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Plexus Upgraded to Neutral

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We are upgrading our recommendation on Plexus Corp. (PLXS - Analyst Report) from Underperform to Neutral. In the recently concluded first quarter, Plexus reported mixed results, where the company’s bottom line beat the Zacks Consensus Estimate by 3 cents though the top line lagged the revenue estimate of $532.0 million.

Plexus has been witnessing a healthy pipeline of program wins coupled with global expansion and improving end-market demand. During the first quarter, Plexus won 28 new programs in the manufacturing solutions group, which are expected to generate approximately $203.0 million in annualized revenue when production ramps.

As an engineering-focused EMS (Electronic Manufacturing Services) player, Plexus is well positioned to benefit from the increasing outsourcing trend among the Medical, and Industrial and Defense/Aerospace OEMs (Original Equipment Manufacturer). Plexus has been able to achieve strong organic growth from these two sectors, as Industrial & Commercial showcased an increase of 600 basis points in fiscal 2011 as a percentage of total revenue.

Medical also grew significantly as a percentage of sales, up 100 basis points in fiscal 2011. We believe that significant new business wins in these two sectors (58.0% of $203.0 million) will continue to drive revenue growth going forward.

Moreover, the recently concluded Kontron deal will also boost revenue from the Industrial & Commercial sector going forward. We believe that strength in these two sectors will also drive top-line growth over the long term.

Additionally, Engineering agreements generate higher margins and help improve the company’s overall profitability. The partnership with The Coca-Cola Company (KO - Analyst Report) is expected to deliver incremental revenues and represents a significant deal win for the company.

Plexus has also been expanding its manufacturing footprint in low-cost regions, establishing its presence in Mexico, Malaysia and China. During the first half of fiscal 2012, Plexus expects to announce the construction of a larger facility in Oradea, Romania to replace the leased buildings. We believe that Plexus’ policy of shifting production from higher-cost to lower-cost regions will boost profitability going forward.

However, the EMS industry is expected to grow at a sluggish rate over the next several years, primarily because it is a mature segment that is being fed by a progressively lower number of outsourcing opportunities. According to data from market research firm IHS, the global EMS Industry grew approximately 10.1% to $206.8 billion in fiscal 2011.

However, the outlook for 2012 is flat and the research firm expects the industry to grow at single-digit rate through 2015. The industry is primarily hampered by overcrowding in consumer electronics (computer, communications and consumer) market, which remains a concern for a small player such as Plexus, going forward.

Additionally, Plexus’ significant exposure to the slowing Networking and Communications industry remains a concern for us. The company also faces foreign currency fluctuation risks, as more than 45.0% of the revenue comes from international operations.

Another weak point for Plexus is the customer concentration. Plexus depends on a few large customers for a major part of its revenues. Given the competitive nature of the industry, the loss of any one of its key customers, or individual projects with these customers would severely impact Plexus results going forward.

Plexus has been plagued by supply chain constrains due to natural disasters in Japan and Thailand during fiscal 2011. Moreover, due to the lack of long-term supply agreements, these shortages are expected to continue in fiscal 2012.

Raw material and component part supply shortages and delays in deliveries can also result in higher rates. Rising raw material prices and reduced consumer spending could negatively affect sales and profitability going forward.

We believe that stabilizing end markets, new business opportunities, particularly in the industrial/commercial and medical sector and global expansion will drive growth over the long term. We also believe that a gradual improvement in the overall U.S. market will boost Plexus’ top line going forward.

Currently, Plexus has a Zacks #3 Rank, which implies a Hold rating in the short term.

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