This article first appeared in The Edge Malaysia Weekly on December 6, 2021 - December 12, 2021

ABOUT two weeks ago, British high-tech home appliance maker Dyson Ltd announced that it had cut ties with its Johor-based contract manufacturer ATA IMS Bhd, following an audit of its labour practices and allegations made by a whistleblower.

ATA’s share price was immediately battered when the bombshell was dropped on Nov 25, whereas that of its electronics manufacturing services (EMS) peers SKP Resources Bhd and VS Industry Bhd soared.

Initially, most research analysts and investors anticipated SKP and VS to be the prime beneficiaries of the diversion of orders, simply because someone had to fill the void created by ATA’s loss. But the euphoria seemed to have died down the following day, with investors questioning whether the two EMS players had sufficient spare capacity and manpower to absorb any redirected orders.

Things escalated quickly last week. Just when the EMS companies were exploring ways to take up possible additional orders, their stocks were hit by the environmental, social and corporate governance (ESG) wave.

The Edge has learnt that labour rights activist Andy Hall met fund managers at a talk organised by Credit Suisse last Thursday morning. It emerged that he had raised concerns about the Responsible Business Alliance’s (RBA) audit on VS.

Founded in 2004 by a group of electronics companies, RBA is the world’s largest industry coalition dedicated to corporate social responsibility in global supply chains.

When contacted by The Edge, Hall says, “There is a need to do more detailed corporate and investor due diligence with regard to the situation of migrant workers at VS Industry and other Dyson suppliers in Malaysia, as indeed I said on the Credit Suisse-organised call with investors today [Dec 2] in response to the specific questions asked of me regarding worker conditions at VS Industry and other Dyson suppliers.”

According to Bloomberg data, Credit ­Suisse does not cover the three EMS stocks.

ESG factors aside, the broader market had pulled back last week as concerns about Covid-19 variant of concern, Omicron, rattled investor confidence. Comments from US Federal Reserve chair Jerome Powell on inflation did not help either.

To make things worse, the impromptu and unexpected public holiday declared by the Federal Territories Minister Datuk Seri Dr Shahidan Kassim for last Friday meant that Bursa Malaysia would be closed. This may have prompted investors to “sell first and ask questions later”.

So, how should investors assess the opportunities and risks in EMS stocks? What are the factors they should consider to approach this rationally?

For perspective, Dyson contributed about 80% to ATA’s revenue, which stood at RM4.22 billion in FY2021 ended March 31.

UOB Kay Hian analyst Desmond Chong says that, following the termination of ATA’s contract with its main customer, the orders diversion could benefit other contract manufacturers (CMs) with proven track records. “While there is no clear direction yet on the portion of allocation, our observation based on historical order bidding trends would be for CMs to take up at least two major new lines to operate efficiently,” he wrote in a report last Monday.

Chong believes SKP could be the prime beneficiary from the orders diversion amid its production capacity expansion coming onstream in the third quarter of 2022. “Should SKP secure RM750 million worth of orders for FY2023 (RM3.6 billion being spread evenly among five CMs), our rough calculation suggests that the earnings potential could be RM45 million,” he estimates.

For context, six major EMS firms in the region have been serving the European multinational corporation best known for its home care products. They are ATA, SKP, VS, Flex Ltd, Meiban Group Pte Ltd and New Kinpo Group (NKG).

So, is this the case of one EMS player’s loss is five EMS players’ gain?

An investor who closely follows EMS stocks in the region believes so. “Basically, there are five major EMS players with operations in Johor: ATA, SKP, VS, Flex and Meiban. Then, of course, there is NKG, a Taiwanese EMS firm that is reportedly a CM of Dyson products,” he says.

“Now, if ATA is out of the picture, the market would naturally expect the other five EMS firms to benefit. Obviously, the orders have to be diverted somewhere. But the real question is, do these EMS firms have sufficient spare capacity to absorb the spillover orders? I think it is subject to the availability of capacity and manpower.”

He reiterates that, as Dyson has made the decision to terminate ATA, the obvious potential beneficiaries should be the likes of SKP and VS. He does not discount, however, the possibility that these orders, which were initially given to ATA, may be moved out of Malaysia.

“Bear in mind that Dyson also has CMs in other countries, for example, NKG’s operations in the Philippines. Don’t get me wrong, I still believe Malaysia will remain a key manufacturing base for Dyson. But at this point in time, we are not sure whether the existing local CMs have the capability to take up the orders,” he stresses.

The investor reiterates that in the event that the EMS firms with operations in Johor cannot step up and the sudden void cannot be filled, those orders may flow out of the country.

“But, realistically, it should be easier to redistribute the orders among the existing CMs in Johor, provided that they have the capability and capacity. In any case, I don’t think we will see an immediate impact on their earnings. An EMS firm usually needs up to six months to set up or readjust its production lines to cater for new orders. It will not happen overnight,” he says.

Meanwhile, a local EMS industry observer highlights that, on top of the ESG issues, one of the most important lessons that local manufacturers can learn from the ATA incident is that they should never be overly reliant on a big client.

“The single customer concentration risk is real. No matter how big your client is and how big their orders are, you should always have a diversified customer base. If you look at other EMS companies, they have been expanding and diversifying their clientele,” he says.

From a broader perspective, he points out, the recent development at ATA is negative for the country and is certainly bad for the local EMS sector because Malaysia is making international headlines for ESG issues.

“Objectively speaking, the ATA incident is bad for the local EMS industry as a whole. Yes, ATA is a serious casualty. It is easy to speculate or imagine that one man’s loss is another man’s gain. So, in this case, the market anticipates SKP and VS to benefit, which is understandably so.

“But, as a country, where does Malaysia go from here? On the one hand, we want to move up the value chain. But, on the other hand, we are still relying heavily on foreign labour. If you ask me, this is not a healthy development.

“If you happen to have a chance to talk to SKP or VS, I am pretty sure they won’t be too happy about the current situation, because this incident puts the industry in a negative light.”

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