Retaining Buy on attractive valuation and favorable risk/reward profile
Tongda issued a profit warning, stating that 1H17 sales could grow 9%-13%YoY (vs guidance of 20%+ YoY), but EPS could decline 20%-30% YoY, due toan A/R impairment loss and rising R&D expenses (on new launches in 2H17).Our conversation with management leads us to believe that the A/Rimpairment and some of the R&D expenses are non-recurring. Tongda could beback on its growth track in 2H17, driven by ASP increases and market sharegains in iPhone waterproof parts, as well as new launches from Chinesehandset clients. Maintaining Buy, given attractive valuation (8x PER, with 19%EPS CAGR and 20%+ ROE) and a favorable risk/reward profile.
1H17 missed expectation due to project delays, higher R&D and Coolpad
Tongda attributed the top-line miss to delays in new model launches from keyclients (Huawei and Oppo). Orders from Xiaomi (for the HongMi series) wererelatively robust, but came with low ASPs. R&D expenses could increase byHKD100mn (YoY), mainly due to preparation work for a key project in 2H17iPhone 8 waterproof parts). Tongda expects opex ratio to decline in 2H17, asmost of the R&D expenses associated with this project should have beenbooked in 1H17. Also, Tongda could book a one-off A/R and inventoryimpairment losses of HKD54mn and HKD10mn in 1H17 transactions relatedto Coolpad (metal casings) and Leshi (internal mechanical parts).
Some silver lining from negative 1H17 pre-announcement
On a positive note, Tongda highlights that GPM could rise 1ppt YoY, due to arising sales contribution from high-margin iPhone waterproof parts (O-rings).Tongda expects its sales to grow from USD15mn in 2016 to USD80mn+ in2017 (~9% sales contribution), thanks to market share gains (from sub-15% to25%-30%) and ASP increases on a spec upgrade (from O-Ring to LSR). Inmetal casings, Tongda expects sales growth to accelerate slightly as theysecure more projects in 2H17 from Chinese clients, on top of a risingcontribution from a Korean client (LG).Valuation and investment risksWe cut our 2017/18/19 EPS forecasts for Tongda by 17%/8%/8%, respectively,to factor in the 1H17 miss and a slower growth rate assumption for the Chinametal casing business. We accordingly trim our target price from HKD2.8 toHKD2.5, still based on 12x PER (2017-18E average EPS), in line with regionalpeers’ trading average. Downside risks include: market share loss with ChineseOEMs, ASP decline due to competition, and weak iPhone demand.