Taiwan Information Technology 6 March 2019

FIH Mobile (2038 HK)

Target price: HKD1.06 (from HKD1.20) Share price (6 Mar): HKD0.98 | Up/downside: +8.2%

Worst likely over; wait for better visibility before revisit Kylie Huang (886) 2 8758 6248  2H18 results poor but expected; 1H19 likely a loss but improving YoY [email protected]  Positive on the scale-down in Nokia; stiff competition still a concern Steven Yang (886) 2 8758 6245  Maintaining Hold (3) rating; lowering TP to HKD1.06 [email protected]

What's new: FIH Mobile’s 2H18 results were poor but in line with its earlier Forecast revisions (%) profit warning (see memo). We are positive on the company’s decision to Year to 31 Dec 18E 19E 20E scale down the loss-making Nokia business; however, the visibility on its Revenue change (7.8) (24.2) (28.4) Net profit change n.a. n.a. 231.1 earnings recovery remains low, likely due to the intense industry Core EPS (FD) change n.a. n.a. 231.1 competition. We maintain our Hold (3) rating and lower our TP to HKD1.06. Source: Daiwa forecasts

What's the impact: 2H18 results review. FIH posted 2H18 revenue of Share price performance

USD8.4bn (+27% HoH; +9% YoY), lower than our forecast by 13%. Due to (HKD) (%) pricing pressure and unfavourable mix, the gross margin arrived at -0.6%, 2.2 105 lower than our estimate of -0.3%. FIH saw a non-operating loss of 1.8 86 USD138m due mainly to impairment and forex losses. The 2H18 net loss 1.4 68 1.0 49 came in at USD508m (vs. a net loss of USD349m in 1H18 and USD329m 0.6 30 in 2H17), roughly in line with the expected net loss of c.USD521m stated in Mar-18 Jun-18 Sep-18 Dec-18 Mar-19 the profit warning issued on 22 February. FIH Mobile (LHS) Relative to HSI (RHS)

1H19 still tough but improving YoY. FIH decided to be more selective on 12-month range 0.66-2.19 the ODM project from Nokia and discontinue the distribution business of Market cap (USDbn) 0.98 Nokia products from end-2018. FIH expects this to reduce its opex and also 3m avg daily turnover (USDm) 0.57 expects its operating loss to be reduced YoY in 1H19, despite the market Shares outstanding (m) 7,830 Major shareholder Hon Hai group (62.8%) conditions remaining tough. On the scale-back of the loss-making Nokia business, we estimate FIH to post a loss of USD133m in 1H19, which is Financial summary (USD) still loss-making but improving from a loss of USD349m in 1H18. Year to 31 Dec 18E 19E 20E Revenue (m) 14,930 14,700 15,920 Worst likely over on the strategy change in Nokia business, but Operating profit (m) (606) (134) 83 visibility on earnings recovery remains limited. We have been worried Net profit (m) (857) (138) 78 Core EPS (fully-diluted) (0.109) (0.018) 0.010 the Nokia business would be an earning drag for FIH (see downgrade EPS change (%) n.a. n.a. n.a. report, May 2016). We view the strategy change in its Nokia business as Daiwa vs Cons. EPS (%) n.m. n.m. n.m. the right move for FIH to improve its profitability in the long term. But, the PER (x) n.a. n.a. 12.5 Dividend yield (%) 0.0 0.0 0.0 benefits from this change could take time and the industry competition in DPS 0.000 0.000 0.000 smartphone EMS/ODM and casing could remain tough on muted volume PBR (x) 0.4 0.4 0.4 growth, which should result in high uncertainty on FIH’s earning recovery, EV/EBITDA (x) n.a. 25.5 2.7 in our view. In all, we expect 2019 to be a loss-making year for FIH. ROE (%) n.a. n.a. 3.5 Source: FactSet, Daiwa forecasts What we recommend: Factoring the cost savings on the scale-down in its Nokia business, we forecast a net loss of USD138m for 2019 and net profit of USD78m for 2020 (from net loss of USD224m for 2019E and net profit of USD24m for 2020E). We maintain our Hold (3) rating and cut our 12-month TP to HKD1.06 (from HKD1.2), still based on a PBR of 0.5x on our 2019E BVPS (from average 2018-19E BVPS). Key downside/upside risks: higher- /lower-than-expected pricing pressure.

How we differ: We are more positive than the market on FIH’s profitability in 2019-20E, likely due to its strategy change in the Nokia business.

