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Friday, March 4, 2016

Brokers Report: Inari Amertron - Greater things in sight

Maintain Buy call with unchanged Target Price (TP) of RM4.30

Inari Amertron Bhd

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 

  1. 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.
  2. Cost competitiveness and manufacturing efficiency from economies of scale power Inari as Avago’s key EMS vendor.
  3. Largely cash generative with sustainable ROE of ~30%. More upside potential as Avago group continues to outsource more of its manufacturing processes.
  4. 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.
  5. USD/MYR forex fluctuations largely dictate margins. High single customer exposure is another risk.

Financial Metrics

  1. Volume growth and ASPs for RF products (premised on introduction of faster cellular network) and stable USD/MYR are key to Inari’s earnings.
  2. EBIT margin can widen as higher orders and potential new job wins optimises utilisation of Inari’s plants in Malaysia, the Philippines and China.
  3. 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

  1. First official coverage by a local research house.
  2. 62% QoQ jump in FY6/14 earnings from larger outsourcing by Avago and first time consolidation of Amertron.
  3. Inari announced 1-for-8 rights issue to expand its operation on higher orders from Avago.
  4. 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).
  5. News on slowing smartphone growth and a volatile MYR against USD causes uncertainty in Inari’s prospects.

Swing Factors

  1. 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%.
  2. Faster-than-expected adoption of LTE-A (from LTE) would improve earnings visibility for Avago and Inari.
  3. 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.

  1. Drastic fall in global Tier-1 smartphone shipment will hamper orders for Avago’s premium RF products and weaken Inari’s earnings visibility.
  2. Failure to renew pioneer status by end-2017 would see lower profitability on higher tax charges.
  3. 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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