- We initiate coverage on Inari Amertron Berhad (Inari) with a BUY and a fair value of RM3.83/share, based on a PE of 15x FY16F earnings, due to surging growth and demand for its radio frequency (RF) chips. It is currently trading at 13x – 1SD above its 5-year average.

- Inari offers a direct play into the Tier 1 smartphone market, benefitting from the success of its key client, Avago. Avago is the preferred supplier of radio frequency (RF) products for top global smartphones due to its superior technology. Inari is one of Avago’s key back-end contract manufacturer for its RF chips.

- We forecast core earnings to accelerate from RM153mil in FY15 to RM189mil in FY16F, before rising further to RM218mil-RM241mil in FY17F-18F (3-year CAGR of 16%). In addition, net profit margins are expected to improve to 18% in FY18F from FY15’s 16%.

- Inari’s robust growth is underpinned by capacity expansion in the RF back-end processing facilities in Penang. Our estimates suggest that RF contributes to >70% of Inari’s earnings. Inari’s five RF processing plants in Penang are currently operating at full capacity. It will increase capacity by 30% in phases in FY16F through its new P13 plant, with additional ~200 million RF chips processed per annum.

- Hence, we have imputed a 25% increase in RF revenue contributions in FY16F, followed by 10%-15% increases in RF capacity and utilisation YoY for our FY17F-18F estimates. This is on the back of pent-up demand from Avago as it resolves its wafer processing constraints.

- We expect Inari’s attractive net profit margins to grow further by 1%- 2% due to:- (1) higher margin product mix; and (2) operational efficiencies in Amertron, which is Inari’s optoelectronics and fibreoptics subsidiary that was purchased in 2013. The group aims to improve its net margins from 6ppt to 10ppt via better cost control and efficiencies from procurement as part of the group’s strategy.

- Appreciation of the USD favours Inari as 99% of its sales are denominated in USD. We currently impute an average exchange rate of USD1/RM4.00. After conducting our sensitivity analysis, we estimate that for every 1% appreciation of the USD against the RM, Inari’s net profits will also benefit by 1%.

- Looking forward, Inari will diversify its earnings to grow its fiberoptics cables and receivers business on the wave of cloud computing and datacenters on a global scale. Its fibreoptics division will contribute an additional USD20mil of revenue in FY16F with its new products.

- Risks for Inari are:- (1) customer concentration risk; (2) significant slowdown in sales of smartphones; and (3) depreciation of the MYRUSD exchange rate below USD1/RM4.00.

- Inari has a strong balance sheet and currently is in net cash position.

- Inari has a dividend policy to distribute up to 40% of its net profit. This translates into a yield of ~3%. Currently it is trading at an undemanding FY16F PE of 13x. Its peers MPI and Unisem are trading at 11x and 14x each, with 3-year EPS CAGR of 5% and 21% respectively.

Source: AmeSecurities Research - 18 Sep 2015