See important disclosures, including any required research certifications, beginning on page 5

FIH Mobile (2038 HK): 6 March 2019

FIH: revisions to revenue and earnings forecasts Revised forecasts Previous forecasts Change USDm 2018E 2019E 2020E 2018E 2019E 2020E 2018E 2019E 2020E

Revenues 14,930 14,700 15,920 16,200 19,400 22,250 -7.8% -24.2% -28.4% Gross profit -84 221 382 -65 233 490 n.a. -5.3% -21.9% Operating profit -606 -134 83 -509 -221 27 n.a. n.a. 210.1% Pre-tax profit -840 -138 78 -564 -224 24 n.a. n.a. 231.1% Net profit -857 -138 78 -564 -224 24 n.a. n.a. 231.1% EPS (USD) -0.109 -0.018 0.010 -0.072 -0.029 0.003 n.a. n.a. 231.1%

Margins (%)

Gross margin -0.6% 1.5% 2.4% -0.4% 1.2% 2.2% Operating margin -4.1% -0.9% 0.5% -3.1% -1.1% 0.1% Pre-tax margin -5.6% -0.9% 0.5% -3.5% -1.2% 0.1% Net margin -5.7% -0.9% 0.5% -3.5% -1.2% 0.1%

Source: Daiwa forecasts

FIH: semi-annual and annual P&L statement 2018 2019E 2018E 2019E 2020E USDm 1H 2H 1HE 2HE Sales 6,563 8,367 6,906 7,794 14,930 14,700 15,920 COGS 6,598 8,416 6,862 7,617 15,014 14,480 15,538 Gross profits -35 -49 44 177 -84 221 382 Other operating incomes 96 -4 45 55 92 100 100 Operating expense 313 300 220 234 613 454 399 Operating profits -253 -353 -131 -2 -606 -134 83 Non-operating income -97 -138 -1 -2 -234 -3 -3 Pretax income -349 -491 -133 -5 -840 -138 78 Net profit -349 -508 -133 -5 -857 -138 78 EPS (USD) -0.045 -0.065 -0.017 -0.001 -0.109 -0.018 0.010 Margin Analysis (%) Gross margin -0.5% -0.6% 0.6% 2.3% -0.6% 1.5% 2.4%

Operating margin -3.8% -4.2% -1.9% 0.0% -4.1% -0.9% 0.5%

Pretax margin -5.3% -5.9% -1.9% -0.1% -5.6% -0.9% 0.5%

Net margin -5.3% -6.1% -1.9% -0.1% -5.7% -0.9% 0.5%

YoY % Sales 50% 9% 5% -7% 24% -2% 8%

Gross profits n.a. n.a. n.a. n.a. n.a. n.a. 73%

Operating income n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Pretax income n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Net income n.a. n.a. n.a. n.a. n.a. n.a. n.a.

HoH % Sales -15% 27% -17% 13% Gross profits n.a. n.a. n.a. 304% Operating income n.a. n.a. n.a. n.a. Pretax income n.a. n.a. n.a. n.a. Net income n.a. n.a. n.a. n.a.

Source: Company, Daiwa forecasts

FIH: 1-year-forward PER FIH: 1-year-forward PBR

20 (HKD) 7 (HKD) 6 10 5 0 4

(10) 3 2 (20) 1

(30) 0

Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-17 Mar-18 Mar-19

Mar-17 Mar-11 Mar-12 Mar-13 Mar-14 Mar-15 Mar-16 Mar-18 Mar-19

Sep-13 Sep-11 Sep-12 Sep-14 Sep-15 Sep-16 Sep-17 Sep-18

Sep-17 Sep-11 Sep-12 Sep-13 Sep-14 Sep-15 Sep-16 Sep-18 Share price 7x 17x 27x 37x Share price 0.5x 0.8x 1.1x 1.4.0x

Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

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FIH Mobile (2038 HK): 6 March 2019

Financial summary Key assumptions Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Average Selling Price (USD) 64.0 43.3 36.2 26.3 43.7 52.2 52.0 56.3 EMS handset shipment (m) 33.5 46.9 65.3 59.6 123.3 149.1 149.3 151.3 ODM smartphone shipment (m) 16.7 50.4 60.8 74.6 101.7 109.8 110.8 111.6

