According to Bloomberg, Apple is looking to cut its dependency on Broadcom-supplied chips that power Bluetooth and WiFi capabilities across devices by 2024 and replace them with chips developed internally. Apart from seeing some cost savings, we believe the move would also give them greater flexibility and control to design their products. For Inari, we believe its OSAT business is unlikely to be affected given its cost advantage and long establishment in the OSAT industry. We advise investors to take advantage of the negative news flow as current valuations look appealing, trading closer to -1 standard deviation. Inari remains one of our top picks for 2023. Maintain Outperform with an unchanged TP of RM3.74 based on 35x FY24 EPS.

• Slowly phasing out third-party chip supplies. Apple is planning to swap out Broadcom-supplied chips used for Bluetooth and WiFi by 2024 and replaced them with chips developed internally. The iPhone maker is currently working on a proprietary cellular 5G modem chip that was expected to replace the Qualcomm chips in the next 2 years. It is worth noting that a cellular modem allows iPhone to handle phone calls and connect to the internet while away from WiFi. Apart from Bluetooth and WiFi chips, Broadcom still supplies Apple with other components including radio-frequency chips and wireless charging chips. The iPhone maker has been working on customizing those parts as well.

• Risky move and time consuming. The chip design development requires a long period of development. Apple first started on its modem in 2018 and it also spent USD1bn to acquire Intel’s modem unit in 2019 to speed up development. However, a source back in mid-2022 cited that it is still not able to produce its own in-house 5G modem and Qualcomm will remain the exclusive supplier chips for the 2023 iPhone models. Currently, Apple has already adopted its own WiFi and Bluetooth chips in certain products like AirPods and Apple Watches. If Apple’s offering is inferior to Broadcom and Qualcomm products, it could put the company’s flagship products at risk.

• Worst-case scenario. In the event Apple successfully develops all types of chips required by its devices, our back-of-the-envelope calculations show that the Inari’s direct exposure to the world leading smartphone maker revenue is only 17%-18% given that Apple contributed about 20% to Broadcom’s annual revenue. At current share price, we think the negative news flow has been fully priced in. Alternatively, Apple could directly outsource its assembling and testing jobs to the usual outsourced semiconductor assembly and test (OSAT) partners given the i) efficiency and size, ii) cost advantage and iii) reliable track record. We think the chances for Apple to expand into the OSAT area are low given the high operating cost structure in the US.

• Diversification is on the way. To reduce its high dependency on one single customer, Inari has initiated moves to diversify its revenue stream. It has established a joint-venture with China Fortune Tech Capital to set up radio-frequency assembly business in YiWu, Zhejiang and the commercial operations are expected to kick start by 2H 2023. It also has collaboration with Singapore-based MIT Semiconductor Pte Ltd to provide customized semiconductor process tools and solutions at P21 plant and it is expected to contribute annual revenue of RM100m.

• One of our top picks. Inari remains one of our top picks for technology sector. We expect to see higher utilization rate for the radio frequency (RF) segment in the upcoming quarter, led by better sales mix with new phone cycle, which requires a longer testing period due to higher RF content value. Management is also bullish on its RF growth outlook in FY24 on the back of RF content value growth and new design wins such as RF double-side moulding system-in-package assembly for next generation smartphones. We think it is a good opportunity to collect Inari shares in anticipation of the bullish outlook. The stock is currently trading at a forward PER of 26x, which is closer to -1 standard deviation. Amongst the technology stocks, Inari’s dividend yield of 3.6%-3.8% is also the highest given its steady dividend payout of more than 80%.

Source: PublicInvest Research - 11 Jan 2023