Inari held a briefing post its 1QFY20 results. Key takeaways include: 1) revenue fell 2.8% YoY mainly due to weakness from the optoelectronics segment on the back of the trade war, albeit it was large cushioned by the core radio frequency (RF) segment’s strength which benefitted from growing RF content per device, 2) thus far in 2QFY20, the RF segment’s utilisation rate remained strong at >70%, driven by a major endcustomer’s new smartphone line-up, and 3) ~10% of P34, the group’s new plant in Batu Kawan, Penang has been fitted. In all, we have cut our FY20/FY21/FY22 earnings estimates by 13.8%/5.1%/5.1% in view of the headwinds from the trade war on the optoelectronics segment and correspondingly, arrive at a lower TP of RM1.98 (previously RM2.17) based on 24.0x CY20 EPS. Downgrade to Hold.

Slowdown in Opto and Generic Largely Cushioned by RF

To recap, Inari’s 1QFY20 revenue and net profit fell 2.8% YoY and 16.0% YoY. This was mainly due to lower volume loadings at the optoelectronics (opto) segment, which saw weakness from the automotive and industrial end user market against the backdrop of the trade war. However, the top-line weakness was largely cushioned by stronger contributions from the core radio frequency (RF) segment, which benefitted from growing RF content per device. 1QFY20’s revenue mix was 49% RF, 41% opto, 10% generic compared to FY19’s of 40% RF, 48% opto, 12% generic.

We Remain Positive on Near-to-Medium Term Prospects

In view of the headwinds from the trade war on the optoelectronics segment, we have cut our FY20/FY21/FY22 earnings estimates by 13.8%/5.1%/5.1% after lowering our sales assumptions in the corresponding period by 12.0%/4.1%/4.1%. Notwithstanding, we remain positive on the group’s near-tomedium term prospects with growth expected to be driven by its RF segment, especially with the proliferation of 5G smartphones, which would necessitate higher RF content to support a higher range of frequency bands. Encouragingly, we note that post the seasonally stronger quarter for the RF segment, its utilisation rate thus far in 2QFY20 remained strong at >70%, driven by a major end-customer’s new smartphone line-up.

Progress at P34, ~10% of Production Floor Fitted

Meanwhile, there has also been progress at P34, the group’s new plant in Batu Kawan, Penang. Management alluded that to date, ~10% or ~70k sqft of the production floor space has been fitted and this includes: 1) 8 lines for RF assembly, and 2) fibre module testing and assembly lines for the manufacturing of optical transceivers (via the group’s recent partnership with Taiwan based PCL Technologies) at Block B. As for the remaining Block A and C, we note that management remains in active discussion with prospective customers. In all, targets are for ~17.6% or ~120k sqft of P34 to be occupied by June 2020.

Valuation & Recommendation

Following our earnings cut, we arrive at a lower TP of RM1.98 (previously RM2.17) based on 24.0x CY20 EPS which is +0.5SD to the stock’s 5-year mean. We opine that the premium is justified by Inari’s capabilities and relevance of products towards emerging technologies, above industry average margins, and robust balance sheet. However, given the narrowed upside potential we downgrade Inari from Buy to Hold. Key downside risks include heightened global trade tensions, strengthening of the ringgit against the USD and surge in commodity prices.

Source: TA Research - 28 Nov 2019