Lens Technology:We are positive on double glass,but not so m

We see unit upside but little ASP upside

2017 net profit up 78%-88%, but trailing the expectation of ~100% growth…

A mixed bag outlook for long term; maintain Hold

    We are positive on Lens’ 4Q17/2018outlook, from the angle of high unitgrowth (driven by the rising adoption of double cover-glass design). However,we are concerned that the market could have overestimated its ASP growth,given the adoption of 3D glass (which costs 100%+ more than 2.5D glass)could be slower than expected. Our industry check suggests Apple is unlikelyto adopt 3D glass in 2018. Retaining Hold rating on valuation.

    Sunway released 2017 result preview and expects net profit to reachRMB950mn to RMB1bn (up 79% YoY to 88% YoY). Despite being a stellarresult, this figure missed DBe/market expectation (of 100% growth) by ~10%.

    Glass back-cover and 3D glass are clear trends for near/mid-term The 3D glass upgrade should increase Lens’s product ASP but not necessarily boost its gross margin, given higher costs and lower production yield. Also, we think the captive account (Apple) will likely stick with 2.5D glass in 2018/2019. Lastly, for the long term, we see a potential over-supply risk, and rising threats from alternative materials (ceramic, sapphire, etc.). The arrival of foldable display (likely 2020 or 2021) might be negative for the glass maker too, as it requires a cover lens, made from film, instead of glass; maintain Hold.

    3Q17earnings preview below expectation

    …due to order/ASP cuts from some clients, forex, finance costs and others

    Glass back-cover and 3D glass are clear trends for near/mid-term

    According to Lens’ 3Q17earnings preview, 3Q17net profit should reachRMB54.7mn to RMB63.0mn (+0% to +15% YoY), a deceleration from 26% YoYgrowth in 1H17net profit. Considering the launch of iPhone 8/8Plus with thenew double cover-glass design, the magnitude of growth appears low. Themid-point of the guidance (RMB59mn) trailed our estimates and Bloombergconsensus by 20%-25%. Lens attributes the weakness to low capacityutilization and unsatisfactory production yield in its new production site. Webelieve the delay to the iPhone X launch is also partly to blame.

    Sunway attribute the miss to 1) order cuts and ASP erosion from some clients(we expect to Oppo, Vivo and tier-two Chinese OEMs) leading to slower toplinegrowth and margin decline in 4Q17, 2) the surge in forex loss (due to RMBappreciation against USD), and interest expense (to finance the Changzhouplants), and 3) RMB100mn+ YoY increase in opex (due to aggressive businessexpansion). Our prior Sunway earnings model had properly factored in theincrease in opex (the third factor), but we underestimated the negative impactsfrom first two factors.

    Major Chinese OEMs have by now launched their 2018 flagship devices. As the market anticipated, most of them (Huawei P20, Vivo X21, Vivo NEX, Oppo R15, Xiaomi M8, etc.) have adopted the 3D glass back-cover design. We think the 3D glass trend will stay with high-end phones in 2019 as well. In general, ASPs of 3D glass could be 100% higher than that of 2.5D glass. But, on the flip side, its gross margin could be noticeably lower, due to longer cycle time, higher production costs and lower production yield (manufacturing complexity in the heating bending, chemical strengthening and decoration/coating processes).

    Double glass remains the trend, but 3D glass adoption appears slower

    Positive long-term outlook unchanged

    Over-supply as a long-term risk - more competitor + alternative materials

    We agree that the rising adoption of a double cover-glass design on high-endsmartphones is a clear trend for the coming two to three years (for wirelesscharging or aesthetic purposes), which is positive for a cover-glass leader likeLens. However, we caution that the upgrade to 3D glass (USD10+) from 2.5Dglass (~USD4) or 2D glass has been slower than expected. Our industry checkindicates the new iPhone in 2018will still have 2.5D glass. Most of the highendsmartphones from Chinese OEMs will stay with 2.5D glass too, due to costconcerns and durability issues (3D glass is more breakable at the edge).

    We remain positive on Sunway, as the progress of winning multiple iPhonecomponent projects stays on track, including 1) Lightning connectors (as the3rd supplier in 2018), 2) VCM cases, and dual cam supporting frame (as the keysupplier), and 3) market share gains in EMI shielding cases. Also, it could likelygain share in Samsung’s wireless charging module in 2018 too.

    For the past decade, the smartphone glass market has been a duopolistic one, dominated by Lens Tech and Biel Crystal. However, the fast adoption of glass back-cover and 3D glasses has drawn aggressive investments and capacity expansion from new competitors, like BYD Elec, AAC, O-Film, Victory Prevision, etc. Due to high entry barriers, they might not cause a dent in the near term, but some of them could emerge to become legitimate competitors by 2019 or 2020, given their solid relationship with tier-one OEMs and good track records in business expansion. Also, 3D glass might not be the only solution for high-end devices. Some might switch to ceramic, sapphire, or metallic plastic for back-cover materials. The potential long-term upgrade will be the foldable display, which requires the cover lens (i.e. the front cover) to be made from film rather than glass.

    Valuation and investment risks

    Valuation and investment risks

    Valuation and risks

    We trim 2017-19net profit forecasts by 7%-13% (to reflect lower GPM andASP assumptions), but raise our TP from RMB26to RMB29.4. Our new TP isstill based on 22x PER, but we roll over the valuation from 22x 2017E EPS to22x 2018E EPS. 22x PER mirrors 0.8x PEG, in line with regional peers.Upside/downside risks include: strong/weak iPhone demand, ASP hike/decline,and market share gain/loss.

    We trim 2017/18/19 EPS forecasts by 10%/4%/4% to price in 4Q17 non-op lossand softer outlook for Chinese clients, and trim TP from RMB52 to RMB50. Ournew TP is still based on 33.5x 2018 PER, or 0.8x PEG (in line with regionalpeers). Risks: market share loss, slow spec upgrade, and iPhone weakness.

    We cut 2018/19 EPS forecasts by 43%/40%, respectively, to reflect potential GPM decline, lack of upgrade in iPhone cover glass, and a 50% stock dividend (the stock dividend alone will reduce EPS by 33%). We hence lower our TP from CNY29.4 to CNY14. Our new TP is still based on 0.8x PEG, or 20x PER. 0.8x PEG is in line with regional peers. Upside/downside risks include: strong/weak iPhone demand, ASP hike/decline, and market share gain/loss.

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