BUY with an upside of 37%. We initiate coverage on Inari Amertron (Inari) with an OUTPERFORM recommendation and a target price of RM2.50 based on CY21E PER of 30x, representing +1SD above its 3- year mean considering it being the purest proxy to 5G adoption in the US flagship smartphone. We forecast a 72% YoY jump in FY21E CNP on the back of (i) c.75% increase in RF filters per handset, (ii) high anticipation among consumers for the upcoming US flagship smartphone given the long overdue (c. 4-5 years) replacement cycle and (iii) broadening exposure in the rapidly growing data centre space. The stock is currently trading at CY21E PE of 21.9x; an ungrounded discount to peers’ average of 27x (based on Bloomberg consensus).

RF content to rise with 5G adoption. Inari’s radio frequency (RF) space is poised for a massive upcycle with the adoption of 5G in the upcoming US flagship smartphone as its key customer has secured a 3-year US$15bil deal to continue supplying wireless components to the US smartphone maker. RF filters per handset is expected to jump c.75% so as to maintain a healthy signal to noise ratio (SNR), especially when incorporating higher frequency bands. In anticipation of higher loading volume, Inari is adding 8 more system in package (SiP) assembly lines for RF in its P34 plant (Batu Kawan), in addition to the existing 8 lines in its P13 plant (Bayan Lepas).

US smartphone replacement cycle is long due with the top 3 active US smartphones in circulation still comprising 4-5 year old models such as the 7th gen (2016), 6th gen (2015) and 8th gen (2017). These models are likely experiencing hardware bottlenecks and end-of-life support for new operating systems (OS) which would result in less-than-optimal user interface (UI) experience. Hence, it is very likely that the 2020 model will be the go-to choice for a future-proof upgrade among consumers. In addition, the new 14th gen OS will bring about long awaited features (eg. widgets, picture-inpicture and app library) which is expected to be very well received and could potentially win over market share from the Android user base.

Riding along data centre expansion. With 5G demanding more frequency bands on the consumer front, back-end data centres are seeing the need for faster wired connection among servers in order to deliver content to consumers at 5G speeds. Inari aims to manufacture optical transceivers that are used in data centres to encode and decode electric signals into light pulse for data transmission over a distance via optic fibre. The group will be focusing on optical transceivers capable of transfer speeds up to 400 Gbps, 4x the speed of current transceivers used in data centres. Contributions are expected to kick in FY21, in tandem with the market’s transition to 400 Gbps as global deliveries for 100-200Gbps ports are expected to peak in 2020.

Forecast FY20E and FY21E NP of RM140.4m and RM240.9m representing growth of -28.8% and 71.26%, respectively. We expect the softness in smartphone shipment to end in FY20, followed by a massive upcycle of 5G adoption in FY21.

Initiate with an OUTPERFORM recommendation and a Target Price of RM2.50 based on CY21 PER of 30x (representing +1SD above its 3-year mean). At current level, Inari is trading at CY21E PE of 21.9x; an ungrounded discount to peer’s average of 27x (based on Bloomberg consensus).

Risks to our call include: (i) less aggressive orders from its key customer, (ii) delay in 5G rollout, and (iii) higher-than-expected input costs.

Source: Kenanga Research - 27 Jul 2020