The Future is Contract Manufacturing

Erik@YWR on Hon Hai Precision Industry Co., Ltd. (2317-TAI | honhaiprecis), Jabil Inc. (JBL-USA | jabilincjblu), Flex Ltd (FLEX-USA | flexltdflexu)

5/7/2025

Summary

The historical manufacturing environment of low tariffs and open markets may be changing. Countries like the US are more sensitive to job creation and strengthening their own manufacturing industry. In the future companies can’t just make everything in the low-cost country. Companies which manufacture products may have to produce goods in multiple local markets where they also sell the product. This increases manufacturing complexity. In addition, the situation is dynamic. Tariffs and regulations can change quickly. This situation makes contract manufacturers, such as Jabil, Hon Hai Precision and Flex, with their global footprint attractive. Where it works, and the scale is big enough, a company can use a contract manufacturer to use their local factories to produce a product and qualify for lower local tariffs. The use of these outsourced factories can be scaled up and down similar to how an AWS customer chooses the geography of their server instances. The contract manufacturing model works well for software defined vehicles (SDV’s) and humanoid robots. Both SDV’s and robots could be big drivers of earnings in the years ahead. These companies trade on forward P/E valuations of 11-15x, which is reasonable, but doesn't reflect how an environment of dynamic and increasing tariffs is good for growth of this business model.

Thesis

Three of the larger contract manufacturers are Hon Hai Precision, known as Foxconn, Flextronics and Jabil. EPS CAGR 2024-2027 Jabil: 11% Hon Hai Precision: +18% Flextronics: +12% FY1 P/E Jabil: 15.5x Hon Hai Precision: 10.4x Flextronics: 13.1x Share Price: Jabil: $150 Hon Hai Precision: TW$ 146 Flextronics: $36 Price Target 2027 Jabil: $170 Hon Hai Precision: TW$ 250 Flextronics: $48 Contract manufacturing has typically been for consumer electronics such as smart phones, desktop computers, laptops and circuit boards. A company designs the product and outsources the assembly to a contract manufacturer which may have factories in China, Taiwan, Vietnam, etc. Recently, building servers for AI data centers has also become a big growth business for Jabil, Flextronics and Foxconn. Two more future trends which fit this outsourced manufacturing business model: 1. Software Defined Vehicles. Electric Vehicles may also be designed and manufactured in the same way as smart phones. Companies will focus on design, software, sales and marketing while actual manufacturing is outsourced. All three of these companies are getting into the EV manufacturing business. This could be another big business line. 2. Humanoid Robots are likely to be another big business in the years ahead. It is similar to the EV cars. The contract manufacturers already have the supply chains for circuits, wiring, batteries, semiconductors, actuators, and assembling a robot will be similar to assembling an EV. Valuations: The companies trade on P/E’s of 11-15x which reflects investor concern about the business model. The growth outlook is actually quite positive, and the P/E’s for Flextronics and Jabil, could be closer to 20x if both the Software Defined Vehicle and Humanoid Robot trends are realised. Foxconn is a dominant operator, but gets a valuation discount for its Taiwan presence, which is seen as an extra risk. On the other hand, investors pay a premium for Jabil’s strong US presence.

Risks

The existing business of all three is still heavily reliant on consumer electronics and data centres. If there were to be a temporary lull in orders for consumer electronics because of US tariffs on Chinese made goods it could hurt earnings in 2025 and 2026 until companies can reconfigure their supply chains and consumers in the US come to accept the new higher prices. The second investor concern is the outlook for data center revenues. There is good visibility on data centre capex by the hyperscalers (Amazon, Google, Oracle, Microsoft) through 2027, but there is a fear that beyond 2027 the data centre market may be oversupplied. Net profit margins for all three are low (2-4%), so profitability depends on high volumes. Each company is trying to become more value added and to increase margins in the future, but for now the margins are low.

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