Investment Highlights

• We maintain our HOLD recommendation on Inari Amertron (Inari) with a higher fair value of RM2.72/share (previously RM2.18/share). We have raised our FY18F-FY20F earnings forecast by 20-28% due to expected higher radio frequency (RF) orders, capacity expansion for iris-scanning components and lower effective tax. Our fair value is pegged to an unchanged PE multiple of 18x based on 1SD above its 3-year average.

• We came away from Inari's analyst briefing feeling more positive about the company's growth prospects. We highlight below the 5 key takeaways from the session:
  1. The next two quarters are expected to be exceptionally strong in conjunction with the launch of a flagship smartphone in September. Judging from the sales response of the previous model, we believe customers had deferred spending for the upcoming "anniversary phone". We believe sales response in the first quarter of the new smartphone's release could resemble the phenomenon in 2015 when the smartphone maker release a big-screen model, which saw a huge bump in unit sales (45% YoY). In view of this, we are raising our growth forecast for RF sales from 15% to 30% for FY18F.
  2. The first phase of the group's P13 plant extension (P13B), which will increase floor capacity by 58,000 sqft from its current 160,000 sqft, is completed. Management is now looking to proceed with the second phase of extension, which will expand floor capacity by 120,000 sqft. The extended building is estimated to cost RM10mil and take 6-7 months to complete (1-2 months for planning and approval; 4-5 months for construction). The additional floor space is needed to prepare for the group for potential pent-up demand for the new smartphone model.
  3. The group's Inari Optical Technology (IOT) division, which produces iris-scanning components, is currently running at 4mil units (KKu) per month. Inari plans to double the division's capacity from its current 5KKu/month by the end of 1QFY18 and expand by an additional 6KKu/month in 3QFY18. We estimate that this would contribute ~10% of FY18F revenue.
  4. With regards to the wafer migration from the 6-inch to 8-inch, we learned that the usage mix is approximately 50:50 at present. Management believes that the migration has reached a "saturation level" seeing that its customers have encountered technical issues in using 8-inch wafers. As such, we do not foresee any negative surprise in RF-related revenue arising from this issue going forward.
  5. Management believes that the group will be able to extend the pioneer status for its RF segment by another 5 years. For this reason, we are lowering our FY18F-FY20F effective tax rate projections from 10-11% to 5-7%. We note that there will be a 6-month lapse (during which Inari has to pay taxes) before the group can enjoy the tax-exempt status as it is currently obtaining final approval. Therefore, the tax-exempt status is expected to kick in during 2HFY18F.

Source: AmInvest Research - 24 Aug 2017