InCap Oyj (HEL: ICP1V)

InCap Oyj (HLSE: ICP1V) is a high return on capital business that operates as an electronic manufacturing services (EMS) contractor. The business generated €221.59 million in revenue in 2023 and €109 million through the first six months of 2024. InCap is headquartered in the mean streets of Helsinki, Finland.

Note: This writeup will cover InCap since 2015 after it divested its mechanics division and focused solely on EMS contracting.

History

InCap was founded in 1985 under the name Teknoinvest and took its current name in 1992 after the merger of three development companies operating in various industries. The business developed further and went public on the Helsinki Exchange in 1997.

InCap operates globally and has several subsidiaries. The first came about with its expansion into Estonia in 2000. A sales office was established in India in 2006 and manufacturing operations were underway by 2007. Its Hong Kong office, which serves as its sourcing and purchasing center, was opened in 2011. AWS Electronics Group was acquired in 2020 which brought InCap to Slovakia and the United Kingdom. The business planted its flag in the United States last year when it acquired Pennatronics of California, Pennsylvania.

CEO

Otto Pukk is the President and CEO of InCap and has served in this role since September 2018. Per InCap’s website, before becoming CEO, he was the director of Incap’s operations in Estonia. Before that he worked at Eesti Energia Technology Industries and ETAL Group.

CEO Compensation

Mr. Pukk’s compensation is comprised of a base salary, a performance bonus, and stock awards through InCap’s long-term incentive plan.

Base salary

Mr. Pukk’s base salary in 2022 and 2023 was €264,000. There was no update in the most recent Remuneration Report on what his base salary for 2024 will be.

Performance Bonus

Per the 2023 Remuneration Report, “The maximum possible bonus under Otto Pukk’s CEO agreement is 60 percent of the fixed annual salary. Payment criteria are revenue, operating profit, and net working capital/revenue.” The Remuneration Committee does not mention how much each criterion contributes towards his performance bonus. His performance bonuses in 2022 and 2023 were €37,125 and €151,272.

Long-term incentive plan

This plan is based on a 3-year performance period, with a new performance period starting at the beginning of each year. The rewards are paid partly in InCap shares and partly in cash although the actual split between the two forms of payment was not disclosed.

The rewards for the performance periods of 2022 – 2024 and 2023 – 2025 will be based on InCap’s cumulative operating profit (EBIT). There was no mention of what the EBIT targets were for either measurement period.

The CEO is obliged to hold 50% of the received net shares until his shareholding in the business equals 100% of his annual base salary from the previous year.

Mr. Pukk’s total compensation is highlighted in the screencap below which was taken from p. 4 of InCap’s 2023 Remuneration Report.

Mr. Pukk has some skin in the game. Per TIKR, he owns 40,000 shares (~€450,000 - €500,000) of stock which equals 0.14% of the business. Not a ton, but he doesn’t make a ton either and I do like that he’s required to hold shares in the business for a period until his shareholding equals his base salary from the previous year.

Per InCap’s HY 2024 Report, as of the end of June 2024, insiders own 2,123,031 shares or 7.2% of the business. This is up substantially from prior years when insiders owned about 1% of the enterprise.

What Does InCap Do?

As stated in the introduction of this write-up, InCap operates as an electronic manufacturing services (EMS) contractor. If you’re like me, you may be unfamiliar with what an EMS contractor is or does. The best general answer I gathered from my research is that businesses in this market work with original equipment manufacturers (OEMs) across a host of industries and offer a variety of design, assembly, manufacturing, and engineering services. Per its website, InCap serves customers in the aerospace, automotive, consumer electronics, data storage and media, defense, environment, food/vending, industrial controls, industrial automation, medical, oil/gas/mining, power, security, scientific instrument, telecom, and transport and infrastructure industries. It focuses on high mix/low volume production. “High mix” means that the business manufactures a large variety of products.

You also may be wondering why an OEM would want to use an EMS contractor in the first place. It, unsurprisingly, boils down to time and money. Using an EMS contractor allows the OEM to focus on their core business through research and development of their products along with sales and marketing. It also allows them to save money on costs because they do not have to undertake the building of manufacturing facilities and hiring additional employees and materials to maintain those operations.