Profit and loss (USDm) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Handsets Set Revenues 3,209 4,217 4,564 3,525 9,828 13,513 13,525 14,813 Components/Modules Revenues 1,000 1,516 1,823 1,859 1,849 1,207 1,033 1,011 Other Revenue 788 1,097 1,064 849 404 210 142 96 Total Revenue 4,997 6,830 7,451 6,233 12,080 14,930 14,700 15,920 Other income 0 0 0 0 0 0 0 0 COGS (4,773) (6,407) (7,065) (5,892) (11,950) (15,014) (14,480) (15,538) SG&A (210) (213) (206) (222) (459) (339) (230) (195) Other op.expenses 115 117 133 101 (145) (183) (124) (105) Operating profit 129 326 312 221 (473) (606) (134) 83 Net-interest inc./(exp.) (6) (10) (6) (1) 11 (4) (4) (5) Assoc/forex/extraord./others (22) (48) (16) (3) (34) (230) 0 0 Pre-tax profit 101 268 290 217 (496) (840) (138) 78 Tax (24) (99) (62) (81) (30) (17) 0 0 Min. int./pref. div./others 0 0 0 2 (0) 0 0 0 Net profit (reported) 78 169 229 138 (525) (857) (138) 78 Net profit (adjusted) 78 169 229 138 (525) (857) (138) 78 EPS (reported)(USD) 0.010 0.022 0.030 0.018 (0.067) (0.109) (0.018) 0.010 EPS (adjusted)(USD) 0.010 0.022 0.030 0.018 (0.067) (0.109) (0.018) 0.010 EPS (adjusted fully-diluted)(USD) 0.010 0.022 0.030 0.018 (0.067) (0.109) (0.018) 0.010 DPS (USD) 0.000 0.000 0.025 0.028 0.018 0.000 0.000 0.000 EBIT 129 326 312 221 (473) (606) (134) 83 EBITDA 284 470 453 362 (302) (465) 26 244

Cash flow (USDm) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Profit before tax 101 268 290 217 (496) (840) (138) 78 Depreciation and amortisation 155 144 140 141 171 141 160 162 Tax paid (24) (99) (62) (81) (30) (17) 0 0 Change in working capital (22) (460) 353 (571) 514 (34) (284) (151) Other operational CF items 1 7 5 2 9 0 0 (0) Cash flow from operations 211 (140) 727 (292) 169 (750) (262) 89 Capex (55) (64) (86) (193) (241) (70) (70) (70) Net (acquisitions)/disposals (1) (7) (5) (2) (9) 0 0 0 Other investing CF items (13) (30) (209) (293) 135 0 158 0 Cash flow from investing (69) (101) (300) (487) (114) (70) 88 (70) Change in debt (87) 39 (169) 409 292 739 45 45 Net share issues/(repurchases) 0 0 0 0 0 0 0 0 Dividends paid 0 0 (192) (219) (142) 0 0 0 Other financing CF items 105 52 (210) (100) 276 0 0 0 Cash flow from financing 18 91 (572) 91 426 739 45 45 Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 160 (149) (145) (689) 480 (81) (129) 64 Free cash flow 156 (204) 641 (485) (72) (820) (332) 19 Source: FactSet, Daiwa forecasts

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FIH Mobile (2038 HK): 6 March 2019

Financial summary continued … Balance sheet (USDm) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Cash & short-term investment 2,517 2,368 2,223 1,532 2,012 1,931 1,802 1,865 Inventory 226 596 333 375 1,025 1,001 965 1,036 Accounts receivable 1,678 2,445 1,595 2,495 3,777 4,499 4,430 4,798 Other current assets 0 299 385 951 427 746 735 796 Total current assets 4,421 5,708 4,536 5,353 7,240 8,178 7,932 8,495 Fixed assets 987 908 854 905 974 903 813 721 Goodwill & intangibles 0 0 0 0 0 0 0 0 Other non-current assets 177 207 416 709 574 574 416 416 Total assets 5,586 6,823 5,805 6,966 8,788 9,655 9,161 9,632 Short-term debt 138 179 13 419 713 1,450 1,494 1,538 Accounts payable 1,585 2,494 1,857 2,770 4,644 5,553 5,157 5,534 Other current liabilities 122 189 152 176 222 299 294 265 Total current liabilities 1,845 2,862 2,022 3,364 5,579 7,302 6,945 7,338 Long-term debt 0 0 0 0 0 0 0 0 Other non-current liabilities 33 31 27 31 29 30 32 32 Total liabilities 1,877 2,893 2,050 3,396 5,608 7,332 6,977 7,370 Share capital 303 312 316 319 324 324 324 324 Reserves/R.E./others 3,406 3,618 3,440 3,251 2,856 1,999 1,861 1,939 Shareholders' equity 3,708 3,930 3,755 3,571 3,180 2,323 2,184 2,263 Minority interests 0 0 0 0 0 0 0 0 Total equity & liabilities 5,586 6,823 5,805 6,966 8,788 9,655 9,161 9,632 EV (1,402) (1,212) (1,232) (135) (322) 496 669 651 Net debt/(cash) (2,379) (2,189) (2,209) (1,113) (1,299) (481) (308) (327) BVPS (USD) 0.499 0.520 0.485 0.456 0.406 0.297 0.279 0.289

