Hon Hai’s Q4 Outlook Points to Robust iPhone Demand but Longer-Term iPhone EMS Risks Remain

We have raised our Hon Hai fair value estimate to TWD 95 from TWD 90 previously, largely to reflect higher gross margin assumptions in fiscal 2020 and 2021. Third quarter’s gross margin expansion tracked higher than our full-year estimates, largely due to production yield enhancement and higher than anticipated COVID-19-related expense rebates from customers and government. Hence, we lift our fiscal 2020 gross margin estimate to 6.0% from 5.8% previously. Meanwhile, management’s 2021 revenue guidance for consumer was slightly ahead of our expectations, which suggests a stronger iPhone cycle that is aided by spillover demand into first half of 2021 due to iPhone 12 launch delay. Therefore, we increase our 2021 consumer revenue and gross margin assumptions. As a result, we raise both 2020 and 2021 operating income by 4% to TWD 114 and 140 billion, respectively. Our fair value estimate of TWD 95 implies a multiple of 9.3 times 2021 earnings, which is in line with its five-year average. We consider shares fairly valued. Although we have adjusted our 2020 and 2021 gross margin higher than previously, we still maintain a conservative stance on Hon Hai’s gross margin (versus CapIQ’s consensus) due to risks of stiffer competition as a result of Luxshare’s iPhone entry in 2021. Further, we don’t think that Hon Hai’s shift to new areas such as electric vehicles, robotics, and medical will be fast enough to offset potential headwinds in its legacy iPhone business.