INARI is garnering a slice of action in the booming AI space via its memory and optical transceivers. It is also riding on the smartphone market in China via its YSIC-JV expansion in Yiwu. We cut our FY24- 25F net profit forecasts by 5% and 3%, respectively, largely to reflect higher water tariff, trim our TP of by 3% to RM4.05 (from RM4.17) but maintain our OUTPERFORM call.

We came away from INARI’s 2QFY24 briefing reassured of its outlook with the following key takeaways:

1. New ventures catering to AI. INARI has started low volume production via single line for its memory customer which is expected to be increased to four lines by June 2024. The group hinted that this memory venture will eventually allow the group to tap into the AI race as memory is one of the key components complimenting the core graphical processing power. In addition, its venture into optical transceivers is seeing more traction as customers are beginning to move into 800G due to the need for quicker data transfer within data centres in anticipation of greater AI adoption.

2. Seasonal 3Q to be cushioned by improved efficiencies. We understand that INARI still felt the impact of power surges in the newly reported 2QFY24 results, resulting in loss of efficiencies. If not for the hiccups, it could have made over RM90m net profit (vs. actual RM86m) during the quarter. However, it ensured that the issues have been resolved and its machinery has been recalibrated and is now able to achieve its desired yield rates. This improvement in efficiencies is expected to cushion the group’s performance as it enters into its seasonally softer 3QFY24 due to the Chinese New Year break where its production of radio frequency (RF) filters is running at sub-80% utilisation rate (vs. c.90%) in the prior quarter.

3. Expanding China’s exposure. INARI's strategy of “China for China; Penang for the West” positions the group to benefit from the smartphone upcycle in both regions. The 54.5% owned YSIC-JV expansion, featuring a 500k sq ft plant in Yiwu, set to be operational by mid-2024, positions the group to tap into the China smartphone market with an ambitious goal of achieving RMB1b in revenue and listing status within three years.

Forecasts. We cut our FY24-25F net profit forecasts by 5% and 3%, respectively, to reflect higher water tariff effective this month as well as marginal capex incurred to increase water tanks within the plants as a contingency during unplanned water disruption.

Valuations. Consequently, we trim our TP by 3% to RM4.05 (from RM4.17) based on an unchanged FY25F PER of 32x. Our valuation reflects a 10% premium on peer’s forward mean, justified by the company's superior net margins of >20%, (vs. peers of single digit). Our TP imputes a 5% premium to reflect its 4-star ESG rating as appraised by us (see Page 4).

Investment case. We like INARI for: (i) it being the closest proxy to 5G adoption, (ii) being highly responsive to the market demand with the roll-out of new technologies such as double-sided moulding (DSM) and system-on- module (SOM), and (iii) its significant expansion in China, capitalising on the superpower’s aggressive push for semiconductor self-sufficiency. Maintain OUTPERFORM.

Risks to our call include: (i) a soft global smartphone market; (ii) new offerings not well-received by key customers, (iii) supply-chain disruptions, and (iv) delays in its expansion in China.

Source: Kenanga Research - 28 Feb 2024