EMS industry exploded, Huazhi Machinery took advantage of the victory and then the gross profit margin declined

Against the backdrop of further refinement of global specialized division of labor and the gradual maturity of the EMS (electronic manufacturing services) model, the global EMS industry as a whole is showing a growth trend.

According to data from New Venture Research, the global EMS industry market size grew from US$329.2 billion to US$430.6 billion from 2016 to 2018, with an average annual compound growth rate of approximately 14.36%.

With the application of the Internet of Things and the expansion of 5G commercialization, the future communication infrastructure and smart hardware industry will be comprehensively upgraded. New Venture Research predicts that the global EMS industry market size will reach US$618.542 billion in 2023, with an average annual compound growth rate of 7.51% from 2018 to 2023.

As the market size continues to expand, EMS companies are also experiencing rapid growth. However, due to the large number of global electronic manufacturing service companies, and the market share is controlled by international companies such as Hon Hai Precision, Pegatron, Flextronics, and Jabil, domestic EMS companies have a relatively small market share.

With my country's strong support for the intelligent manufacturing equipment industry, the level of intelligent manufacturing has rapidly improved. Local EMS companies have formed a certain manufacturing scale and comprehensive service capabilities by virtue of their own flexibility and enthusiasm for meeting customer needs, and have won recognition from mainstream electronic brands at home and abroad. Their share in the EMS market has gradually increased.

Benefiting from the ever-expanding market share, Huazhi Machinery Co., Ltd. (hereinafter referred to as "Huazhi Machinery"), an EMS manufacturer focusing on network energy, has also achieved stable growth in performance after binding major customers.

Recently, Huazhi Machinery restarted the GEM IPO process. In the article "Heavily dependent on Huawei/Vertiv, Huazhi Machinery's ability to develop new customers is worrying?", Jiwei.com focused on analyzing the company's business model and customer risks. In this article, we will focus on analyzing the risks behind its revenue data. Against the background of the continuous expansion of its business scale, its gross profit margin has been declining year by year, which will further reduce its profitability. With the potential risks of major customers highlighted, the future prospects are worrying.

Revenue compound growth rate 5%

There are many electronic manufacturing service companies in the world, including Hon Hai Precision, Pegatron, Flextronics, Jabil, Sanmina, Celestica, New Kinpo and other internationally renowned companies. These companies occupy a large market share in the EMS industry by virtue of their advantages in scale, experience and other aspects.

MMI pointed out that in 2017, the top 50 EMS companies in the world accounted for 75% of the market size, and Hon Hai Precision Industry accounted for about 1/3 of the EMS industry market size, and the industry concentration was relatively high.

In recent years, my country's innovative strength in the manufacturing of high-precision electronic products and key components has gradually become apparent. In addition, the country has a vast consumer market, abundant labor resources and an increasingly complete industrial supporting system, which has attracted many electronic brands to set up offices or manufacturing branches in China, gradually shifting to completing core component procurement and complete machine assembly locally.

At the same time, my country's domestic electronics industry has also shown a rapid development trend with the support of national policies. Relevant companies have taken advantage of the situation and, with the continuous improvement of the level of intelligent manufacturing, domestic EMS companies have gradually been recognized by mainstream electronic brands.

Huazhi Machinery is one of the beneficiaries. The prospectus shows that in 2017, 2018, 2019 and the first half of 2020, Huazhi Machinery's operating income was 408 million yuan, 508 million yuan, 519 million yuan and 246 million yuan respectively; among them, the main business income was 402 million yuan, 508 million yuan, 517 million yuan and 245 million yuan respectively, with a compound growth rate of 5.06%.

Among them, network energy products are its main source of performance, which are used in communication base stations, data centers, photovoltaic power generation and other fields. Since network energy is a key infrastructure to ensure the safe, reliable and stable operation of the entire communication network, a communication base station or a data center usually requires multiple network energy products, so the growth of investment in communication equipment will drive the growth of network energy.

With the advancement of 5G construction, operators have put forward higher requirements for communication power supply power density, efficiency, and environmental temperature adaptability when upgrading or expanding telecommunication systems on a large scale. The scale of new base station construction has also increased the demand for communication power supply. Overall, the commercial development of 5G communication technology has brought huge development potential to the communication power supply industry, and its shipments will usher in a substantial growth trend in the next few years.

However, against the backdrop of growing market space and expanding business scale, Huazhi Machinery's gross profit margin has shown a downward trend.

Gross profit margin is on a downward trend

The prospectus shows that in 2017, 2018, 2019 and the first half of 2020, the gross profit margin of Huazhi Machinery's main business was 23.78%, 18.32%, 19.16% and 19.82% respectively, showing a slight upward trend after a sharp decline.

In this regard, Huazhi Machinery explained that the company's customer structure was relatively stable in 2018. Affected by the decline in Huawei's gross profit margin, the company's main business gross profit margin decreased by 5.46% year-on-year compared with 2017; in 2019, Huawei's revenue share and gross profit margin both increased, and its contribution to gross profit margin increased; Vertiv's revenue share and gross profit margin both declined, and its contribution to gross profit margin decreased, which resulted in the company's main business gross profit margin increasing by 0.84% ​​compared with 2018.

"From January to June 2020, Huawei's revenue share and gross profit margin further increased, resulting in a 0.65% increase in the gross profit margin of its main business compared to 2019."

The gross profit margin increased significantly due to customer demand, which was mainly due to the fact that Huazhi Machinery's business model and orders mainly came from large customers.

Jiwei.com learned that Huazhi Machinery's main customers are Huawei and Vertiv, and its sales in the first half of 2020 accounted for 99.82% of its main business income (the difference in other years is not much). Among them, the sales revenue to Huawei is a customer-supplied material model, and the sales to Vertiv is a self-purchased material model.

Under the self-purchased materials model, the revenue scale is larger but the gross profit margin is lower; under the customer-supplied materials model, the revenue scale is smaller but the gross profit margin is higher.

In 2018, Huazhi Machinery adopted an active market development strategy to obtain a large share of bids for multiple Huawei product families. Since the unit price of Huawei's rectifier module products was low that year, but the unit cost was high, the product gross profit margin was negative, which also caused Huazhi Machinery's gross profit margin to drop by 5.46% year-on-year compared with 2017.

In 2019 and January-June 2020, affected by the United States' tightening control over Huawei, Huawei adjusted its product structure, converted some overseas raw materials into domestic raw materials, and renegotiated prices with suppliers for the adjusted new products. As they are new products and customers have higher requirements for delivery time and quality, the gross profit margin is relatively considerable. As a large-share supplier of its multiple product families, Huazhi Machinery actively introduced new products. Coupled with the increasingly significant economies of scale and learning curve effects as its revenue scale expands, its gross profit margin has rebounded.

Although the decline in its gross profit margin was caused by the influence of major customers, compared with Guanghong Technology, which mainly adopts a customer-supply model, Huazhi Machinery's gross profit margin level is far lower than that of Guanghong Technology.

The prospectus shows that in 2017, 2018, 2019 and the first half of 2020, Guanghong Technology's gross profit margins were 27.8%, 31.91%, 31.83% and 26.84%, respectively, far higher than the gross profit margin of Huazhi Machinery.

This makes people wonder about the level of competitiveness of Huazhi Machinery's products, or whether it has chosen a low-price customer acquisition strategy.

If it is the latter, the low-price customer acquisition strategy is not a long-term solution. While damaging the company's own net profit level, it will also disrupt normal market conditions. If other companies also seize the market through low prices in the future, can Huazhi Machinery still hold the victory and continue to win orders from Huawei?