Listed below are the services offered by InCap along with a description of each which were taken from InCap’s homesite:

Prototyping and Engineering Services – Per its website, Incap supports prototype projects and new product introduction as a part of design validation services. Prototyping is one element of the New Product Introduction (NPI), which involves short production runs for testing as well as for design validation and manufacturability.

Assembly and test of prototype products will undergo detailed review providing design feedback and evaluation of quality, documentation and production.

Regarding new product introduction, Incap supports NPI in the early stage of the product life-cycle process to assist OEMs to shorten their lead time to market. The efficiency and effectiveness of the NPI process is driven by dedicated teams.

Regarding its engineering services, “… we contribute to improved product design by early involvement in the design process and further help improving the manufacturability through Design for Manufacture (DFM) to reduce the number of issues encountered during mass manufacturing. In addition, we contribute to improved design for testing (DfT).”

PCB Assembly Manufacturing – Per pcbonline, printed circuit board (PCB) assembly is a finished electronic board mounted and soldered with all components and cables it requires. This is InCap’s core competency.

Box Build Assembly – InCap assembles all the components of a specific electronic product into its enclosure (the box).

Customized Solutions ­– The focus here is on “Test Development” meaning InCap works with its customers to develop testing and inspection methods to reduce product defects.

Cable and Wire Harness Assemblies – The best definition I could find on cable and wire harnesses comes from JEM Electronics which states, “The difference between cable assemblies and wire harnesses is that cable assemblies create a path from one point or circuit to another, while wire harnesses connect several points or circuits with multiple breakouts running in different directions, serving multiple functions with multiple terminations on each breakout.”

Engineering Services – On its website, InCap states that its engineering services “… contribute to improved product design by early involvement in the design process. We further help improve the manufacturability through Design for Manufacture (DFM) to reduce the number of issues encountered during mass manufacturing.  We also contribute to improved design for testing (DfT).”

Magnetic Assemblies – I’m going to be honest with you here. I’m not sure what magnetic assemblies are. They’re not described in detail on InCap’s website and the best definition of them that I could find comes from a company called Stanford Magnets which state that they are, “… components or devices or systems that combine magnetic & non-magnetic materials with the aim of high magnetic field and cost reduction. They are used for a huge variety of applications including latches, signs, displays, tools, and fixtures.”

After Sales Support and Services – Per its website, this segment focuses on maintenance, repair, and overhaul (MRO) of electronics. InCap has the capabilities to repair current, legacy, and non-InCap equipment, refurbish and upgrade equipment, reverse engineer legacy equipment and handle obsolescence management.

InCap’s global operations are shown in screencap below.

Helsinki, Finland – Headquarters of the business and serves its management, investor relations, and finance functions.

Hong Kong, China – Serves as InCap’s sourcing center.

Kuressaare, Estonia – Per its website, Incap Estonia is logistically well situated to enable fast deliveries to the Scandinavian and Central European markets. The factory has 7,300 square meters of total floor space.

The modern factory building enables fast and flexible manufacturing of different types of products with a focus on the ramp-up of new products. It also offers InCap’s prototyping and engineering services, PCB assembly manufacturing, customized solutions, box build, and after-sales services. A YouTube video about this factory and its operations can be found here.

Tumkur, India – Per its website, InCap India’s modern manufacturing facilities in Tumkur serve global customers all over the world. The factories have 26,500 square meters of total floor space.

The Tumkur factories specialize in the manufacturing of electronics and box-build products, having long experience particularly in power electronics. Hundreds of different products are being produced in our Tumkur factory – among them are power supplies, inverters and UPS, fuel dispensing systems, boards for LV/MV drives and other industrial electronic products. A YouTube video about this factory and its operations can be found here.

