Obsolescence Insurance, a New High-Margin Business for EMS Companies
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The industry is nearly half way through 2015 and it has been a mixed bag of market sentiment for the wider semiconductor and electronics industry. At a macro level, there is significant optimism mid- and long-term for volume and revenue growth. This growth optimism is due to the anticipated rise of the Internet of Things (IoT) which spans just about every market vertical you can think of. Add to the IoT diversification promise the possibility for greater component penetration into a wider set of electronic end-products, and it sounds like the makings of a great growth story. Tempering this IoT promise is the current global economic backdrop.
One of the key pieces to understanding market cycles, and hence, demand (and supply) questions rests in global economic stimulus plans. There are major (positive) shifts in major economies: the U.S. is rebounding and the dollar has been strengthening; the Eurozone (EU) is stabilizing and seeing movement from slightly negative to slightly positive growth; Japan has for the first time in many years entered positive territories economically; and China and India are engaged in major structural changes moving from export to service based economies. Additionally, as Cheng Li, Director of The John L. Thornton China Center, The Brookings Institute, offered, “China is a huge market and China’s emerging middle class is a historical phenomenon. The size, at the moment, the percentage is probably still 24 percent or 25 percent, but it is already equivalent to U.S. population, like 280 million people.” These events are real positives for the semiconductor and electronics industry and will produce good growth drivers. However, with this strengthening, there is also the double edged sword of foreign exchange (forex) rate changes that cut into earnings and affect purchasing behaviors (i.e., demand).
While the Eurozone (EU) saw a 2.7 percent month-on-month rise in semiconductor sales, according to the most recent ESIA report, “[…] exchange rate effects affected significantly the European sales picture when comparing market growth in Euros and in Dollars,” pulling the month-on-month rates down by ~5.1 percent. We see in the recent earnings reports across companies that the U.S. dollar’s strength is a real headwind for some regions’ business growth. These forex effects are real market game-changers that are contributing to the market cycle changes that Nicole Lewis recently explored. While there is a flattening in traditional market cycles, there are still other cycles that are inherent to the global economy affecting our industry’s patterns. Current strategy, as Lewis reminds us, is to diversify not only across verticals as exemplified by IoT opportunities, but also across durative electronics to give a smoothing effect during ‘bumpier’ periods that variables like forex add to the mix.
Foreign exchange rates are a big piece of the market puzzle and they’ve been behaving differently than we’ve seen lately. Right now, the U.S. dollar is continuing to surge against other currencies based on a strengthening U.S. recovery, employment, interest rates, controlled inflation, among other positive economic trends. The end result in the U.S. of these positive trends is that we are seeing increases in business investments and consumer confidence, all of which means that the U.S. is set to shake off the last of the global recession concerns. Great news, right? Well…. Sort of.
What’s great for the U.S. doesn’t necessarily translate as equally positive news globally. A strong dollar means that any exports suddenly got more expensive in other currencies, not so great if you’re buying the latest high-end electronics export from the U.S. but now in that weaker currency. Losses in earnings due to the forex situation have worsened this quarter, and we don’t see it letting up in the near term. That means those exported U.S. consumer electronics devices just got more costly, making the consumer think twice before upgrading. As the reporting season continues, we’re seeing lower earnings stretching back to 4Q14.
It’s not all gloom on the economic front: low oil prices are helping shave margins for consumers, freeing up some of the tension forex pressure has put on their goods. Also, it bears repeating that the U.S. growth and economic strengthening is seen as a bell-weather for overall global trends. If the U.S. is solidly rebounding, it can pull others along the upward trend.
We find evidence of these trends in in the EU and Japan. As Credit Suisse explored, there is real change happening in these two tough economies. There are real positives to the current forex situation, maybe not for individual companies where we see growth trimmed and likely also the source of some of the current softness along the channel, but for stimulating trade catch-up situations that will have positive macroeconomic upsides that will help push us all towards the next growth wave to come from IoT adoption. We just need to gain that momentum within the microeconomics of our supply chain and across the macroeconomic hurdles as well.
The overall outlook, especially with China and India’s major economic restructuring, along with turn-around for the EU and Japan, all signal greater global economic upswings. If central banks can keep all of the positive momentum on track, and forex rates stay in reasonable ranges, the growth potential of IoT with market openings and growth promises a very positive next era of wider opportunities along the electronics supply chain.
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