Q-Tech’s 1H23 result was disappointing with net income falling 87% YoY to only RMB21m, slightly worse than its previous profit alert. To step out of the operational distress, company needs to see a full recovery in Android; fast growing non-smartphone business accounts for less than 5% of total revenues. However, we remain conservative on the strength of the market rebound in 2H23 given Android’s upgrade cycle remains weak so far. Maintain HOLD with new TP of HK$3.90 (was HK$4.00) based on 10x 2024E EPS.
　　Key Factors for Rating
　　1H23 results: Q-Tech reported 1H23 revenue of RMB5,477m, down 23% YoY, missing BOCIe and consensus by 9% and 10% respectively, which is mainly due to the decrease in sales volume of CCM (-21% YoY) owing to weak smartphone demand. GPM was down 1.9ppts YoY (but up 1ppts HoH) in 1H23 to 3.4% due to 1) price war, 2) low utilisation and 3) USD appreciation. OP was -RMB86m and net income was only RMB21m (-87% YoY), below its negative profit alert (down 60-80% YoY) due to FX and financial asset fair value adjustment.
　　Product structure optimisation in smartphone business: Mgmt. guides up 32M+ CCM volume mix to 40% from 35% in 2023, given Q-tech’s smooth high-end strategy. Mgmt. expects to take 40-50% domestic OIS market share in 2023, and believes the penetration of OIS and periscope adoption will further benefit Q-tech’s ASP and margins.
　　FPM: in 1H23 FPM GPM remained negative at -4.5%, slightly improved from 6.7% in 2H22 as company proactively cut low-end projects. We expect this business would not achieve breakeven by 2H24.
　　Non-smartphone business shows potential: Non-smartphone CCM volume grew 64% YoY to 2.7m in 1H23. Mgmt. keeps its over 50% volume growth 2023 guidance unchanged, driven by automotive, AR/VR and IoT.
　　Key Risks for Rating
　　1) Lack of upgrade and demand on fingerprint module; 2) new client and new product qualification progress; 3) economic, political and pandemic risk on tech end demand; and 4) intensified competition.
　　Valuation
　　We trim our shipment volume forecasts of CCM slightly to reflect the sluggish smartphone recovery in 2023. Meanwhile, we adjust down GPM and OPM to reflect weak margins and operating leverage. We slightly increase 2023 EPS by 8% to reflect non-ops impact but lower 2024 EPS by 2%.
　　We use 10x 2024E EPS to value Q-Tech (unchanged) as we think 2024 will be a better earnings proxy from the current smartphone demand trough. Our new target price is HK$3.90 (was HK$4.00). Maintain HOLD.