Newcastle-under-Lyme, United Kingdom – Per its website, Incap’s factory in UK, based in Newcastle-under-Lyme, provides full turn-key product supply including PCBAs, electro-mechanical assembly, cable and wire harness assembly alongside a dedicated standalone rapid prototyping facility (Fast Track) and maintain, repair and overhaul services (MRO). The factory has 4,400 square meters of total floor space. It has over 20 years of experience in the defense, security, and aerospace markets. A YouTube video about this factory and its operations can be found here.

Námestovo, Slovakia – Per its website, Incap’s factory in Slovakia, based in Námestovo, provides a competitive-cost volume manufacturing option for customers in addition to featuring a dedicated hall for automotive business. The factory has 6,400 square meters of total floor space. It provides specialist, niche PCB assembly, complete product build and electro-mechanical assemblies along with box build services. A YouTube video about this factory and its operations can be found here.

Pennsylvania, United States – Per its website, InCap US offers PCB assembly, box build, design engineering, function test design, and customer repairs management. The factory has 6,500 square meters of floor space.  A YouTube video about this factory can be found here.

What Is Unique About InCap?

I had a difficult time trying to crack what was unique about InCap. There wasn’t much mentioned in its public filings about what sets it apart from other EMS businesses. I was able to find one defining feature, decentralization, which I will discuss at the end of this section, but the bulk of what I believe sets this business apart from the others comes from an equity research report I found on CEO Otto Pukk’s Twitter/X account. He linked to a report by Antti Viljakainen at Inderes. Mr. Viljakainen is listed as the “Head of Research” at the company which describes itself as one that “… democratizes investor information by connecting investors and listed companies. We help over 400 listed companies better serve investors. Our investor community is home to over 70,000 active members. We build solutions for listed companies that enable frictionless and effective investor relations. For listed companies, we offer Commissioned Research, IR Events, AGMs, and IR Software.” Inderes operates in Finland, Sweden, Norway, and Denmark.

I thought Antti’s report on InCap was fantastic and one of the best equity research reports on a microcap business that I’ve ever read. There is a five-page section in the report (pp. 21 – 25) about InCap’s strategy where Antti drills the unique attributes of this business. I have screencapped those pages below.

A link to the full report on InCap can be found here. I highly recommend reading it: https://www.inderes.fi/en/research/incap-extensive-report-pressure-test-passed-growth-path-lies-ahead

You may be thinking it’s lazy to post someone else’s work and I would reply by saying, “Thank you.” I would follow up by telling you that Antti’s access and work on InCap’s strategy and what makes the business unique is way better than I could’ve hoped to achieve, and I think it would be stupid to try and compete with him on this when he is a) largely right in his analysis and b) did a lot of the heavy lifting. He absolutely deserves almost all of the credit for this section. I also reached and got his approval to use those pages in this writeup.

About that decentralization. Otto Pukk was asked recently in a couple of recent investor Q&A’s about what sets InCap apart from its competitors in the EMS market. His answer was decentralization which gives the business three advantages over the competition. They are:

1. Customer service is very high. Each of InCap’s customers has a dedicated team to work with them on every facet of their relationship and product journey. This allows InCap to go the extra mile with its customers by allowing them to get their product(s) to market quickly.

2. Employees are allowed to take responsibility for their work, which drives decision-making and the overall business.

3. Low overhead, especially at the executive level. There are <10 people at InCap headquarters.

   1. Related to low overhead is that each of its locations seem to be mostly independent of one another and left on their own as long as they’re meeting the standards set by headquarters. In the “Factories are responsible for the whole” subsection on pp. 9 – 10 of the equity research report linked above it states, “Factories that operate as independent cost centers are responsible for their production planning, customer acquisition, offer calculation, actual production processes and pricing, as set out in the Group Guidelines. In turn, component procurement is mainly organized through local teams within the production operations, although procurement is also coordinated at group level through the Hong Kong supply unit as well.”

Valuation

All of the data in the screencaps below, besides my calculations of real free cash flow, ROIC, and ROIIC, were taken from TIKR.

Revenue

InCap’s revenue growth from 2015 – 2023 is shown in the screencap below.

