Inari’s 1QFY19 core earnings improved 12% qoq but still fell short of the high expectations although we are of the view that earnings should have bottomed out. The RF business is still undergoing a rough patch and contribution from new products from Osram has yet to mitigate this, although it is likely to materialize by 2HFY19. The ytd stock price correction provides a good opportunity to accumulate ahead of likely stronger quarters ahead. The key catalyst for the stock lies in the transition to 5G, where we see significantly better prospects for Inari. Maintain BUY but with a lower 12-month target price of RM2.25.

1QFY19 Core Profit Down 28% Yoy – Below Expectations

Inari’s 1QFY19 core profit of RM52m (-28% yoy) was below expectations accounting for 15-17% of our previous and the street’s full-year FY19 estimates. The RF business is still undergoing a soft patch due to weak demand for the major smartphone brands. The 1QFY19 EBITDA margin is also lower by 1.8ppts yoy due to softer loading for the profitable IRIS sensor chip, which operated at full capacity in the previous corresponding period. We cut our FY19-21E EPS by 11%-21%, lowering our growth expectations.

Sequential Improvement

1QFY19 revenue excludes the revenue contribution from Ceedtec which was disposed in the previous quarter. Inari had held a 51% stake in the company which contributed c.RM60-70m revenue/year. Notably, margins have remained fairly stable.

Maintain BUY

In our view, the pullback in stock price provides a good opportunity to take position in one of the best plays in the global RF testing space. We strongly believe that Inari would be a key beneficiary in the 5G transition as demand would be spurred by a multiple-fold increase in RF components in the new devices. Meanwhile, the new product line-ups from Osram, which include a health sensor, facial recognition (2D and 3D) and a mini LED product in addition to the IRIS chip, could help support earnings, in view of the current RF soft patch. We maintain our BUY rating with a lower target price of RM2.25, based on an unchanged 24x on CY19E EPS.

Risks

Key downside risks: sharp appreciation of the RM, a slowdown in global demand for smart devices, rapid ASP erosion, loss of customer base and the introduction of new technologies that may render Inari’s products obsolete.

Source: Affin Hwang Research - 27 Nov 2018