Investment Thesis: Incap

Newsletter nº7

Introduction

In today's newsletter we bring you the first investment thesis that we published in this substack but translated into English. Preparing this thesis has been a very interesting and enriching exercise, since I had never before written to this level of detail about a company. Before anything else:

DISCLAIMER: This article should not be considered as a recommendation to buy or sell any type of financial asset. Any action or decision you take as a result of viewing this article is solely your responsibility. Each person has to carry out their own analysis before making any type of decision on the purchase or sale of financial assets.

Ok, let's go. The company that we are going to talk about today is a company that hardly attracts attention in the fintwit community. It is not a fashionable growth company (although they are not so fashionable anymore), it is not a dividend aristocrat, nor is it a commodity company. It's nothing like that. Today we are going to talk about Incap ($ICP1V). It is a Finnish company that capitalizes 500 million euros and delivers EMS (Electronic Manufacturing Services). At first glance you stay the same, it does not attract attention, you do not see it in Youtube videos or in Twitter threads.

To be honest, I admit that I found this company by pulling the Investing.com stock screener, looking for good opportunities in the Nordic markets, I found it. I am neither an electronics expert nor did I know the sector before, which has even more merit.

The EMS sector

First of all, I think it is convenient to explain in a few details what the EMS consist of and what the sector is like. As I anticipated in the introduction, EMS are electronic production services. This sector includes all the companies that design, test, manufacture and sell electronic components and products for OEMs from a multitude of sectors.

The companies that sell this type of EMS services usually offer the following products:

• Assembly of PCBs (Printed Circuit Board), either with THT technology (assembling components by inserting them into holes on the board) or SMT (surface mounting of components on the board, the most widely used)

• Custom Cable Assembly, which is a great value for OEMs. In these cases, the EMS manufacturer not only manufactures, but also includes in its scope the engineering and testing of the cabling once it is assembled.

• Electromechanical assembly that OEMs usually also entrust to these companies the assembly of electronic components in the client's equipment or in a part of them. They are the services called “Box Build”.

• Testing, either TIC (Integrated Circuit Testing) or AOT (Automated Optical Inspection)

• Manufacture of PCB prototypes, 3D printing, soft tools (soft tooling), etc.

• Complete manufacturing. Many clients are looking to outsource the entire scope of the equipment, both design and manufacturing. Then the client is in charge of the commercial part of the business, selling it, distributing it, etc.

As you can see, EMS providers can reach a level of vertical integration in the manufacture of the OEM product almost complete, from a simple PCB card to the manufacture of the complete equipment.

The EMS industry took off at the end of the 70s and in the 80s with the boom in consumer products (computers, household appliances, automobiles, telephones, etc.). Previously these electronic components were manufactured by the OEMs themselves. Today nearly all of these services are outsourced to EMS providers. The pioneers in the sector were companies like Solectron or Sanmina-SCI in the United States. The EMS sector is a very fragmented sector, it is estimated that there are some 16,000 companies dedicated to this type of service throughout the world, of which the Top100 accounts for 84% of the market. Here the main global players are companies such as Foxconn (one of Apple's main suppliers), Pegatron, Wistron, Compal, Quanta, Celestica, Sanmina-SCI, Jabil, Elcoteq, Ikor and many more. At a European level, the main manufacturers are companies such as Zollner, Scanfil, Videoton, Katek, etc. To give you an idea, Incap ranks 96th among EMS providers worldwide. Here you have the top 10 EMS manufacturers

The business model of the EMS industry is based on specialization and creating economies of scale for manufacturing, collecting raw materials and pooling expert resources in the different fields of electronic design and manufacturing and repair in order to create a added value to the final product. Thanks to this, customers do not need to manufacture or store large inventories of products. In turn, this work philosophy makes it possible to deal with sudden peaks in demand faster and more efficiently.

As for the future prospects of the EMS sector, as you can suppose they are very good. With technology increasingly present in our lives, it is a sector with a great future. The EMS industry grew in 2021 to a revenue figure of more than $500 billion, with an annualized growth of 9% projected to reach $915 billion in 2028.

Inside Incap

Well, once we have talked a little about the EMS sector, it is time to meet Incap, starting with its origins. Incap was founded in 1985 although at that time the company was called “Teknoinvest”. It would not be until 1992 when, after a merger of several companies, the name of Incap was adopted. In 1997 the company was listed on the Helsinki stock exchange. Next comes its expansion and relocation process. In 2000, Incap also established itself in Estonia, buying the Altron factory. In 2006, Incap began its operations in India with a commercial office in Delhi, followed by the purchase of the TVS Electronics factory in Tumkur. In 2011 Incap opened an office in Hong Kong to support the supply chain with materials from China.

