Scanfil CMD: A couple of notches toward growth

Translation: Original comment published in Finnish on 3/6/2024 at 7:30 am EET

Yesterday, Scanfil announced a strategy update and presented the updated strategy at its CMD in Stockholm. In the updated strategy, Scanfil slightly shifts its focus toward (in)organic growth after the strong organic growth period in the past 3 years and a margin that has risen roughly to the bottom end of the updated profitability target. We feel Scanfil has good conditions for implementing the strategy considering its competitive position, industry dynamics and financial situation. However, we make no changes to our forecasts or our view of Scanfil after the CMD.

The focus shifts a few notches toward (in)organic growth

Scanfil’s strategy update involved no upheaval, as the main lines of the strategy based on the roles of the factories, efficiency and utilizing the growing contract manufacturing market remained largely unchanged. Over the past 3 years, Scanfil has focused especially on organic growth. We estimate that this has been supported by the growth of Scanfil’s customer base, which mainly consists of larger industrial companies and has at times even been unusually strong during the COVID pandemic and its aftermath. In an economic situation that seems subdued for the next few years, we estimate that continuing on the same path could have left the company clearly at the lower end of the global 5-7% growth range of the EMS market considering Scanfil's customer structure, portfolio and clear Europe focus. In its strategy update, Scanfil raised its growth target to 10% over the business cycle (was 5-7% annual organic growth), which suggests an increasing role of inorganic growth in group growth. As expected, Scanfil seeks acquisition targets in the fragmented contract manufacturing market from Asia outside China, Eastern Europe and North America. To support organic growth, the company simplifies its business structure into three segments (Industrial, Energy & Cleantech, Medtec & Life Science). We feel the change will also clarify the structure from the investor's point of view. In the selected segments, we also believe that Scanfil already has a good position. On the other hand, seeking a more significant breakthrough, e.g., in the hot defense sector would be difficult, at least organically, on a larger scale due to the background (i.e. no significant defense sector customers).

The bar was also raised for profitability although we expected a slightly more aggressive raise

Scanfil raised the profitability bar for the level of the adjusted EBIT margin to 7-8% (was 7% adj. EBIT %). We expected the profitability target to be raised, as Scanfil almost reached its target already (2023: adj. EBIT-% 6.8%) and many Nordic peers have achieved higher profitability levels than Scanfil and/or their targets aim for higher levels than Scanfil's target. However, the target was raised slightly less than we expected (8%). In our opinion, this indicates that in terms of profitability, the company is starting to be quite close to its potential. Naturally, this also speaks for shifting the focus a notch toward (in)organic growth to enable continued value creation.

The balance sheet provides leeway for M&A transactions

Scanfil set a formal balance sheet target for the first time and aims to maintain the net debt/adjusted EBITDA ratio below 1.5x (0.6x at the end of 2023). We feel the net debt/EBITDA ratio fits well as Scanfil’s target, as the company’s EBITDA has historically been fairly stable and there have been no major fluctuations, especially downward. Scanfil has also historically been largely below the current target level, and the target level reflects Scanfil’s rather conservative way of utilizing the balance sheet. This allows the company to quickly seize the opportunities that arise in the M&A field and, on the other hand, to keep the stock’s risk profile moderate. Based on the balance sheet target, the balance sheet at the end of 2023 and 2024 guidance, Scanfil would have a capacity of nearly 150 MEUR for M&A transactions. Considering the typically lowish net sales multiples in M&A transactions in the sector, we estimate that the company could acquire approximately 200-300 MEUR more revenue with the help of its balance sheet. We are in principle positive about M&A transactions, as Scanfil’s arrangements have historically been primarily good and the fragmented structure of the sector supports consolidation. However, M&A transactions must always be assessed case by case.

If the forecasts materialize, the stock has good leverage

Our and consensus forecasts for the coming years expect Scanfil to generate average organic growth of 5% and 7% adjusted EBIT-%. Thus, there is a rather clear upside in the forecasts if the company was close to its targets. In addition, the share is already valued moderately with current forecasts, as the P/E ratios based on our forecasts for the coming years are 10x-12x and EV/EBIT ratios are single-digit. Thus, if the targets materialize, the stock’s expected return would be quite good even without an increase in the multiples. However, we do not make changes to Scanfil’s forecasts or view of the company based solely on the targets, even though we find the targets realistic for the company. Scanfil also has a rather good track record of achieving previous targets.

Efficiency is sought through digitalization and automation

Scanfil also introduced its 'Dream Factory' concept at the CMD, which aims to improve the competitiveness of the factories by utilizing automation and digitalization. As contract manufacturing is relatively capital-light, automation of the industry does not require massive investments in the most complex technology either, and Scanfil’s planned digitalization investments amount to some 6 MEUR/year in 2024-2028. A 3-year digitalization project completed at the Suzhou plant in China (incl. inventory, production, shipping) also produced excellent results both financially (estimated ROI-% 27%) and qualitatively (e.g. NPS rose to high levels). We believe that utilizing technology in the industry is not entirely straightforward either, as factories and production lines differ from each other, and the people operating them also act as variables. We, therefore, believe that skilled technology utilization can provide a small head start in contract manufacturing, even though we believe it is rather difficult to build sustainable competitive advantages purely through investments in the industry. By 2028, Scanfil aims to achieve a productivity improvement of over 26% with its concept and investments, some of which would, of course, go to maintaining competitiveness and compensating for wage inflation.