We hosted Inari’s CEO Mr Lau Kean Cheong, ED Mr Ho Phon Guan and Corporate Affairs Head Mr Justine Jiew in Singapore recently. Maintain BUY with our TP raised to MYR4.41 (from MYR4.35, 29% upside) following revisions in our USD/MYR assumptions as management reaffirmed its intent to expand the RF and fibre-optics businesses by leveraging on its close rapport with Avago.

Continued radio frequency (RF) unit expansion. Inari Amertron’s(Inari) integrated packaging and testing services (IPTS) houses >500 units of testers. Management is looking to increase this to >700 units by September. We expect machines to be installed on a staggered basis in its newly-completed P13 production plant with its full capacity of >850 testers (based on existing floor space) to be achieved by 2H16. Beyond that, the group is looking to further expand its RF division with a new building to be erected next to its current P13 plant. Construction of the building, estimated to cost ~MYR45m-50m, is slated to commence in September with Phase 1’s completion pencilled for early 2H16.

Amertron to focus on profitability. On its existing Amertron business,management reiterated its near-term focus to enhance production efficiency in order to improve profitability. Ultimately, the group is eyeing to improve the segment’s NPM to 10% from 6-7% currently. Inari South Keytech SB (ISK) is currently running at about 50% utilisation rate with annual revenue contribution of MYR15m-20m. To achieve greater economies of scale, ISK is planning to work closely with AvagoTechnologies (Avago) (AVGO US, NR) to capture other open sources by offering value-add services on Avago’s existing fibre-optics products.

Other highlights. Management also intends to ramp up operations at 51%-owned Ceedtec SB, hoping to double its presence in the next 1-2 years from the current revenue run-rate of MYR40m-50m pa. Given the capital-intensive nature of the business, we see a potential spin -off of Ceedtec to help raise capital for further expansion, as the company is eyeing for more job opportunities with Agilent Technologies (Agilent) (A US, NR). Progress for its newly set up fibre-optics chip fabrication wing, parked under Inari Semiconductor Labs SB now, is largely on track with commercial operations set to commence by early 2016. Although earnings accretion is unlikely to be significant, we see this, upon official commission, as an important milestone and a testament to Inari’s capability to be involved in higher-skilled upstream semiconductor works.

Firing On All Fronts Continued expansion of its RF business unit. Inari’s IPTS segment currently houses more than 500 units of testers, all on a consignment basis from its major customer Avago. Management is looking to increase this to more than 700 units by September, to be in line with Avago’s latest sales projections. We expect the machines to be installed on a staggered basis at Inari’s newly-completed P13 production plant, with its full capacity of more than 850 testers (based on existing floor space) to be achieved by 2H16. Beyond that, the group is looking to further expand its RF division with a new building to be erected next to its current P13 plant. Construction of the building, which is likely to cost an estimated MYR45m-50m, is slated to commence in September, with completion of Phase 1 by early 2H16. We laud management’s move to further strengthen its presence within the RF space to ride on escalating demand from Avago, due to the fledging sales of the latter’s film bulk acoustic resonator (FBAR) filters. In essence, the FBAR filter is a vital component in smart devices, which helps users to obtain optimal connection speeds across different frequency bands. The technology allows phones to operate over multiple bands worldwide, thereby eliminating interference and allowing phones to transmit more effectively. The continued rollout of 4G networks across the world , in our view, is likely to help further expedite the adoption of this FBAR filter, given that 4G networks typically cover multiple frequency bands across different spectrums. Amertron to focus on profitability. On its existing Amertron business, which currently makes up about 40-45% of the group’s revenue, management reiterated its near-term focus to enhance production efficiency in order to improve profitability. Ultimately, Inari is eyeing to improve the segment’s NPM to 10% from 6-7% currently. While demand for its optoelectronics components has been largely stable, we see room for potential cost savings via the introduction of automation at its production lines to optimise resource allocation and to reduce overall headcount.

ISK picking up gradually. Meanwhile, Inari’s ISK subsidiary, which produces fibreoptics transmitters and receivers for use in telecommunication industry, is currently running at about 50% utilisation rate with an annual revenue contribution of MYR15m-20m. To achieve greater economies of scale, ISK is planning to work closely with Avago to capture other open sources by offering value-added services on the latter’s existing fibre-optics connector offerings and, subsequently, marketing the products to Tier-2 and Tier-3 customers that Avago currently does not serve. Management is currently contemplating the setting up of a new production facility in the Philippines next to the current CK1 plant. This new plant, to be named as CK2, is slated to cost approximately MYR40m with gross manufacturing floor space of 90,000 sq ft. The development blueprint is currently being finalised, with management targeting to get it completed by early 2H16.

Ceedtec in ramp-up mode. Over the medium term, management also intends to ramp up operations at 51%-owned Ceedtec, hoping to double the company’spresence in the next 1-2 years from current revenue run-rate of MYR40m-50m pa. Given the capital-intensive nature of the business, we see a potential spin -off of Ceedtec to help raise capital for further expansion, as the company is eyeing for more job opportunities with Agilent.

Chip fabrication to commence in early 2016. On the other hand, progress for Inari’s newly set up fibre-optics chip fabrication division – now parked under Inari Semiconductor Labs – are largely on track with commercial operations set to commence by early 2016. Although earnings accretion is unlikely to be significant, we see this, upon official commission, as an important milestone and a testament to Inari’s capability to be involved in higher-skilled upstream semiconductor works. Capex to be self-funded. Inari’s net cash pile closed at MYR197.9m as at Mar 2015. Coupled with its operating cash flow of MYR140m-210m pa, based on our estimates, we believe its capex requirements for the proposed extension of its P13 and CK1 facilities should be well-funded internally. On a side note, management reiterates its dividend policy of a minimum 40% payout going forward, which translates into anannual yield of 2.9-3.2% for FY16F-17F (Jun).

Other highlights. Inari’s 4QFY15 results are scheduled for release in mid -August. We expect numbers to be largely in line with our full-year net profit estimate of MYR141.6m. Foreign shareholdings now stand at approximately 17%, with management holding some 20% while local institutions make up around 25-30%.

Earnings revision. Given the recent weakness in the MYR against the USD, we are factoring in a revised average USD/MYR of MYR3.785 for FY16F (from MYR3.55). As a result, we are upgrading our FY16F EPS by 5.6% while leaving our FY15F and FY17F estimates largely unchanged. We are now forecasting for FY15/FY16/FY17 core earnings of MYR141.6m/MYR179.8m/MYR205.3m respectively.

Key investment risks. These include: i) potential downside to our earnings forecasts should the Government increase the nation’s minimum wage, ii) customer concentration risk as we expect over 55% of its FY16 revenue to come from Avago, and iii) fluctuation in earnings amidst the current USD/MYR volatility, given that all of its revenue and 70% of its cost of goods sold (COGS) (a majority in raw materials procurement) are denominated in USD.

Maintain BUY. Following our earnings revision, we upgrade our TP to MYR4.41(from MYR4.35), based on an unchanged 18x FY16F P/E. Given the appealing upside of 29%, we maintain our BUY recommendation on Inari. We advise investors to ride on the earnings accretion from the favourable forex environment as well as RF capacity expansion, while full earnings accretion from P13 is likely to kick in come FY17.