Initiating coverage: Dixon Technologies (Outperformer) - Geared for growth

India’s Electronic Manufacturing Services (EMS) industry is set to take off on the back of growing demand for consumer durables, enhanced competitiveness among domestic players and rising trend towards outsourcing. Dixon is well placed to capitalise this growth, spurred by its wide product portfolio and cost leadership. The company’s deep client relationships, flexible manufacturing and design capabilities give it a competitive edge over peers. We expect Dixon’s focus on client addition and backward integration to drive 21% revenue and 37% earnings CAGR over FY17-20E. We expect Dixon’s rich valuations (28x FY20E earnings) to sustain versus global peers, led by its sustainable asset-light business, expected strong growth and superior return ratios (25%+). Initiate with an Outperformer and target price of Rs3,700.

Domestic EMS poised for growth: India’s EMS industry is likely to register 31% CAGR over FY17-21 (Frost & Sullivan estimates) on improving competitiveness of domestic players (rising wages in China and favourable business environment), focus on domestic manufacturing (change in policy) and rising outsourcing trend by brands (focus on core competencies).

Cost leadership gives it a competitive edge: Dixon is a leader in 3 out of 5 domestic EMS segments, which gives it the scale to achieve cost competitiveness. Sustained backward integration focus will help Dixon add value and improve its cost competitiveness further (plans to manufacture washing machine motors and PCB in house over 1-2 years).

ODM focus, customer adds to drive growth: Dixon’s strong product design capabilities have facilitated a shift towards Original Design Manufacturer (ODM) model (22% in FY17 to 30% in FY20E). The company has long-standing relationships with brands and continues to add customers across segments (Samsung, Crompton, Flipkart, Wipro, etc), which is likely to drive 21% revenue CAGR over FY17-20E. As ODM share rises (strong growth in washing machines) and scale benefits accrue, we expect margins to expand 120bps to 4.8% over FY17-20E.

Asset light model with robust growth: Dixon’s continued focus on cost competitiveness, increase in backward integration, expansion of product range (fully automatic WM, 63”TVs, etc), and higher value offering should aid 37% earnings CAGR over FY17-20E. We expect strong growth and focus on asset light business, with lean working capital to drive sustained superior return ratios (25%+). Dixon should be able to sustain its premium valuations (38x/28x FY19E/20E earnings) versus global peers, as we expect strong growth and superior return ratios to continue. Initiate with Outperformer and target price of Rs3,700.