Inari’s 1HFY20 core net profit of RM80m (-26% YoY) was below expectations as lower order loading led to diminishing economies of scale. Declared second interim dividend of 1.0 sen per share. On the quarterly YoY basis, the lacklustre performance was due to weakness in optoelectronics. Covide-19 plagued Kunshan production and is likely to drag 3QFY19. We cut our FY20-22 earnings forecasts which resulted in a lower TP of RM1.32, pegged to 20x of CY21 EPS. Reiterate SELL.

Below expectations. 2QFY20 core net profit of RM34m (-28% QoQ, -41% YoY) brings 1HFY20’s total to RM80m (-26% YoY), only accounted for 37% and 38% of HLIB and consensus full year forecasts, respectively. This disappointment was mainly due to lower order loading leading to weaker EBITDA margin as economies of scale diminishes. 2QFY20 one-off adjustments include inventories reversal (RM7m), PPE disposal loss (RM0.2m) and forex loss (RM3m).

Dividend. Declared second interim single tier dividend of 1.0 sen per share (2QFY19: 1.5 sen), which goes ex on 17 Mar. YTD dividend amounted to 2.3 sen per share (1HFY19: 3.1 sen).

QoQ. Top line lost 16% to RM265m due to lower volume loading, while forex was relatively stable at RM4.16/USD. Filtering down, core net profit deteriorated by 28% to RM34m attributable to less favourable sales mix and lower operating leverage as EBITDA margin fell by 1.6ppt.

YoY. Turnover was lower by 12% due to lower contribution from optoelectronics products. Stripping off non-core items, core earnings fell by 41% attributable to the weaker sales, changes in product mix and higher D&A.

YTD. For the same reasons above, revenue and core earnings contracted by 7% and 26%, respectively.

Virus impact. Post-CNY production resumption in Kunshan factory was delayed from 3 Feb to 17 Feb as a result of directives from the Chinese government to contain Covid-19 and shortage of returning operators due to transport disruption.

Outlook. As global semiconductor market concluded 2019 with 13% decline, WSTS is projecting 2020 to grow 6% to USD433bn, with optoelectronics recording the highest growth rate followed by logic, sensors, analog, integrated circuits and others. Gartner has estimated worldwide device shipments to add by 3% in 2020. As 5G proliferates, 5G smartphone shipment is expected to exceed that of 4G over 12 months. Inari’s RF division is looking forward to sustainable growth driven by higher chip complexity for 5G. However, we are rather cautious considering the availability of more advance 5G solutions in the market. Overall, Inari shared that short term outlook is very much clouded and the Group remains cautiously optimistic.

Forecast. After lowering our margin assumptions, FY20-22 bottom line was cut by 7- 8%, respectively. Maintain SELL with a lower TP of RM1.32 (from RM1.43) reflecting earnings cut as well as warrant dilution upon expiry. Our TP is pegged to unchanged PE multiple of 20x of CY21 FD EPS. This is the 6th consecutive quarterly earnings disappointments and RF demand may falter into early 2020 as consumers anticipate for 5G version. Besides that, the threat of its RF product being substituted by end-to-end (modem RFFE-antenna) solution is a major risk. Thus, we opine that its huge valuation premium against peers is not justifiable.

Source: Hong Leong Investment Bank Research - 26 Feb 2020