HNHPF - Hon Hai: Consider Financial Outlook And Political Risks (Rating Downgrade)

2023-10-30 13:27:21 ET

Summary

• Hon Hai's revenue declined by -19.7% YoY in September, and the company's full-year FY 2023 top-line is expected to be lower than what it achieved last year.
• The Taiwanese company is too reliant on Mainland China as its key production center, and it might be negatively affected by tensions between China and Taiwan.
• I lower my rating for Hon Hai to a Hold, taking into account its financial prospects for the near term and risk factors relating to politics.

Elevator Pitch

My investment rating for Hon Hai Precision Industry's stock (HNHPF) [2317:TW] is a Sell.

Earlier, I reviewed Hon Hai's financial results for the second quarter of this year with my prior update for Hon Hai published on August 17, 2023.

With the current article, I downgrade Hon Hai's rating from a Hold previously to a Sell now. I have an unfavorable view of Hon Hai's full-year fiscal 2023 prospects, and I am concerned about the company's political risks relating to its dependence on Mainland China for production needs.

Investors should be aware that Hon Hai's shares are traded on both the Taiwan Stock Exchange and the OTC or Over-The-Counter market. The three-month average daily trading values for Hon Hai's Taiwan-listed and OTC shares were $90 million and $0.3 million, respectively as per S&P Capital IQ data. Readers keen on trading in Hon Hai's relatively more liquid Taiwan shares can engage the services of stockbrokers which provide trading access for international equity markets such as Monex Boom Securities.

Recent Top-Line Performance Has Been Disappointing

Hon Hai has a policy of disclosing its monthly revenues, and the company's recent top-line performance has been poor.

The YoY top-line contraction for Hon Hai worsened from -1.2% in July and -8.0% in August to -19.7% for September, which the company largely attributed to below-expectations "customer pull-in for cloud and networking products" as indicated in an October 5 Seeking Alpha News article . In the company's September 2023 revenue disclosure announcement , Hon Hai also highlighted that the "slowdown in PC market demand" also hurt its sales in the most recent month.

In my opinion, Hon Hai's full-year FY 2023 revenue outlook isn't good judging by various indicators.

Firstly, Hon Hai's top-line had already decreased by -7.7% from NT$4,664.9 billion for the first nine months of 2022 to NT$4,308.2 billion in 9M 2023. The company's negative revenue momentum year-to-date has unfavorable read-throughs for its full-year top-line performance.

Secondly, the sell-side has an increasingly bearish view of Hon Hai's revenue performance for the current year. In the last three months, Hon Hai's full-year FY 2023 top-line estimate was revised downwards by -5.7% according to consensus data taken from S&P Capital IQ .

Thirdly, Hon Hai's forward-looking commentary for Q4 2023 as outlined in the October 5 Seeking Alpha News article emphasized QoQ or sequential improvement rather than YoY expansion. This suggests that Hon Hai's full-year performance for this year is expected to be weaker as compared to last year. Notably, the current market consensus forecast of a -6.4% revenue decline in local currency terms (source: S&P Capital IQ ) for Hon Hai in FY 2023 is comparable to that of the -7.7% top-line contraction for 9M 2023.

Hon Hai is expected to release the company's complete third quarter financial results (including profitability, balance sheet, and cash flow metrics) on November 14 . I take the view that Hon Hai's Q3 2023 bottom line performance will also fail to live up to market expectations due to an unfavorable sales mix. As mentioned above, Hon Hai's cloud & networking products and computing (PC) products segments have underperformed in Q3, which means that the relatively lower gross margin smart consumer electronics products (smartphones) segment will account for a larger proportion of the company's top-line for the recent quarter.

Dependence On Mainland China Production Is In The Spotlight

Factories in Mainland China are responsible for about three-quarters of Hon Hai's worldwide production as mentioned in an August 14, 2023 Financial Times article .

Hon Hai has a supply chain diversification strategy known as BOL or Build-Operate-Localize, and the company is actively expanding its production in other markets like India, Southeast Asia, and Saudi Arabia as indicated in its recent quarterly earnings presentation . According to a recent October 23, 2023 news article published in The Times Of India , Hon Hai is targeting to have the scale of production in India grow to a level comparable to that of China within the next decade. As such, it will be fair to assume that Mainland China will remain a key manufacturing hub for the company in the medium to long term.

Nikkei Asia reported on October 23 that "Chinese authorities are investigating mainland bases of Taiwanese contract manufacturer Hon Hai Precision Industry, known as Foxconn, on tax and other compliance grounds." HNHPF's shares dropped by -3.7% on the same day, which implies that investors are concerned about Hon Hai's reliance on Mainland China as a production hub and the associated political risks. It is worthy of note that Hon Hai's founder Terry Gou declared in August his intention to be in the running to become Taiwan's new president.

Taiwanese companies that are dependent on China for either manufacturing or sales have a reasonably high level of political risks, and Hon Hai isn't an exception as evidenced by recent news flow and the company's share price reaction.

Closing Thoughts

Hon Hai's significant YoY revenue decline for September was disappointing, and the company is too dependent on Mainland China as a manufacturing hub. This explains my decision to award a Sell rating to Hon Hai.

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