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Stock Analyst Update

Tech Sector Pain Means Manufacturing Stocks Gain

As big tech companies struggle, their outsourcing partners soar.

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As the technology sector continues to decelerate, more and more struggling firms, like wireless-phone giant Ericcson (ERICY), are choosing to outsource their manufacturing operations. Although that move hasn't resurrected Ericcson's battered shares yet, decisions like these have been a boon to Flextronics International (FLEX), the electronic manufacturing service (EMS) firm that landed Ericcson's $800 million manufacturing contract this January. Indeed, while Ericcson's shares are down 56% over the trailing one-year period, Flextronics was up 34% for the same period.

Ericcson isn't the only battered tech outfit that is trying to save money by offloading its inefficient manufacturing operations and focusing more on core competencies. Troubled Motorola (MOT), for example, signed two separate contracts worth a combined $31 billion with Flextronics and Celestica (CLS) last year, while the hapless Lucent (LU) continues to shift its manufacturing operations to EMS firms like Sanmina (SANM) and Jabil Circuit (JBL). When it comes to EMS firms, the gloomy thunderclouds hovering over the tech industry have a noticeable silver lining. 

That's not to say, however, that all EMS firms have gained from the tech industry's pain. One of this year's worst-performing EMS providers, SCI Systems (SCI), is heavily reliant on the PC industry, which has been buffeted by a sharp slowdown in consumer spending. As such, the stock is one of the cheapest among the six top-tier EMS firms listed below, and thus a favorite among value managers like Rick White of the Neuberger Berman Guard Fund (NGUAX)

 Top Six Electronic Manufacturing Service Firms

YTD Return
( % )

1-Year
Return
( % )
Full Analyst
Report
Flextronics International (FLEX) 29.6 34.2 Analyst Report
Celestica (CLS) 21.5 45.0 Analyst Report
Jabil Circuit (JBL) 14.2 -24.4 Analyst Report
Sanmina (SANM) 2.8 39.5 Analyst Report
SCI Systems (SCI) -1.4 -29.0 Analyst Report
Solectron (SLR) -4.5 -2.4 Analyst Report

Data as of 02-14-01.

So what's the secret formula behind successful EMS firms like Flextronics and Celestica? For starters, these companies have built state-of-the-art manufacturing facilities in foreign countries like China, where there are fewer regulatory hurdles and labor costs are low. Their huge size also gives them economies of scale and considerable buying power that companies like Lucent can't match, says Pilgrim Baxter fund manager Mike Sutton. 

That said, Sutton thinks the EMS companies with the most promise are those with the broadest customer bases and a concentration in high-growth areas such as optical networking, telecommunications, and wireless handsets. For example, Sutton sold off his holdings in Jabil Circuit, which he had owned in his PBHG Large Cap Growth Fund (PBHLX), because of its heavy exposure to slow-growth PC makers. In addition, more than half of its sales came from just four customers, including Lucent and Cisco (CSCO). A company like Flextronics, on the other hand, with its deep bench of customers, has the wherewithal to withstand a downturn in a particular business sector because its business mix is so varied, says Sutton.

For those looking to invest in today's tumultuous tech sector, EMS providers offer a safer bet since they stand to gain the most from the sector's travails. To uncover the best of the six top-tier players listed above, Premium Members should find Morningstar analyst Jay Ritter's Stock Analyst Reports quite helpful.

Read the latest Analyst Reports on 1,000 stocks and 2,000 funds, free for 30 days. 

Frank Stanton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.