Can EMS companies continue to grow as interest rates rise?

There’s no doubt the electronics sector has been in a ‘super cycle’ of growth for the last few years. But as interest rates rise, can the aggressive expansion of EMS companies powered by M&A activity continue?

Since 2016, an explosion in demand for miniaturised, connected and robotic devices has been served by the rapid growth of EMS provider’s capabilities and reach. For many companies, this has been made possible by a historic era of low-interest rates and low inflation.

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How exponential EMS growth was powered by lending

EMS financial agility has been powered by a healthy stock market, the availability of institutional capital for strategic acquirers, private equity, and hedge funds. And earlier this year, according to EMS Quarterly, the trend seemed set to continue:

With the EMS sector set to expand significantly, more mergers and acquisitions (M&A) activity is expected for consolidating key capabilities and introducing additional capital to realize near- and long-term growth opportunities."

But all this may be about to change.

Interest rates around the world are climbing, banks are coming under tighter regulatory scrutiny, and the era of ‘cheap money’ is at an end.

Banks and businesses under pressure as interest rates rise

As reported in Venture Outsource:

With all of the chaos currently happening in the banking industry and greater financial markets, in the coming months it will become increasingly obvious to many contract manufacturers and their customers there will be fewer banking options, and increasingly restricted access to capital."

Some experts are predicting inevitable pull-back on investment by indebted companies, as a result. Chairman & CEO of Landry, Tilman Fertitta said on CNBC’s “Taking Stock 2023” special.

“As you keep raising rates, companies cannot do their cap funds for new projects, they’re not going to borrow money”

And some of the latest figures seem to be bearing this out.

Data from America reported Capex investments in the manufacturing sector decreased by half in the first quarter of 2023. In the same report, there was a 50% increase in companies citing unfavourable financing conditions as the reason for their pullback on investment.

Can your EMS provider sustain levels of investment?

For those companies who have been relying on borrowing and the free-flow of capital to power their growth, it may be difficult to keep up levels of investment to meet new customer demand.

As ESCATEC’s Chief Sales Officer and CEO Designate Charles-Alexandre Albin, points out:

We see many companies have a very high debt position from trying to grow rapidly and do heavy M&A. And their interest expense is up. The cost of doing business, of holding inventory for working capital, for these entities is increasing. Customers should be watchful of suppliers’ financial obligations, lest these inadvertently become increased costs of production.”

OEMs who want reassurance about their suppliers’ financial capabilities should definitely conduct due diligence around debt status.

4 ways to assess an EMS provider’s financial obligations

Financial Indicators

Evaluate the EMS supplier's financial indicators, such as liquidity, gearing, and asset turnover ratios to assess their financial health and ability to invest in equipment.

Liability Metrics

Consider liability metrics for OEM electronics supply chains with EMS manufacturing partners, which may provide insights into the financial stability and risk management practices of the EMS supplier.

M&A Activity

Stay informed about the EMS sector's expansion and expected M&A activity, as this can indicate the industry's financial dynamics and the potential for specific EMS companies to access capital for investment.

Professional services

Consider using credit and financing services offered by the likes of Dun & Bradstreet to assess the financial risks and benefits associated with engaging an EMS supplier.

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Is it time for a strategic evaluation of your EMS partnership?

The current global economic climate calls for a strategic evaluation of their EMS providers by OEM customers. Where interest rates and resulting operational costs are increasing, partners servicing big debts may not be as responsive and agile to changing CapEx demands as you need them to be.

The aggressive M&A growth strategy adopted by many in the low-interest past may not be sustainable in more straitened times. But those businesses who have grown more organically and sustainably may have more laid by for continued investment in facilities and capabilities.

Charles-Alexandre Albin from ESCATEC certainly thinks this is the case. He argues that those with less debt will be able to keep investing in meeting the changing demands of innovating OEMs at a time when others are failing:

At ESCATEC we pride ourselves on having little to no external leverage, which allows us to manage the ups and downs of the global economy easier. This conservative approach may result in less rapid growth in low-interest environments, but is beneficial for all when rates rise and economic conditions toughen”

For more information on Can EMS companies continue to grow as interest rates rise? talk to ESCATEC Mechatronics Ltd