Since then, Incap has been developing and moving all its production to Estonia and India. In 2020 Incap buys 100% of AWS Electronic group, an EMS provider specialized in highly complex services and with factories in the UK and Slovakia.

Below we summarize the following products and services that Incap offers within the EMS sector:

• Engineering and prototyping services

• PCB manufacturing

• Box build

• Customized solutions

• cabling supply

• Manufacture of low voltage transformers

• Engineering services

• after sales service

Incap works for a multitude of clients spread across various sectors, some more cyclical than others:

• Aerospace

• Data storage

• Automotive

• Defending

• Consumer electronics

• Electricity generation

• Industrial

• Instrumentation

• Medicine

• Environment

• Mining

• Oil & Gas

• Safety

• Telecommunications

• Transport and Infrastructures

• Vending

So now we have a company whose headquarters are still in Helsinki but all its production is relocated to the UK (Defense, security and aerospace), Estonia (electronics and box built products), Slovakia (automotive) and India ( electronics and "box built" products).

A key factor in Incap is the expansion they are carrying out in India, where they already have two factories with 2,000 employees, 16,000m2 of surface area and where they are building a third factory that will add 8,500m2 more surface area and which will be enter in production in Q1 2023.

Incap India's customers are globally operating electronic device manufacturers, who may be based in Europe but manufacture in Asia. Incap's factories in India deliver to customers all over the world. The catalog of products supplied from Incap India is very extensive, from power supplies, inverters and UPS to fuel supply systems, LV/MV drive boards and other industrial electronics.

In short, we have a company with a global presence and with the cost savings of having factories in India, especially in Estonia and Slovakia. And it is that India is becoming one of the main global EMS manufacturing hubs, due to the great growth in the country and the future access of more than 60% of the Indian population to the consumer class that demands consumer products. Forecasts indicate that the EMS market in India for electric vehicles is expected to grow from $7.5 billion in 2022 to $95 billion in 2026, a CAGR of 86.8%, not bad. For its part, the EMS sector for televisions is estimated to grow from the current 79 billion dollars to 238 billion in 2026, a CAGR of 31%.

Let’s dive into Incap numbers

Now let's go to what possibly interests you the most, the Incap numbers. The company closed 2021 with revenues of 169.79 million euros, an operating profit of 25.97 million (15% margin) and a net profit of 21 million euros (12.4% margin), higher margins than the ones of its peers. The latest results presented for Q3 2022 show spectacular numbers. Incap grows in revenues at 50% YoY, operating profit at 40% YoY and net profit at 21%. The numbers for the first 9 months of 2022 are equally incredible compared to the previous year. Here below you have the summary with the data extracted from the official Incap report of Q3-2022.

In the last earnings report they confirmed the guidance to end 2022 with revenues of 262-270 million and an EBIT of 38-42 million. If it is fulfilled, we have a company growing at a rate of 50% YoY. Not bad..

We are talking about a company with a return on invested capital (ROIC) of 34%, well above its competitors.

Regarding debt, Incap only has a net debt of 9 million euros, which gives us a Net debt/Ebidta ratio of 0.26, we are fine. In turn, Incap has 4.3 million euros in cash, and an available line of credit of 6.9 million euros.

But here the key question is, why does Incap have such good numbers? where is the secret? It is not an easy question to answer. On the one hand we are in a growing market with obvious tailwinds. At the same time, Incap is strongly committed to the acquisition policy and in which it takes advantage of synergies and economies of scale. They also have a very efficient business model and give a lot of strength to the Indian leg of the business, with the 3rd factory already operational in Q1 2023. They also have a highly decentralized structure and an entrepreneurial culture. On the other hand, they invest a lot in R&D and staff training, a key factor in this business. One more strenght of Incap is the close relation with its clients, with increasing vertical integration in the manufacturing of the OEM product, and the support they get from Incap not only in manufacturing but also in design and testing of equipment.

Management

Another key point when analyzing a company is to study the management team. At the controls of Incap we have the President & CEO Otto Pukk, born in Estonia 44 years ago. He has been CEO of the company for 4 years, and previously he was in charge of the Incap division in Estonia, and has previously held other management positions in companies such as ETAL or Eesti Energia. Otto owns 38,200 Incap shares after an incentive program approved by the Incap board following the 2021 results. It's not a significant stake in the company, but it's always a good sign for the CEO to have those kinds of incentives based on results. In turn, Otto Pukk's salary between base salary and bonus amounted to 244,000 euros per year in 2021, which seems to me to be a correct figure for the size and business of the company.

