Investment suggestion
Fuzhikang Group downgraded its rating from "recommended" to "neutral".
Reason
It is expected that the performance in the first half of 2016 will fall by 84.4% and 92.2% compared with the same period last year. Fuzhikang issued a profit warning for the first half of 2016 and expects net profit in the first half of 2016 to fall 84.4% from a year earlier to US $10 million. The median of the net profit forecast range is 85.7% lower than we expected, and 86.3% lower than the market consensus, mainly due to: 1) inventory backlog of major customers. According to the announcement, the company's revenue in the first half of 2016 is expected to be less than US $2.456 billion, which is 29.6% lower than our forecast and 33.5% lower than the market consensus.
2) the exchange rate factor may lead to a decline in the company's gross profit margin; in addition to the lower-than-expected revenue, the appreciation of the RMB in the first half of 2016 may also lead to a decline in the company's profit margin. 3) other business income decreased, such as service charges and mold sales income.
The progress of the spare parts business is slower than expected. Since the second half of 2015, the growth rate of smartphone shipments of Fuzhikang Group's main customers, including XIAOMI and Sony Group Corp, has slowed. XIAOMI has a higher profit margin contribution to Fuzhikang because Fuzhikang mainly supplies high-margin spare parts products to XIAOMI (we expect to account for more than 20 per cent of Fuzhikang's profits in the first half of 2016) although Sony Group Corp is also an important customer of Fuzhikang, but we expect Sony Group Corp to contribute less than 10 per cent of Fuzhikang's profits in the first half of 2016. In order to offset the negative impact of the slowdown in the growth of the two major customers, Fuzhikang has partnered with Huawei in the assembly business and higher value-added parts business. But the progress of the parts business seems to be slow.
Profit forecast and valuation
Taking into account lower sales and gross profit margin, the company lowered its 2016 earnings per share forecast by 39.2% to 0.02 US dollars, and lowered its 2017 earnings per share forecast by 25.4% to 0.02 US dollars. The Fuzhikang Group was downgraded to "neutral" and the target price was lowered by 12.6% to HK $3.06, based on 0.82 times 2016 market-to-net ratio.
Risk.
Growth in the smartphone market is slowing; volume in India is slowing.