We reiterate our Accumulate recommendation for Incap and raise our target price to EUR 13.50 (was EUR 12.50). Since the rocket-like growth at the start of the decade,  the company has faced a pressure test in the past quarters due to the destocking of the largest customer, but we feel Incap is passing the test with flying colors. We estimate that the company’s demand picture is starting to look slightly brighter and expect Incap’s key strength, i.e. cost efficiency, to carry the company also in growth mode. We still find Incap’s valuation reasonable (2025e: EV/EBIT 9x) considering the earnings turnaround budding in H2 and the earnings growth potential of the next few years. 

High-performance contract manufacturer

Incap is an electronics industry contract manufacturer that primarily specializes in high mix / low volume applications. The company creates added value for its customers 1) by allowing more efficient resource allocation for OEMs core business activities such as product development, sales and marketing, and 2) by bringing flexibility to OEMs through outsourced production both to capacity and cost management. Incap's organization model is decentralized, which in turn has resulted in a light organization structure, low overhead expenses, swift operational responsiveness, and a cost-conscious culture. In addition, a significant share of the company's production is in low-cost countries (particularly India). We believe that these factors are the key strengths of the company. The main risks are still a single large customer (in 2023 the largest customer generated 47% of the company's revenue), the inherent variations in investment-driven demand, as well as possibly tightening competition.  

We expect the company to return to earnings growth soon

Incap's customer risk partly realized last year and in Q1, when the company's largest customer lowered its inventory levels due to slowing growth. In practice, Incap’s sales have stalled in the past 3 quarters, but the company’s strengths still enabled it to maintain an excellent double-digit margin in every quarter. In Q1, revenue also turned to quarterly growth. However, the electrification of the world and the resulting increase in electronics, as well as growing outsourcing rates and shares of industrial OEMs also drive the demand for contract manufacturers upward in the longer term faster than GDP growth. In addition, the fragmented structure of the industry, together with Incap's current strong balance sheet position, provides a solid foundation for inorganic growth. Considering the backgrounds of the company and the industry, we find Incap’s value creation opportunities to be good (incl. successes in AWS and Pennatronics acquisitions). In our neutral scenario, we now expect Incap to return to sales and earnings growth already this year, which is a more optimistic estimate than the company’s guidance. We expect growth in the coming years to be clearly slower than in 2021-2022. We expect profitability to remain very strong relative to the industry at 13% adjusted EBIT level, based on the strengths mentioned above. 

The valuation picture is still cautiously attractive as long as the performance starts to improve

Incap’s P/E ratios for 2024 and 2025 based on our estimates are 16x and 13x, while the corresponding EV/EBIT ratios are 11x and 9x. Absolute multiples are justifiably higher than historical levels but they are also at the lower end of our neutral multiple range for next year that is cleaner. We, therefore, consider the valuation of Incap, which has convincing quality features, attractive, and the expected return is still good, as long as the company’s earnings growth expected to start in H2 is roughly in line with our estimates. We slightly lowered  Incap’s required return that increased last year as the outlook continues to brighten.