Highlights

• Briefing outcome was neutral due to near term challenges in RF while improvement is only expected by Sep 16. Relentless diversification with new income streams ahead, including chip fab (FY17), mixed signal testing (FY18) and fibre expansion with new China customer (FY18).

• RF: Current capacity is sufficient although only added 50% while client doubled theirs. Will only match demand when orders are firm via P13B extension. Testers are expected to top 680 units by Sep 16 while pushing for higher productivity by extending utilization time. Avago is expanding end client portfolio, focusing on China to reduce dependency on current 2 main ones. 4QFY16 revenue is projected to gain 20% qoq leveraging on new product launches as supply chain evolves towards JIT to minimize wastage.

• ISL: More opportunities ahead as client transfers the chip fab process from Pennsylvania and Taiwanese rivals. Maiden contribution is expected in FY17 with RM60m.

• PCL: Synergistic tie-up and knowledge transfer (SiP, wafer level and CoC) to expand fibre optics business with new potential China client while Inari has the capability to capture the most of the value chain.

• IIS: P21 phase 1 has begun to set up a cleanroom occupying 25% of the floor space. This is to serve Broadcom’s mixed signal testing by housing 50 testers. Qualification is expected to take 1 year and generate RM60-80m sales in FY18.

• The CK2 expansion at Clark Field factory yielding 90k sqft is completed and ready for commissioning.

• Business opportunity with Osram is expected to be delayed.

• Beyond FY16, Inari is guiding for 18% yoy growth in FY17 on the back of bullish growth expectation of 35% in RF.

Forecasts

• Cut RF segment sales forecast based on latest management guidance which led to lower FY16-18 EPS by 21-28%.

Catalysts

• Wireless communications / mobility / IoT (M2M) / LTE.

• Business diversifications into optoelectronics and T&M.

• Favorable FOREX.

• Continuous effective operational strategy.

Risks

• Major client risk (Avago) / high dependency.
• FOREX risks.
• Patent disputes.
• Resources / labour shortage.

Rating

HOLD , TP: RM2.86

Positives

• Appreciation of greenback, 40% dividend payout providing reasonable yield and strong earnings growth.

Negatives

• Innovation stalemate in telecommunication.

Valuation

• Reiterate HOLD after lowering our TP by 20% from RM3.57 to RM2.86 reflecting the downward earnings revision. Our TP is pegged to unchanged P/E multiple of 15x CY17 FD EPS.

Source: Hong Leong Investment Bank Research - 20 May 2016