According to a new Citi Research reported dated January 2, the electronics manufacturing sector is maturing and could soon move into Phase 3 and Phase 4 of the sector economic cycle. Citi analysts Jim Suva and Zhen Yang suggest that this maturation of the EMS sector economic cycle not only makes now a good time to selectively invest in the sector, but also means that M&A activity is likely to pick up in 2014.

Maturing EMS sector economic cycle

Although current global macroeconomic uncertainties lead the analysts to say the EMS sector is still “stalled in Phase 2”, they are sanguine that the overall economy is gradually improving and that the EMS sector is likely to follow. That said, given that Phase 3 is still on the horizon, the analysts suggest the best strategy for 2014 is still investing in specific companies with strong growth prospects (i.e., ramping orders) rather than buying the sector indices.

EMS Sector

M&A activity

Suva and Yang begin by pointing out that there has already been a significant amount of M&A activity over the last couple of years in the EMS sector. 2013 deals of note include Jabil Circuit, Inc. (NYSE:JBL)’s $665 million acquisition of Nypro, Flextronics International Ltd. (NASDAQ:FLEX)’s acquisition of RIWISA and Motorola hand set manufacturing, Amphenol Corporation (NYSE:APH)’s acquisition of GE’s Advanced Sensors Business and Sensata Technologies Holding N.V. (NYSE:ST)’s $318 million purchase of Wabash Technologies.

As one might expect in a maturing sector, the analysts are not expecting a lot of blockbuster deals in 2014, but rather more accretive acquisitions. “Of note, we do not expect any transformational acquisitions in the near-term, but rather small tuck-in activity that either adds a new technology or service, or expands a company’s geographic reach.”

Top stock picks

Citi Research suggests the connector industry as the place to be in 1H 2014. Specific stocks to consider include TE Connectivity Ltd (NYSE:TEL) and Amphenol Corporation (NYSE:APH) as both companies are poised for strong growth, driven by increasing demand for a variety of electronic devices, and continued accretive M&A in a highly fragmented industry. Suva and Yang specifically mention Amphenol as a candidate for a positive earnings surprises.

Also see: Apple Inc. (AAPL)’s Mac Pros To Be Built In U.S. By Flextronics