HNHPF - Hon Hai: Q2 Results Missed Expectations (Rating Downgrade)

2023-08-17 12:52:56 ET

Summary

• Hon Hai Precision Industry Co., Ltd.'s Q2 2023 financial performance and FY 2023 guidance were below expectations.
• But Hon Hai's shares are at a fair valuation based on the PEG metric.
• Taking into account its quarterly results, full-year outlook, and current valuations, I am of the view that Hon Hai should be rated as a Hold.

Elevator Pitch

I rate Hon Hai Precision Industry Co., Ltd. shares ( HNHPF , HNHAF) [2317:TW] as a Hold. Previously, my February 9, 2023, article touched on Hon Hai's January 2023 revenue numbers and other key metrics for the company.

In this latest write-up, my focus is on Hon Hai's Q2 2023 financial performance and the company's business outlook for the rest of the year. I have a negative view of Hon Hai's second quarter results and the company's FY 2023 prospects, but the stock is fairly valued. Therefore, I have decided to downgrade my rating for Hon Hai from a Buy to a Hold.

Readers should note that Hon Hai is listed on the OTC market, and in Taiwan as well. Hon Hai's OTC shares with the HNHPF ticker have a reasonably decent three-month mean daily trading value of more than $0.3 million. As a comparison, Hon Hai's shares listed on the Taiwan Stock Exchange with the 2317:TW ticker boasted a three-month average daily trading value exceeding $130 million. For investors with an interest in dealing in the more liquid Taiwan-listed Hon Hai shares, they can consider international brokerages with foreign markets access like Monex Boom Securities.

The Market Was Already Expecting Revenue Decline And Margin Contraction For Q2

Before Hon Hai disclosed its results for the second quarter of the year on August 14, the analysts were already projected a lower top line and weaker profit margins for the company in Q2 2023.

Based on consensus data sourced from S&P Capital IQ , the sell side was previously forecasting that Hon Hai's revenue will decrease by -11% YoY and -8% QoQ to NT$1,343 billion for Q2 2023. The market also expected the company's EBIT margin to contract from 2.9% for Q2 2022 and 2.8% for Q1 2023 to 2.6% in the most recent quarter.

In the subsequent section, I touch on Hon Hai's actual financial performance for the second quarter of the current year.

But Hon Hai's Actual Second Quarter Results Were Still Lower Than Analysts' Consensus Estimates

Hon Hai's Q2 2023 financial results were announced on Monday, August 14. The analysts turned out to be right in expecting a decline in top line and weaker operating profitability for Hon Hai in the recent quarter, but the company's actual results were even worse than what the sell side had anticipated.

Revenue for Hon Hai declined by -11% QoQ and -14% YoY to NT$1,305 billion for Q2 2023, and Hon Hai's second quarter top line was -3% below the market's consensus Q2 top line projection.

The company's actual Q2 2023 EBIT was NT$30,925 million, which translated into an EBIT margin of 2.4% in the recent quarter. In comparison, the sell-side analysts' consensus second quarter EBIT and EBIT margin forecasts were NT$34,504 million (source: S&P Capital IQ ) and 2.6%, respectively.

In its Q2 2023 results announcement, Hon Hai cited "external variables" like "global monetary tightening, geopolitical tensions, and inflation" as factors affecting its business operations. At its second quarter earnings call on August 15, 2023, the company also acknowledged that "peak demand driven by the Covid-19 pandemic is over." These factors such as macroeconomic headwinds and post-pandemic normalization explain why Hon Hai's key financial metrics for the recent second quarter came in below expectations.

Hon Hai's Financial Guidance Wasn't Encouraging

On top of its Q2 2023 revenue and EBIT miss, Hon Hai issued negative guidance for full-year FY 2023.

Hon Hai disclosed at its Q2 2023 results briefing that it has changed its "2023 (revenue) outlook" from "a flat outlook (earlier) to a slight decline" as per "information from our customers and suppliers." For the company's server segment, the growth in AI-related products hasn't been as fast as expected, considering that the current revenue contribution for AI-related products as a proportion of total server product sales is still in the 20%-30% range. This is one of the key reasons for the downward revision in Hon Hai's top line guidance.

Separately, the company emphasized at its second quarter results call that it "will be quite challenging" for Hon Hai to "reach the same (gross profit margin) level" as last year (of around 6%) in 2023. Also, Hon Hai's capital expenditures are expected to increase substantially for full-year fiscal 2023 due to geographical expansion (e.g., Indian market) and new business development (e.g., electric vehicles).

Based on Hon Hai's guidance, it is reasonable to assume that Hon Hai's top line and operating income for FY 2023 will be lower as compared to that for the prior fiscal year.

Hon Hai's Shares Are Fairly Valued Implying Limited Downside

Even though Hon Hai's second quarter results missed expectations and the company's full-year guidance isn't exactly good, the downside for its shares might be limited.

Hon Hai is currently valued by the market at 10.3 times consensus forward next twelve months' normalized P/E as per S&P Capital IQ's valuation data. The company's consensus FY 2022-2025 adjusted core EPS CAGR is +11.4%. As such, Hon Hai's price-to-earnings growth or PEG multiple is 0.9 times. Using a PEG ratio of 1.0 times as a yardstick for fair valuation, Hon Hai's stock is fairly valued or slightly undervalued.

Concluding Thoughts

Hon Hai Precision Industry Co., Ltd. stock doesn't deserve a Buy rating anymore, taking into account its Q2 2023 financial performance and FY 2023 outlook. But a Sell rating for Hon Hai is also unwarranted, as the company's shares aren't overvalued. In that respect, I view a Hold rating for Hon Hai as fair and appropriate.

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