The business managed to CAGR its revenues by 24.6% per year over that time frame. Three- and five-year revenue CAGRs were 9.28% and 25.55% indicating that the business has experienced a substantial decrease of late. 2023 was a down year due to its largest customer having too much inventory and therefore not requiring as much business from InCap. Management believes this issue has largely been alleviated.

Revenues through the first six months of 2024 were down 15.6% to €109 million from €129.1 million during the same period in 2023. Not great, however, the business did manage to increase revenue outside of its largest customer by 34.2%. I will comment on this in the Risks section of this writeup.

InCap also provides a geographic breakdown of revenues which I have posted below. These data were taken from InCap’s annual statements, not TIKR.

Europe has been and continues to be InCap’s largest market by far. North America, the largest EMS market in the world, has experienced substantial growth over the last few years even before Pennatronics was acquired. I did not find any commentary on the lack of exposure to South America.  Asia has seen steady revenue growth and is up 70% since 2021. I’m unaware as to what went on in Africa and Australia. Both continents were experiencing impressive revenue growth and then didn’t contribute any revenue in 2023.

Last point about revenue, Otto Pukk stated in InCap’s Q2 2024 Report that revenue will be higher in 2024 than 2023, but operating profit will remain the same.

The business currently trades at ~1.4x 2023 revenues given its current market cap of ~€311 million.

Real Free Cash Flow (RFCF)

InCap’s real free cash flow is shown in the screencap below.

InCap’s aggregate RFCF growth has been explosive with a CAGR of 108%+ per year between 2015 and 2023. Those results, while staggering, have been quite variable, especially over the last three years, mainly due to changes in accounts receivable and inventories. Accounts receivable increased by €7.78 million in 2021, €5.42 million in 2022, and decreased by €17.93 million in 2023. Inventories in 2021 and 2022 increased by €34.62 million and €35.59 million respectively, while they decreased by €25.91 million in 2023. The business currently trades at <9x 2023 RFCF which seems like a cheap multiple for a business of this caliber.

Antti Viljakainen’s report offered gainful insight into InCap’s cash flow situation on p. 13 of the report linked above where he states, “Incap's operations are working capital intensive because with the actual figures of the last few years, Incap has in a simplified calculation gained an EBITDA of around 0.15 MEUR from 1 MEUR revenue growth and the corresponding working capital commitment has been some 0.25 MEUR. Thus, during Incap's particularly strong organic growth in 2021-2022, the company has not generated much cash flow from operations, despite a very strong result as the result has been tied up in inventories. However, the silver lining of last year’s volume drop was that cash flow improved and turned abundant especially in Q4. In the short term, earnings and cash flow can continue to tell different stories, but we would not be too worried about this.”

More insight on InCap’s cash flow was provided on p. 26 of the report where it states, “Considering Incap's organic growth picture and the working capital needs it requires, the cash flow ratio (cash flow from operations/EBITDA) is generally under 100%. However, this is normal for contract manufacturers and Incap's cash-flow profile is in no way different from normal. In our view, the company's fixed capital expenditure needs for the coming years are moderate, which together with high operating profitability should provide the basis for comfortable free cash flow generation now when the outlook for the growth rate is lower than in 2021-2022 in all scenarios. Looking further ahead, good cash flow is also a prerequisite for profit distribution, although, as mentioned earlier, we hope that the dividend will continue to play a small supporting role in Incap's capital allocation.”

Capital Structure

The asset side of InCap’s balance sheet is shown in the screencap below.

This side of the balance sheet looks pretty good. The cash balance ballooned in 2023 due to the decreases in accounts receivable and inventories mentioned above along with the issuance of debt to fund the acquisition of Pennatronics. I didn’t see any additional causes for concern.

The liabilities and equity side of InCap’s balance sheet is displayed in the screencap below.

The only possible concern I saw was the increase in long-term debt in 2023 to €23.64 million from €5.43 million the previous year. From what I gathered in 2023 Annual Report, most of the increase in debt was related to the acquisition of Pennatronics during the year.

Returns on Invested Capital (ROIC)

InCap’s returns on invested capital from 2015 – 2023 are shown in the screencap below.

