Positive
reinforcement to Inari’s new plant, P-21
We are positively surprised by the MYR100m matching grant
awarded by MIDA; a testament to Inari’s capabilities. Look beyond temporary earnings
weakness in 3QFY16 as Inari continues to offer long-term growth prospects. Our
forecasts and MYR4.30 TP (17x CY17 EPS) are unchanged for now; reiterate Inari
as the Top Pick of the sector for its improved earnings visibility and strong
growth prospects.
The biggest grant
awarded by far
Following the acquisition of the P-21 plant for the setting
up of Inari Integrated Systems (IIS), a wholly-owned subsidiary of Inari, the
Malaysian Investment Development Authority (MIDA) has granted MYR100m matching
grant to Inari to upgrade its P-21 plant and for the purchase of equipment and
machineries. This is to power Inari’s next growth engine in the areas of
advanced communication chips and die preparation. The MYR100m 1-for-1 matching
grant for capex spent is broken into:
I.
MYR20m in convertible preference shares at 2%
dividend p.a. issued to MIDA, which are convertible into Inari shares at any
time within a 3-year period, at a price to be determined. At Inari’s current
share price, for example, this would convert to 0.6% additional shares.
II.
II. MYR80m to be disbursed by MIDA to IIS over a
period of 3 years, on a gradual basis as and when capex is incurred, at an
interest rate of 2% p.a. (10 years) on the amount drawn down; a reasonable
rate.
Further upside to our
forecasts
Having factored job wins worth MYR150m/300m into our FY17/18
forecasts previously, we see further earnings upside as Inari populates P- 21,
its largest plant, over the next 9-12 month for mass production. For this, we
expect Inari’s capex to hit MYR150m/200m in FY16/17. Its unutilised land in
Batu Kawan Industrial Park is a wild card. Inexpensive valuations (0.8x PEG)
for 20% 3-year earnings CAGR; BUY.
Value Proposition
- Inari is the biggest semiconductor player in M’sia. One of Avago’s top EMS providers in the thriving wireless division. Owns >650 units of test handlers, the largest in SEA.
- Cost competitiveness and manufacturing efficiency from economies of scale power Inari as Avago’s key EMS vendor.
- Largely cash generative with sustainable ROE of ~30%. More upside potential as Avago group continues to outsource more of its manufacturing processes.
- Returns hinge on Avago’s orders which have good visibility. Avago enjoys tailwind from network transition (3G to LTE) and growing data server farms to power IoTs.
- USD/MYR forex fluctuations largely dictate margins. High single customer exposure is another risk.
Financial Metrics
- Volume growth and ASPs for RF products (premised on introduction of faster cellular network) and stable USD/MYR are key to Inari’s earnings.
- EBIT margin can widen as higher orders and potential new job wins optimises utilisation of Inari’s plants in Malaysia, the Philippines and China.
- Visible quarterly growth as wafer shipment from Avago is projected to be up. Expect higher utilisation to meet Avago’s demand and new clients in RF related products.
Price Drivers
- First official coverage by a local research house.
- 62% QoQ jump in FY6/14 earnings from larger outsourcing by Avago and first time consolidation of Amertron.
- Inari announced 1-for-8 rights issue to expand its operation on higher orders from Avago.
- Amid slow global semiconductor sales, Avago announced (i) stronger results (due to higher RF content) and (ii) upbeat outlook wireless division (~20% in RF content).
- News on slowing smartphone growth and a volatile MYR against USD causes uncertainty in Inari’s prospects.
Swing Factors
Upside
- Forex: MYR’s further weakness against USD – positive revenue impact. 1% change in our base assumption of USD1/MYR4.10 for FY16-17 will impact earnings by 2%.
- Faster-than-expected adoption of LTE-A (from LTE) would improve earnings visibility for Avago and Inari.
- Potential new contract wins from Osram which has earmarked EUR3b investment (EUR1b for chip plant) in Kulim (~60km away from Inari’s plants in Penang) by 2020.
Downside
- Drastic fall in global Tier-1 smartphone shipment will hamper orders for Avago’s premium RF products and weaken Inari’s earnings visibility.
- Failure to renew pioneer status by end-2017 would see lower profitability on higher tax charges.
- Single customer risk; >80% of Inari’s group revenue derived from Avago. In the event where Inari fails to deliver to Avago, Inari may see its partnership revoked.
Source: Maybank IB Research, 04 March 2016
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