Hammond Manufacturing Update 05/04/2024

• Operating Leverage

  • Operating expenses as a percentage of revenue decreased from 2020 to 2023 due to higher utilisation of the old plant. From 2010 to 2020 operating expenses as a percentage of revenue were not decreasing. In the second half of 2023, a new plant opened and is now working one shift, compared to 2 shifts for the old plant, so it is currently only partially utilised. As a result, operating expenses as a percentage of revenue increased from 23.1% to 24.4% of revenue in 2023 compared to 2022. This year the new plant will be working for the whole year instead of only half a year, so if the utilisation doesn't increase it is probably reasonable to assume that operating expenses as a percentage of revenue will increase by around 1.3 percentage points more to 25.7% of revenue, in line with 2019 levels. In the long run, I expect that operating expenses as a percentage of revenue would fluctuate in the 23% to 26% range because as the capacity utilisation of the old plants increases they will build new plants diluting the operating margin.

• Gross Margin

  • Revenue: after Covid, there was a surge in demand and all manufacturers increased prices. Prices were increasing throughout 2022 and Hammond was following, as it is typically a price taker. In 2023 only one competitor increased prices, but Hammond decided not to follow with the price increase. Someone from the company said that some customers are not demanding to lower the prices and are not threatening to go to competitors. So it is reasonable to assume that prices will not be going up as fast as they were in 2022 or not going up at all, but they are also unlikely to be dropping.

  • Expenses: around 70% of the company’s expenses are wages, and roughly 30% is the cost of materials (metal). While the prices were increasing, the wages were not growing proportionately because they are typically set once every three years during negotiations with the labour union, and were set in 2020, before inflation increased around the world. Currently, the company is negotiating with the labour union and the wages are likely to increase by 4% this year, it's not clear what the increases in the next two years will be.

  • Gross margin: this year there are not likely to be any price increases, but the wages are likely to increase by 4% so the gross margin is probably going to contract. There was no fundamental change in the industry structure or the company’s product mix and the industry remains competitive so there will probably be pressure on margins in the future.

• Capital Allocation

  • Management intends to keep building plants.

• Revenue Mix and Drivers

  • Revenue Mix: roughly 20% of revenue is from servers. According to someone from the company, servers are the most competitive segment, as customers are price-sensitive and often buy from Chinese manufacturers.

  • Drivers: the majority of revenue is from factories and warehouses, so the main driver is probably manufacturing capex and manufacturing activity.