace order from a US OEM, backed by the new Chyamaraj Nagar facility (set to begin serial production by 4QFY25 and ramp up in FY26), with this client expected to be the largest FY26 revenue contributor, fueling A&D growth. Further, the company collaborates with ISRO for third-party satellite launches (revenue expected from FY27) and leverages its design and ODM expertise for Kavach rail signaling and high-margin projects across aerospace, railway, and defense sectors. This ensures long-term, diversified growth.

* AVALON secured new business in the railway vertical from a global leader, further strengthening its position in the sector.

* CYIENT reported strong growth in 2QFY25, with defense revenue up 82% YoY and aerospace up 20% YoY, driven by rising demand for high-value electronics manufacturing. Additionally, Thales guaranteed USD10m of business as part of a facility transfer to CYIENT. Meanwhile, SYRMA achieved 79% YoY growth in the IT and railway segments.

* DATAPATT leveraged high-margin contracts in the aerospace and defense electronics sectors, expanding its EBITDA margin to 37.7% in 2QFY25. The company’s growth drivers include radars, electronic warfare, avionics, and export demand, alongside deferred government orders worth INR275m.

* Companies such as AMBER are diversifying into high-growth railway subsystems, along with their core AC business.

Accelerating export-led growth across EMS companies 

* Export opportunities for domestic EMS companies are gaining traction, fueled by global companies investing in India, thereby establishing strong relationships with them.

* Companies such as CYIENTDL (51% export mix in 1HFY25) and AVALON (59% export mix in 1HFY25) are already well-positioned in global markets with an established presence, while SYRMA and KAYNES are actively capitalizing on the growing export opportunities. Of the entire EMS pack, only AVALON has a manufacturing presence in the international market, while other players are gradually establishing their presence through inorganic routes.

* For instance, KAYNES recently acquired a 54% stake in Austria-based Sensonic to enhance its railway safety and infrastructure management capabilities. KAYNES’ order book jumped 57% YoY to INR54.2b, indicating strong growth visibility, with exports likely to pick up notably from 4QFY25/FY26. This is likely to contribute ~20% of revenue by FY26 and one-third of revenue in the next 2-3 years.

* SYRMA also acquired PerfectID in Sep’21, which strengthened its RFID exports to the US. In exports, the company primarily services the industrial and healthcare sectors. The acquisition of Johari Digital in Sep’23 enhanced SYRMA’s MedTech capabilities, driving demand in these segments across global markets. SYRMA expects USD1.2b in exports for FY25, with strong growth anticipated in the second half, particularly in the healthcare segment, which will enhance its ODM and RFID capabilities. Exports contributed 19% of sales in 1HFY25 (as compared to 27% in 1HFY24). The company expects exports to contribute 22-24% of FY25 revenue (INR10-11b), supported by accelerated order execution and ongoing capital expenditure at the Pune and Hosur facilities.

* CYIENTDL, with the Altek acquisition in Oct’23, is set to enhance its presence in high-value international markets from 3QFY25, with its current order book mix of 60% exports and 40% domestic expected to drive a future revenue mix of ~70% exports and ~30% domestic.

* AVALON achieved a 37% YoY revenue growth in 2QFY25, driven by 57% YoY growth in US operations. The company's strong order book of INR25.85b highlights significant short- and long-term export opportunities. AVALON is focusing on clean energy storage EMS growth in the US, leveraging cost advantages from shifting operations to India. Additionally, a new plant for exports has commenced operations, further boosting its export capabilities.

* DATAPATT is reducing dependence on Indian government contracts by onboarding global private clients, targeting aerospace and defense electronics exports to markets such as Europe, South Korea, and the UK.

* DIXON is poised for strong export growth across mobile, lighting, washing machine, and telecom products. Mobile exports, driven by Motorola, are expected to rise to ~2m in FY25 from ~1.5m units in FY24, with 28-30% catering to the US market. In lighting and washing machines, new clients from the UAE, US, Germany, and Japan (Sharp) are boosting opportunities. Telecom and North American lighting orders further signal sustained export momentum.

* Propelled by swift project execution and a growing focus on exports, EMS companies are on track to significantly boost their global market share, reinforcing India’s position as an emerging hub for EMS exports.

Healthy half-yearly growth despite mixed margin trends

* The aggregate order book for the sector grew 24% YoY to INR147b in 1HFY25 (excluding Dixon and Amber), reflecting robust demand across key players. KAYNES led with 57% YoY growth, followed by SYRMA at +26%, while CYIENT experienced a 13% YoY decline, with order inflows likely to improve once repeat client orders are secured.

* Aggregate revenue surged 90% YoY to INR266b in 1HFY25 (sans Dixon and Amber, up 41% YoY). Dixon led with 2x YoY growth (driven by its mobile segment), followed by Kaynes at 64% YoY growth (its Industrials up 2.2x in 1Q, including EV). Meanwhile, DATAPATT was the only company to report flat revenue in 1H, with ~97% decline in development revenue due to order deferment.

* Sector EBITDA grew 68% YoY to INR14b in 1HFY25, with margins contracting 70bp YoY to 5.3% due to a shift in the business mix. DATAPATT ranked last in EBITDA growth but reported a 200bp margin expansion, followed by KAYNES with a 70bp expansion. In contrast, SYRMA (-70bp), CYIENT (-60bp), and DIXON (-30bp) faced margin contraction.

* AVALON reported a strong quarter, with revenue growing 37% YoY in 2QFY25 (up 9% YoY in 1HFY25), driven by a healthy recovery in the US operations (up 57% YoY) and consistent performance in the Indian business (up 16% YoY). Operating profitability improved 470bp primarily due to a shift (of ~45-50%) of the US manufacturing operations to India along with favorable operating leverage.

* The sector demonstrated significant improvements in working capital efficiency during 1HFY25, with several companies optimizing their operational cycles through better inventory and receivables management.

* AMBER achieved the most substantial improvement, reducing its working capital days to 27 in 1HFY25 from 52, followed by SYRMA with a lean cycle of under 60 days. CYIENT cut its cycle to 127 days from 171, reflecting a strong operational focus.

* While DIXON maintained its negative working capital of three days, AVALON improved its working capital to 134 days from 161 days in FY24. KAYNES maintained its working capital at 108 days, in line with the previous year's corresponding period.

Valuation and view: EMS industry experiencing an uptrend

* Our aggregate revenue for the EMS coverage basket is poised to post a 42% CAGR over FY24-27. This growth will be aided by order flows from new as well as existing segments, both in domestic and international markets, in areas such as high computing servers, railways, A&D, medical and healthcare, clean energies, EVs, automotive, and industrials.

* Consequently, combined EBITDA margin is likely to expand ~50bp over FY24- 27E, fueled by favorable operating leverage. Accordingly, EBITDA is expected to clock ~46% CAGR over FY24-27.

* We reiterate our BUY rating on KAYNES/AVALON/CYIENTDL/SYRMA/DIXON/ AMBER and our Neutral stance on DATAPATT.

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