Dixon Tech surges 7% today on Jefferies report, initiates buy coverage with Rs 12,600 target

Dixon Technologies is trading at a market cap of over Rs 10,400 Cr. This conviction is underpinned by notable industry opportunity ('Make in India') with EMS (Electronic Manufacturing Services) market likely to grow at +47% CAGR over the next five years, leadership position and expansive product mix, upside from PLI scheme in mobiles (8x sales estimated over FY21-23e), pristine Balance sheet (net cash; working capital at less than 20 days), high return ratios (RoE (Return on Equity)26%, RoCE (Return on capital employed) 31%) and buoyant growth prospects (FY20-23e sales/PAT (Profit after tax) CAGR at +33%/41%). Considering the key risks, Jefferies thinks the upside scenario target for Dixon could be Rs 15,000 and on the downside, the target could be Rs 7000.

Massive Industry Opportunity:

The Indian (EMS) market size was $6 bn in FY20 and is expected to reach $ 40 bn by 2025 (+47% CAGR), as cited by the company.

Key drivers to focus would be:

 1) Higher manufacturing costs in other countries

 2) Larger OEMs outsourcing production, with focus on branding & distribution,

 3) Government boost for indigenisation e.g. restrictions on imports of colour TVs in Aug'20

 4) Govt PLI schemes

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Dixon Technology is Well Placed:

Dixon is the largest EMS player in India, with a diversified product mix - Consumer Electronics (48% of sales mix), Lighting (26%), Appliances (9%), Mobile Phones (12%) and Security Systems (5%). Focus on margin accretive ODM sales (34% now) could be a key positive. Importantly, Dixon has been expanding capacities across segments and would be well-poised to capitalise on this notable industry opportunity.

PLI Scheme - A Game Changer:

In the month of April 20 the Indian government launched Production Linked Incentive (PLI) scheme for mobile phones/electronics, which provides incentives of up to Rs 410bn over next five years. As per government notification on 6 Oct, Padget Electronics (subsidiary of Dixon) has been awarded one PLI scheme. Jefferies estimated 8x sales growth in mobiles over FY21-23e, with +40bps margin expansion. They project Dixon's mobile sales/EBITDA contribution to rise from 12%/9% in FY20 to 44%/31% by FY23e.

Outlook:

Over FY20-23e, Jefferies estimated Dixon's sales/PAT to register +33%/41% CAGR, aided by sturdy industry opportunity, upside from government PLI scheme (mobiles), new launches, client expansion and focus on ODM. Jefferies pencils in flattish operating margin at 5%, in view of the rising share of mobiles (lower margin) in overall mix.

Financial Strength:

 Dixon exhibits a robust Balance with net cash (net D/E at -0.03x as of FY20), optimum working capital (< 20 days), high return ratios (RoE 26%, RoCE 31%), robust cash flow and cash pile (average OCF (operating cash flow)/cash at Rs 1.9 bn / Rs 1.5 bn pa over FY21-23e). Jefferies believes the robust indigenisation opportunity could help Dixon sustain its pristine financials.

Initiates coverage with a Buy Rating:

Dixon's historical growth and RoCE outpaces several FMEG (Fast moving electrical goods) /FMCG (Fast moving consumer goods) players, while retaining a strong B/S. Jefferies initiates coverage on Dixon with a Buy rating and price target of Rs 12,600, assigning a target PE of 50x to Sept’22 EPS, premium (35%+) to its historical average, in view of the emerging indigenisation opportunity, strengthening biz model, upside from PLI scheme, ODM, capacity expansion, new launches and client expansion. Jefferies target PE is broadly in line with the average of FMEG / FMCG cos.

Key Risks:

Extended demand slowdown, market share loss for key customers, rising competition, pricing pressures.

(Authored by Rahul Kamdar)