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EMS Sector: Growth Masks Cash Crunch
20 Feb
Summary
- Deteriorating accounting quality noted despite strong earnings growth.
- Working capital needs and capex lead to negative free cash flows.
- Memory chip prices surge, raising sector-wide risks.
The electronics manufacturing services (EMS) sector is exhibiting signs of declining accounting quality and strained cash generation, even as reported earnings show robust growth. A key report highlights a growing disparity between profitability and actual cash flows. This situation is exacerbated by increasing working capital requirements and significant capital expenditure, resulting in negative cumulative free cash flows across many companies.
While sectoral revenue, EBITDA, and profit after tax saw growth of 13%, 31%, and 39% respectively in Q3FY26, this headline expansion masks underlying financial pressures. Global memory chip prices are surging due to AI-driven demand and constrained supply, introducing further risks. Companies like Kaynes Technology face scrutiny over earnings quality, with negative pre-tax operating cash flow and rising working capital intensity.
Amber Enterprises is noted as a strong performer in accounting metrics, while Avalon Technologies' cash conversion issues are linked to working capital investments, though this pressure is reportedly easing. Dixon Technologies faces valuation concerns and risks tied to PLI incentives, despite strong ROCE. Overall, sustained expansion and working capital investments are expected to keep free cash flow generation subdued in the near term, necessitating investor focus on accounting quality and capital efficiency.