Otto Pukk's execution as CEO of Incap is impeccable, with continuous growth in sales and profits since 2018 as can be seen in the following graphs from his 2021 annual report.

The CFO is Antti Pynnonen, he has been with the company since 2019, serving as CFO since then. He was previously at Wärtsilä and ABB. Although he has a relatively young profile for a CFO position, an important point is Antti's previous experience in M&A roles, a key factor for Incap's growth.

M&A

Incap's growth is both organic and through acquisitions of other EMS providers. Several companies or factories have been acquired by Incap, such as the purchase of the Indian factory from TVS in 2007 or the purchase of 100% of AWS Electronics in 2020. These purchases have allowed Incap to relocate and expand its capacity of production in a significant way.

In such a fragmented sector, it is essential to have this M&A culture in order to grow in the sector, and it is a point where Incap's CFO has significant weight. In the Q3 2022 report, they already state that they are looking for future acquisitions in markets such as the United States or Germany, although they consider also other countries.

Risks

Investing in any company is not exempt of any risk. In the case of Incap, the main risk we see would be in the event of a prolonged recession. Although Incap produces for OEMs in a multitude of sectors, some more cyclical than others, it is not a business that is exempt from some exposure to the cycle. An important part of their business is focus on green energy, with obvious tailwinds.

Another risk that we have is that given the small size of Incap compared to the big ones in the sector, a big fish comes and eats us. This is a risk that can be both a threat and an opportunity, it all depends on the price they pay for the company.

A risk that is still present is Covid, although luckily less and less. This issue affected the company due to the closure of the factories in India due to the lockdowns in the successive waves of covid during 2020 and 2021.

Other risks to consider are the current geopolitical situation, the price and availability of raw materials. The case of energy is not a relevant risk for Incap since its factories are not gas intensive.

Incap shareholders

Regarding the shareholders of the company, the stake of the Incap insiders is low, the CEO only has 0.13% of the shares, it is one of the only weak points that I see in the thesis. Incap's largest shareholder is Erkki Etola with 22% through Etra Invest, the investment arm of the Etola Group, a holding company of Finnish industrial companies.

In addition, we have other Nordic holdings with a slightly lower stake. We know that there are several Spanish funds that hold Incap shares (True Value Compounders, Cornamusa, Bankinter, Acacia, etc).

The performances of Incap stock $ICP1V

Regarding the behavior of the Incap $ICP1V stock on the stock market, in the last 5 years it has registered +1547%, a pity not having discovered this company much earlier. In 2022 the share had a YTD +9%, which for such a bad year for investors is not bad at all. Let us also take into account that the Helsinki index of midcaps of which Incap is a part was -23% in 2022.

Regarding the returns to shareholders, in the short term the company does not contemplate distributing dividends or repurchasing shares. The cash they generate needs to be used to invest in the new factory, improve existing factories and future acquisitions.

The truth is that it is a very little-known company, right now it is only followed by one analyst. A factor that is an advantage for us, as long as it continues to compose as it has done up to now, it seems perfect to us.

Valuation and target price

Right now, the Incap share is trading at €17.24, which means a PER 20 and an EV/Ebitda 15. It cannot be said that it is a cheap company, compared to its competitors it is at an averager valuation. But considering the growth of this company and the quality of the business I see it as a fair valuation.

Regarding the target price, if we estimate a PER 15 and an annual growth of 20% (you cannot grow at 50% every year), we have an Incap share price of €28 in 2025. This is without considering any further acquisition, So I think that's a pretty conservative price target.

Conclusion

And as a conclusion, I give you my personal opinion about Incap and why I have it in my portfolio. I believe that the Incap share is one to keep in the portfolio for the long term and that it will keep compounding as a good Nordic. Incap is in a sector with tailwinds, it has a good acquisition policy, good margins and returns on capital, and a management that, although it does not have a significant stake in the company, has been performing impeccably in the last 4 years. Every time Incap corrects I take the opportunity to expand my position and in fact it is already in the Top 4 of my portfolio. I repeat, it is a long-term action, it is not an action to trade or to keep it in your portfolio for 6 months or 1 year.

I hope you liked the first thesis of my substack. If you have comments, doubts, information to contribute, you know, write below.