Key ratios (%) Year to 31 Dec 2013 2014 2015 2016 2017 2018E 2019E 2020E Sales (YoY) (4.6) 36.7 9.1 (16.3) 93.8 23.6 (1.5) 8.3 EBITDA (YoY) n.a. 65.7 (3.8) (20.0) n.a. n.a. n.a. 831.6 Operating profit (YoY) n.a. 152.9 (4.3) (29.4) n.a. n.a. n.a. n.a. Net profit (YoY) n.a. 118.0 35.2 (39.6) n.a. n.a. n.a. n.a. Core EPS (fully-diluted) (YoY) n.a. 114.6 31.8 (40.3) n.a. n.a. n.a. n.a. Gross-profit margin 4.5 6.2 5.2 5.5 1.1 n.a. 1.5 2.4 EBITDA margin 5.7 6.9 6.1 5.8 n.a. n.a. 0.2 1.5 Operating-profit margin 2.6 4.8 4.2 3.5 n.a. n.a. n.a. 0.5 Net profit margin 1.6 2.5 3.1 2.2 (4.4) (5.7) (0.9) 0.5 ROAE 2.1 4.4 6.0 3.8 n.a. n.a. n.a. 3.5 ROAA 1.5 2.7 3.6 2.2 n.a. n.a. n.a. 0.8 ROCE 3.4 8.2 7.9 5.7 n.a. n.a. n.a. 2.2 ROIC 7.3 13.4 15.0 6.9 (21.8) (32.6) (7.2) 4.3 Net debt to equity n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Effective tax rate 23.4 36.9 21.2 37.2 0.0 0.0 0.0 0.0 Accounts receivable (days) 102.6 110.2 99.0 119.8 94.8 101.2 110.9 105.8 Current ratio (x) 2.4 2.0 2.2 1.6 1.3 1.1 1.1 1.2 Net interest cover (x) 21.1 31.3 54.1 235.8 n.a. n.a. n.a. 18.2 Net dividend payout 0.0 0.0 84.0 158.0 n.a. n.a. n.a. 0.0 Free cash flow yield 15.9 n.a. 65.6 n.a. n.a. n.a. n.a. 1.9 Source: FactSet, Daiwa forecasts

Company profile

FIH Mobile (FIH), previously named Foxconn International Holdings, was formerly the handset division of Hon Hai Precision Industry (Hon Hai), and was spun off as a 100%-owned subsidiary of Hon Hai in 2000. FIH has since grown its business aggressively, both organically and through M&A activities. FIH was listed on the Hong Kong Stock Exchange on 3 February 2005. Its key accounts include global handset OEMs such as Sony, and China brands such as Xiaomi.

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FIH Mobile (2038 HK): 6 March 2019

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FIH Mobile (2038 HK): 6 March 2019

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Research Analyst Conflicts For updates on “Research Analyst Conflicts” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The principal research analysts who prepared this report have no financial interest in securities of the issuers covered in the report, are not (nor are any members of their household) an officer, director or advisory board member of the issuer(s) covered in the report, and are not aware of any material relevant conflict of interest involving the analyst or DCMA, and did not receive any compensation from the issuer during the past 12 months except as noted: no exceptions.

Research Analyst Certification For updates on “Research Analyst Certification” and “Rating System” please visit BlueMatrix disclosure link at https://daiwa3.bluematrix.com/sellside/Disclosures.action. The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analyst is named on the report); and no part of the compensation of such analyst (or no part of the compensation of the firm if no individual analyst is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report.

The following explains the rating system in the report as compared to relevant local indices, unless otherwise stated, based on the beliefs of the author of the report. "1": the security could outperform the local index by more than 15% over the next 12 months. "2": the security is expected to outperform the local index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local index (better or worse) over the next 12 months. "4": the security is expected to underperform the local index by 5-15% over the next 12 months. "5": the security could underperform the local index by more than 15% over the next 12 months.

Disclosure of investment ratings Rating Percentage of total Buy* 70.8% Hold** 19.8% Sell*** 9.4% Source: Daiwa Notes: data is for single-branded Daiwa research in Asia (ex Japan) and correct as of 31 December 2018. * comprised of Daiwa’s Buy and Outperform ratings. ** comprised of Daiwa’s Hold ratings. *** comprised of Daiwa’s Underperform and Sell ratings.

Additional information may be available upon request.

Japan - additional notification items pursuant to Article 37 of the Financial Instruments and Exchange Law (This Notification is only applicable where report is distributed by Daiwa Securities Co. Ltd.)

If you decide to enter into a business arrangement with us based on the information described in materials presented along with this document, we ask you to pay close attention to the following items.  In addition to the purchase price of a financial instrument, we will collect a trading commission* for each transaction as agreed beforehand with you. Since commissions may be included in the purchase price or may not be charged for certain transactions, we recommend that you confirm the commission for each transaction.  In some cases, we may also charge a maximum of ¥ 2 million (including tax) per year as a standing proxy fee for our deposit of your securities, if you are a non-resident of Japan.  For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements.  There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements.  There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us.  Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us. Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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