Due to the slowdown in smartphone sales, radio frequency (RF) sales are expected to see a slight drop of 4% in the 2HFY23, bringing the full-year decline to 5%-8%. On top of working on the new flagship phone, management also stressed that it will keep its focus on bringing in more customers and diversification of products to mitigate the high dependency on a single customer volume. Meanwhile, we have already inputted the increased cost pressure and weaker RF sales in our FY23-25F earnings forecast. Maintain Outperform with an unchanged TP of RM3.74 based on 35x FY24 EPS. Dividend yield is attractive, standing at about 4%.

• 2QFY23 results round-up. During the quarter, RF sales made up 63% followed by Optoelectronics, 29% and generic, 8%. The weaker YoY sales were mainly dragged by lower loading volume in optoelectronics business due to the slow progress in market deployment of 5G fiber products. Management also guided that the RF business was supported by doing more legacy phones compared to the new phones. Capex spending for the 1H stood at RM29m and it plans to allocate RM60m for 2H.

• Escalating cost pressure. Margins are expected to be under pressure in the coming months in view of the massive electricity tariff hike, which result in an additional cost of RM1.2m/month, coupled with higher overtime allowance due to shorter weekly working hours. To mitigate the impact, management has rolled out a series of measures. Firstly, it will have solar power installation for the manufacturing plants and will impose control on the day & night temperature and lights. In addition, it will embed ASP adjustment in new products but existing products are unlikely to see adjustment given the lucrative margins.

• Capacity expansion completed for P21 plant. Under a joint-venture with MIT (IMJV), it has commenced operation at P21 plant, focusing on customizing automated solution or literally known as OSAT equipment for Inari and its clients’ consumption. For better cost saving for customers, it has established a core design team consisting of electrical, mechanical and software integration. Also, it has recently completed the phase 2 expansion for P21 plant, raising the floor space from 4,100 sq ft to 9,700 sq ft.

• Another building for P34 plant. The plant, has a floor space of 680k sq ft, is currently running at utilization of 60% for a memory customer and System On Module (SOM) for automotive. The remaining 40% occupancy is allocated for a new product. Management is now planning to convert an open parking space into a 11-storey building with 7 production levels and 4 car park levels, bringing the total floor space 1m sq ft for P34 plant. The new P34 Block D building is likely to be catered for multi-national customer from China. It has also secured a 5-acre land nearby and it has plan to build a P89 plant.

• Penetrating into new products in Philippines. Apart from serving legacy products such as fiber optic modules, optocouplers and IC/Hermetic packages at CK1 and CK2 plants, the Philippines operation plans to build a new 4-storey factory (floor space: 233,653 sq ft), CK3, to cater for new products like power module and high speed fibre (Silicon Photonics). It is worth noting that the optocouplers are mainly applied on the automotive and industrial segments. Meanwhile, after seeing a delay due to tight qualification in auto and industrial segments, management expects to see high volume of orders coming from the high power LED products in the final quarter.

• Missing target. There is a push back for the sales target of RM100-120m from the new customers to FY24 in view of the slowdown in semiconductor spending. Meanwhile, management thinks that the worst is over for both optoelectronics and generic segments as customers’ current inventory levels are relatively low.

• Upbeat on YSIC project. The 54.5%-owned Yiwu Semiconductor International Corp plant is on track for completion in 3Q 2023, with the initial production line set up by 4Q 2023. It provides premium outsourced semiconductor Assembly and Test (OSAT) services for the local Chinese companies especially from smartphone (high volume) and electric vehicle (high value) industries given its strength in both segments. We estimate that YSIC could potentially generate up to RMB1bn (RM650m) revenue upon full utilization.

• Alleviating worries over the potential risk of RF products. Despite the reports citing that a key US smartphone maker is currently working on an all-in-one in-house chip that would power cellular Wi-Fi and Bluetooth functionality on its devices, Inari management thinks that RF products cannot be easily replicated given the complicated process in terms of frequency and accuracy, which is more difficult compared to Wi-Fi and Bluetooth. It believes RF growth will remain intact with customer and end-customers for the next 2-3 years. In the event Apple successfully develops all types of chips required by its devices, our back-of-the-envelope calculations show that the Inari’s direct exposure to the world leading smartphone maker revenue is only 17%-18% given that Apple contributed about 20% to Broadcom’s annual revenue. At current share price, we think the negative news flow has been fully priced in. Alternatively, Apple could directly outsource its assembling and testing jobs to the usual OSAT partners given the i) efficiency and size, ii) cost advantage and iii) reliable track record. We think the chances for Apple to expand into the OSAT area are low given the high operating cost structure in the US.

Source: PublicInvest Research - 24 Mar 2023