Slower pace of recovery, but long-term trend remains positive
We expect FIH to post strong YoY EPS growth in 1H14, but recognize the degree of growth could miss our prior estimates/Street expectations, owing to weak Sony ODM orders. We believe recent share price weakness should have priced in the potential miss. Retain Buy, given its rising China smartphone exposure (especially Xiaomi). In addition, more Chinese brands are adopting premium casings on their devices for product differentiation, which will benefit FIH. For instance, the metal casing of Xiaomi Mi4 phone is made by FIH.
1H14 preview: strong YoY growth but might not live up to the high expectation
We expect FIH to post net profit of USD45mn (+154% YoY) on sales of USD2.35bn (-5% YoY). Despite strong Xiaomi orders, the top line could miss Bloomberg consensus by 6%, due to order cuts from Sony (the largest client, 39% of 2013 sales), while bottom-line could miss by 28%, due to high fixed costs/expenses. We previously expected the Sony business to grow 25% YoY in 2014 (as FIH won more ODM projects), but now expect this to decline 5% YoY (due to lukewarm end-market demand for these ODM phones), with sales contribution dropping to 25% in 2014.
China smartphone business: volume, ASP and gross margin on the uptrend
We view China smartphones as FIH’s key growth driver in the next two years.First, FIH is the primary ODM partner for Xiaomi, Huawei, Lenovo and some emerging brands (Meizu, Smartisan, Infocus, etc), which will likely gain market share with high-cost performance products. Second, we expect ASP and gross margin upside for FIH’s handset casing business. Xiaomi introduced the Mi4 phone in late July, which highlights a premium stainless steel frame, combined with an IMD plastic back-plate (FIH makes both). Our industry checks suggests more Chinese brands will use premium materials and complicated surface treatment technologies to build their new phones. Apparently, Chinese brands are shifting focus away from pure spec upgrades to better industrial designs, to differentiate their devices among the “me-too” pack.
Valuation and investment risks
We trim our 2014/15 EPS forecasts from 3.5/4.9 US cent to 2.2/4.1 US cent to reflect the weak Sony business. We accordingly trim our ROE-PB based target price from HKD5.8 to HKD5.2 (COE of 6.7%, ROE of 7.5%). Downside risks: USD depreciation, price cuts from competitors, and market share loss.