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3Q21: Worst Is Likely Over But Remain Cautious On Underperformance

AAC’s 3Q21 net profit declined 57.4% yoy to Rmb183m, at the midpoint of its profit warning range. The sharp decline was due to component cost hikes, ASP declines, shipment delays and cancellations due to a chip shortage, and lockdowns at its Vietnam base. The worst is likely over for AAC, but we remain cautious given its consistent underperformance vs competitors. We fine-tune our assumptions and cut our 2021 forecasts by 2.2%. Upgrade to HOLD and raise target price to HK$36.80.

• 3Q21 net profit at the midpoint of guided range. AAC Technologies’ (AAC) 3Q21 net profit declined 57.4% yoy and 52.9% qoq to Rmb183m, largely at the midpoint of the profit warning’s guidance range of Rmb166m-210m. The sharp yoy decline was due to an unfavourable operating environment, including component cost hikes, ASP decline due to despec amid weak smartphone consumption, chip shortage and the COVID-19 outbreak in its Vietnam production base.

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• 3Q21 revenue was down 6.1% yoy and 1.6% qoq at Rmb4.2b. AAC’s 3Q21 revenue came in behind our estimates, primarily due to a sharp decline in optics business (-17.3% yoy and -51.7% qoq to Rmb390m), as the impact from order cancellations and shipment delays turns out to be more severe than we anticipated. This is partially offset by dynamic components (acoustics) (+1.9% yoy and +8.0% qoq to Rmb2.2b) which registered better than- expected sales. The yoy decline of electromagnetic drives & precision mechanics (haptics and casing) (-7.9% yoy and +15.0% qoq) and micro electromechanical systems (MEMs) (-31.0% yoy and +6.6% qoq) was well expected and falls in line with our estimates.

• Gross margins were largely in line at 22.7% (-0.9ppt yoy and -1.9ppt qoq). The weak margins were well expected, as management has guided for one-off disruption at its Vietnam plants (which caused a 7.4ppt qoq decline in the Androi acoustic business), and impacts from the optics business’ low production yields. MEMs’ margins are not expected to recover in the near term, but haptics and casing’s margins (+0.2ppt yoy and -1.8ppt qoq to 20.3%) were weaker than expected. This is offset by the acoustics margins (-0.3ppt yoy and -2.1ppt qoq at 26.3%) which turned out to be better than our expectations.

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STOCK IMPACT

• Acoustics: Continued support from iOS in 4Q21, and expanding penetration in Android. AAC’s Vietnam production base saw the biggest impact from the lockdown in Jun- Jul, which affected the product yield and product delivery in 3Q21. The plant has since
resumed normal operations, and the 7.4ppt margins decline for Android acoustic products will be a one-off event in 3Q21. Going forward, management expects margins to recover to normal levels in 4Q21, and aims to continue promoting its standardised small cavity acoustic box products (accounted for 10% of shipment in 3Q21) and expand its penetration in the Android camp as a key growth driver for the acoustic segment.

• The worst is likely over for the optics business, but remain cautious on underperformers. The optics segment’s revenue of Rmb390m consists of about Rmb180m from camera modules (-48.2% qoq) and about Rmb200m from plastic lens (-54.4% qoq).
Due to a significantly lower production yield for both camera modules (about 5% of gross margin in 3Q21) and plastic lens (25%, about -8.4ppt qoq). ASP for plastic lens was actually relatively stable at only about -3% qoq, but the competition will likely further intensify in 2022 and ASP will remain on the downtrend. On the bright side, production yield and orders should revert to normal levels in 4Q21 (hence recovery in margins) as the chip shortage eases. The R&D of 7p and 8p lens is also underway and management targets a launch date in one to two quarters’ time, but management reiterated their stance in focusing on the development and promotion of WLG lens as it is AAC’s key edge against its competitors. Nevertheless, we remain cautious on AAC’s competitiveness in the optics industry, as the company significantly underperformed its competitors in 3Q21.

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• Haptics & casing business: Haptics remains solid and casing’s client base is expanding. Management expects the x-axis haptics motor for Android customers and hardware+software customised integration solutions to see sustained high growth across the
Android camp in the near future as tactile feedback is becoming a more important driver behind lifting user experience. The casing side is still under pressure, but AAC is gradually diversifying its product portfolio and client base through the acquisition of Toyo Precision, a tablet and laptop casing manufacturer. The acquisition will be finalised in early-22, coupled with the integration and development of the new business, its casing business will likely remain depressed through 4Q21-1Q22.

• Semiconductor shortage may persist until 2Q22. Management stated that the biggest uncertainty lies on the upstream, primarily on chips shortage which can cause more fluctuations to its shipment, and expects the shortage to persist through 4Q21-2Q22.

• Vehicle-related business: On the automobile optics side, AAC is currently cooperating with Tier 1 automobile suppliers and Chinese OEMs on the development of vehicle lens covering a wide range of vehicle cameras*. Apart from the optics, AAC is also working with a Chinese OEM in developing an audio system specialised for a small cockpit. Nevertheless, there is still no visible timeline for any meaningful contribution.

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EARNINGS REVISION/RISK

• We fine-tuned our assumptions and our 2021 net profit is cut by 2.2% to Rmb1,877m. This is based on higher sales and margins assumption for acoustics, but a lower revenue assumption for optics. Our 2022-23 earnings estimate is largely unchanged.

VALUATION/RECOMMENDATION

• Upgrade to HOLD and raise target price to HK$36.80 based on 16.5x 2022F PE, 0.5SD below mean. We upgrade our rating on AAC as we believe the worst is likely over, but remain cautious on the company given its consistent underperformance vs its competitors.