InCap performs well on the ROIC front as it has managed to keep its ROIC well above 20% in most years with lower, but still healthy results, in 2016 and 2023. InCap’s documents and Antti Viljakainen’s report both indicate that the business’ profitability is near the top of its industry globally. Looks like they’re running a tight ship over there in Helsinki. On to ROIIC.

Returns on Incremental Invested Capital (ROIIC)

InCap’s returns on incremental invested capital from 2015 – 2023 are shown in the screencap below.

My analysis indicates that InCap compounded its value by 18% from 2015 – 2023. Per Yahoo Finance, InCap’s stock price closed at €1.35 on 12/30/2015 and €7.72 on 12/29/2023 resulting in a CAGR of 21.38% which was mostly in line with my calculations. The stock price has rocketed an additional 36% to ~€11.00/per share since the beginning of 2024 and that raises its stock price CAGR to ~25% which points to the business being somewhat overvalued.

Risks

Customer concentration – InCap’s customer concentration has historically been quite high. Its two largest customers have routinely accounted for 60% - 70% of revenues with that figure peaking at 74% in 2017. Its largest customer contributed 67% of revenues in 2022 and 47% of revenues in 2023. I mentioned earlier that sales to customers outside of its largest account were up 34.2% during the first six months of the year, which I find encouraging. This risk should decrease assuming InCap’s continues to grow and gains a more diverse customer base.

Pricing power – InCap’s gross and net profit margins don’t fluctuate much with increasing revenues indicating that it doesn’t have much pricing power, economies of scale, or perhaps both.

Copying of operating model – In theory, there is nothing stopping one or all its competitors from adopting a decentralized, lean structure like what we’ve seen at InCap. Realistically, I think it’s very difficult for current competitors, especially the large ones, to emulate this business, but it would be easier for a start-up operation or smaller competitor to implement.

Loss of customers - Antti Viljakainen’s report mentions this, and I think it’s important. Customers are quite sticky in the EMS market. That’s great for repeat business, but gaining a new one takes a while. Losing or replacing clientele is a real pain in the ass.

Tailwinds

Electric products and digitalization – Per p. 9 of the 2023 Annual Report, “The increasing need for sustainable energy solutions, medical equipment, emerging 5G and IoT ecosystems and the proliferation of electric vehicles contribute to the demand growth. Population growth and aging population will also create opportunities in for instance health care technology.”

Acquisitions – There are thousands of EMS businesses globally giving InCap’s management the opportunity to spread the gospels of decentralization and lean cost structures across the planet.

Size of the EMS market – The EMS market is massive. Antti Viljakainen’s report states that the current contract manufacturing market to be worth ~$550 billion. Gekko the Great, who does great work, especially if you know Spanish, cites data that the EMS market generated $500 billion in revenues during 2021 which will increase to $900+ billion by 2028 in his writeup on InCap. Both of these figures could be off by 50% and still leave InCap with a tremendous growth runway.

Continued outsourcing to EMS contractors– This remains a win-win scenario for both parties involved and I don’t see it slowing down anytime soon. EMS contractors will continue to handle the manufacturing while their customers are able to focus their attention on the design, sale, marketing, and branding of their product.

Conclusion

I found InCap to be an intriguing business. It’s a well-run enterprise that operates in a win-win scenario for its customers, has high returns on invested capital, and a massive growth runway. What’s not to like about that? My only problem is its stock price. In the best-case scenario it’s fully valued and most likely a bit overvalued. I would need more confidence that revenues were going to increase at levels like we saw during COVID for a sustained period for me to be comfortable with buying shares at current prices. InCap has been moved near the top of my watchlist and I’ll continue to monitor it going forward, but for now I must pass.

Thanks again as always for reading. If you liked this writeup, please feel free to share it and subscribe!

Please reach out to me at possiblevalueresearch@gmail.com, @PossibleValue on Twitter and @Heshy on MicroCapClub with any comments, concerns or questions. Lastly, don’t forget to tell someone that you love them.

*** Remember that this isn’t investing advice. Consult a trusted financial or investment advisor before making any kind of investment decision. ***

Disclosure: I do not own shares in InCap.