Server ODM Giant To Remain A Key Winner Of The Gen AI Investment Trend
FII is one of the largest AI server ODMs globally. Thanks to its extensive client coverage
and its capabilities to offer full-stack solution for AI data centres, FII has managed to
capture a quarter of the global AI server’s market share and achieved significantly
higher margins than its peers. At an undemanding valuation of 9.1x 2024F PE, we
believe FII is currently one of the best investment targets in the GenAI value chain.
Initiate coverage with BUY and a target price of Rmb18.90.
INITIATE COVERAGE
- A leading AI server manufacturer with the most extensive coverage across the value chain. Foxconn Industrial Internet (FII) is one of the largest AI server manufacturers and ODMs globally, responsible for producing a quarter of the world’s high-end data centre servers in 2023. We believe FII is one of the best positioned names globally to capture the investment in generative AI (GenAI) from cloud applications, thanks to its extensive exposure across the AI data centre supply chain, and its ability to offer full-stack AI data centre solutions.
- The AI-related business is likely to register robust growth in 2023-25, driven by robust investments from CSPs, ramp-up of data centre chip production and a surge in the use of GenAI applications. We expect FII’s AI-related business to grow 39.9%/107.1%/57.6% yoy in 2023-25 to Rmb56b/Rmb117b/Rmb184b (Figure 3), contributing to 12.1%/21.3%/28.9% of total revenue during the respective periods.
- The networking equipment business will also benefit from the boom in cloud infrastructure investment. FII’s communication network equipment business consists of network equipment, telecom equipment, and the precision component business. The current boom in cloud infrastructure investment is driving a new round of product upgrades for highspeed switches (eg from 400G to 800G and 1.6T switches in 2023-25 driven by the rapid upgrade of data centres) and high-speed routers, which can drive a meaningful recovery in the segment’s sales and profitability from 2024 onwards.
- Concerns over US export restriction risks are overdone. FII’s AI business (12% contribution to total revenue) has 10-20% exposure to China (1.3-2.6% of total revenue), which will be affected by the US export restrictions. However, we expect minimal impact in 2024 as the robust demand backlog from overseas should be more than enough to offset the shortfall from China.
- Initiate coverage with BUY and a target price of Rmb18.90, based on 13.5x 2024F PE, on a par with its historical forward mean. After the >50% share price correction from the peak, we believe the current valuation of 9.1x 2024F PE (~1SD below historical forward mean) has already discounted market’s concerns of a slowdown in growth beyond 2024, as well as risks related to geopolitical issues. We also believe its valuation is undemanding considering our estimates of a 18% earnings CAGR in 2023-25.
STOCK IMPACT
We expect a 18% net profit CAGR in 2023-25. We are expecting FII to register a revenue growth of -9.1%/+18.1%/+15.9% yoy in 2023-25 respectively, primarily driven by a +39.9%/+107.1%/+57.5% yoy growth in AI ODM business (contributing to 12.1%/21.3%/28.9% of total revenue). Thanks to the improvements in product mix, we expect margins to expand by 1.2ppt/0.5ppt/0.1ppt yoy to 8.5%/9.0%/9.1% in 2023-25 respectively, driving a 18% net profit CAGR during the period.
VALUATION/RECOMMENDATION
Initiate coverage with BUY; target price of Rmb18.90 based on 13.5x 2024F PE, on a par with its historical one-year forward mean. FII’s share price has corrected by more than 50% from the peak in mid-23, as the market is concerned about the sustainability of cloud investment’s growth and geopolitical risks from the US’ export restrictions. However, we believe that FII’s current valuation of 9.1x 2024F PE (<1SD below historical forward mean) has already discounted market’s concerns of a slowdown in growth beyond 2024, as well as risks related to geopolitical issues. We are also expecting investment in cloud to remain elevated in the coming three years, driven by robust investment into GenAI, as well as the accelerating adoption of GenAI enabled by edge-AI’s penetration.
