Looking into 2025, we believe Sunny Optical will benefit from a revived smartphone camera upgrade cycle led by domestic OEMs, US client share gain and the intensifying domestic NOA competition. Regarding XR, we believe it will likely serve as a key re-rate driver from mid-2025 when investors see more AR glasses rushing into market. We lift 2024- 26 EPS by 4-6% and lift TP from HK$69 to HK$77. Maintain BUY.
　　Key Factors for Rating
　　2025 catalysts to watch out: during our recent roadshows, investors generally care about domestic fiscal stimulus on consumer electronics, camera upgrade, US client share gain, BYD (1211 HK/TP: HK$325.00, BUY) accelerating autonomous driving via upgrading automotive cameras, XR esp. AR AI glasses development, in regard to Sunny Optical. We feel a general positive sentiment as Company is on the recovery path, while some expressed concerns on 1) automotive lens margins outlook as domestic auto OEMs outgrowing overseas peers; 2) AR glass growth contribution may be small over 2025-26; and 3) the speculated smartphone national subsidy in 2025 may not come through as expected.
　　Smartphone: YTD shipment of HLS/HCM were +14.6% YoY / -7.7% YoY, vs 2024 guidance of +5-10% YoY / flat YoY. While overall smartphone demand remained in-line, strong HLS was due to share gain in key US client as well as robust Android high-end demand; on the contrary, HCM shipment was much weaker especially in 2H24 and Company attributed it to a strategic shift of focus to higher-end products. For instance, Sep/Oct/Nov HCM shipments were down -29.6%/-37.5%/-28.1% YoY while ASP of HCM were up more than 30-40% YoY as a result of mix shift. This also aligns with our recent channel check that peer companies collectively reported better HCM YoY growth in 2H24.
　　Automotive: we believe automotive will be a key growing segment in 2025 as more domestic auto OEMs enter autonomous driving or NOA race in late 2H24, which calls for acceleration of camera/LiDAR hardware adoption per car. We now forecast 2025 VLS shipment to grow +20% YoY (previously +12% YoY) and VCM revenue to grow 30% YoY (previously +20% YoY), mainly driven by more intense NOA competition such as BYD.
　　XR: we believe from 2026, variances of edge AI devices will converge into AR AI glasses, from which the Company is able to hike on a new product cycle wave for its exposure in camera and waveguide optics. A new re-rate cycle of the Company will likely kick off from mid-2025 when more similar AR AI glasses being showcased.
　　Key Risks for Rating
　　1) Demand miss for high spec smartphone; 2) slower-than-expected market share gain; 3) new price war initiated by peers; and 4) weak macro.