HNHPF - Hon Hai: Focus On January Sales And Key Metrics

Summary

• Hon Hai Precision achieved better-than-expected sales in January 2023, which indicates that disruptions associated with its iPhone manufacturing plants should be a thing of the past by now.
• The key metrics relating to Hon Hai Precision's EV business, gross margin, and valuations suggest that the company's shares should benefit from a positive re-rating in time to come.
• I raise my rating for Hon Hai Precision to a Buy, taking into consideration above expectations January revenue, the company's financial targets, and the stock's valuations.

Elevator Pitch

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

In my previous article written on May 31, 2021, I reviewed Hon Hai Precision's Q1 2021 results and previewed its Q2 2021 earnings. With the current update, I upgrade my rating for Hon Hai Precision from a Hold previously to a Buy now. Hon Hai Precision's January 2023 top line was a positive surprise, and I have a favorable view of the company's medium term outlook after assessing relevant key metrics.

January 2023 Sales Numbers Were Encouraging

Seeking Alpha News recently reported on February 6, 2023 that Hon Hai Precision's top line expanded by approximately +48% YoY and +5% MoM (Month-on-Month) to NT$660 billion in the first month of 2023. According to the consensus financial numbers taken from S&P Capital IQ , Hon Hai Precision's actual January 2023 sales were equivalent to around 46% of the company's consensus Q1 2023 revenue of NT$1,747 billion. In other words, the company's top line registered in the prior month had come in significantly better what the market anticipated.

More importantly, Hon Hai Precision's robust January 2023 sales send a clear message to the market that its iPhone manufacturing plants in China are operating normally again after suffering from disruptions relating to COVID-19 earlier.

The sell-side analysts covering Hon Hai Precision's shares have reduced their bottom line estimates for the company in the past few months, due to worries that its financial performance will be negatively impacted by lower-than-expected iPhone shipments. Specifically, the consensus earnings per share or EPS for Hon Hai Precision was cut by -8% from NT$11.98 as of November 1, 2022 to NT$11.00 now as per S&P Capital IQ data.

Hon Hai Precision's above expectations top line in January 2023 should put an end to the analysts' earnings cuts for the company.

Key Metrics Are Supportive Of A Positive Re-Rating

There are a few key metrics that investors should be paying attention to, when they are considering Hon Hai Precision as a potential investment candidate.

One key metric is the revenue target for the company's Electric Vehicle or EV business. Hon Hai Precision is of the view that its EV business can generate NT$1 trillion of revenue and take a 5% share of the worldwide EV market in three years' time.

This implies that the EV business could potentially contribute as much as 14% of Hon Hai Precision's top line based on the sell-side's consensus FY 2025 revenue of NT$7.3 trillion. This will be an incredible feat for this new business segment which was only started in late 2020. In its most recent Q3 2022 financial results presentation , Hon Hai Precision cited notable developments for its EV business, including strong preorders for the Luxgen n7 CUVs (Crossover Utility Vehicles), and the successful delivery of electric buses known as Model T. These positive developments imply that Hon Hai Precision is making pretty good progress in growing its EV business.

Another key metric is Hon Hai Precision's profitability target. The company aims to increase its gross profit margin from 6.0% in fiscal 2021 to 10.0% for FY 2025.

The analysts aren't convinced that Hon Hai Precision can deliver a substantial improvement in the company's overall profitability in the next few years, which suggests that there could be positive surprises in store for the company's investors. The current consensus FY 2025 gross profit margin forecast for Hon Hai Precision is 7.4%, which is way lower than the company's gross margin target of 10%.

Hon Hai Precision's EV business has the potential to generate gross profit margins in the 20%-30% range, while Hon Hai Precision used to achieve annual gross margins between 5.7% and 8.4% in the 2010-2020 financial period before diversifying into EVs. Assuming that Hon Hai Precision's FY 2025 revenue split between EV and non-EV businesses is 15:85 and it registers gross margins of 20% and 7.5% for its EV and non-EV businesses in three years' time, the company's FY 2025 gross margin could be as high as 9.4%. Even if Hon Hai Precision's FY 2025 gross profit margin doesn't meet its own intermediate term goal, the company's actual gross profitability might still exceed market expectations based on my calculations.

The company's valuation metrics are also worth noting.

The market currently values Hon Hai Precision at consensus forward EV/EBITDA and normalized P/E valuation multiples of 5.3 times and 9.7 times, respectively as per S&P Capital IQ valuation data. The 15-year average forward EV/EBITDA and P/E metrics for Hon Hai Precision were relatively higher at 6.4 and 11.0 times, respectively. If Hon Hai Precision can deliver a substantial expansion of its gross profit margin in the next three years, it is reasonable to expect Hon Hai Precision to be trading at above historical average valuation multiples then.

Closing Thoughts

A Buy rating for Hon Hai Precision is justified. Hon Hai Precision's current valuation multiples are below their historical averages, and the company's stock price should rise assuming the company meets its 2025 financial goals.

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