1H24 net profit beat on GM recovery across the board; Business outlook more +ve than in FY23 resultAAC’s 1H24 revenue and net profit attributable to shareholders arrived at RMB11,247mn/RMB537mn respectively (+22.0%/+257% Yoy).Topline was largely in-line with Bloomberg consensus,while net profit was 9% above consensus estimates and reached 36% of FY24E market forecasts, thanks to better than expected GM. AAC do not declare interim dividends in 1H24.

AAC’s 1H24 blended GM reached 20% for the first time since 1H21, and arrived at 21.5% (2.5ppts/1.3ppts higher than 1H24E/FY24E market estimates), thanks to GM Yoy recovery across the board, in which optics GM turned positive. AAC remained positive on its automotive related business exposure for its acoustics (software+hardware solutions in smart cockpit for OEMs, including leading Chinese NEV) and optics segment (automotive lens and CCM). It seems to us that Management’s tone on business outlook is more optimistic than in FY23 result, and they provided a clearer vision in mid-term for each business segment. Below are the 1H24 reslt highlights: Acoustics (~31% of 1H24 revenue): Sales rose 4.1% Yoy to RMB3,466mn, with GM up 4.4ppt Yoy to 29.9%, thanks to steady share gain in mid-high end market and improved product mix. In 1H24, AAC shipped >12mn (+200% yoy) SLS and 4.5mn units of 2-in-1 acoustic and electromagnetic product.

Meanwhile AAC also launched high-performance speakers with industry-leading thinness in foldables. Though AAC expects stable global smartphone shipment in 2H24 and would arrive at 1.15-1.2bn units by end-2024, Management sees stable high-end Android demand and new products would drive ASP to go up by double-digits in FY24E, which would support GM to stay above 30% level and trending towards mid-30s.

Meanwhile, spec upgrade by AI phone will be more visible in 2H25 / 2026.

AAC currently runs a flexible business model for automotive acoustics, that can offer combination of products and services to meet clients’ demand. For instance, comprehensive solution from ultra-flagship to high cost-performance by covering a set of audio solutions including single component (amplifier module, speaker set), tuning services, software systems and a flexible combination of both. As acoustic system would become one of the core components of the intelligent cockpit, we believe AAC could ride on their ongoing expertise and leadership in acoustic solutions to fulfill clients’ need , this would be a new market niche for AAC to further explore and expand in mid-long run.

PSS - automotive & consumer acoustics (13.5% of revenue): AACdisclosed PSS consolidated financials for the first time, with revenue came in at RMB1.5bn (13.5% of total revenue) and GM at 25% (above Group average and ~16% of AAC’s 1H24 GP). Management expects growth from PSS would be stable in the near term. A recap that PSS is a leading automotive and consumer speaker OEM based in Belgium, with wide client base including European, US auto OEMs (incl. Tesla) and Chinese EV OEMs (incl. new entrant Xiaomi). PSS has >3,000 employees, with R&D facilities in Belgium, US, China and Malaysia and manufacturing facilities in Belgium, Hungary, China, Malaysia and Mexico.

AAC Management previously estimates PSS has 15-20% market share in global automotive speaker market, they can leverage on PSS to strengthen AAC’s presence in global automotive acoustics equipment industry. AAC Management expects there’s room for margin expansion post acquisition, driven by better efficiency and integration of resources.

Haptics and precision mechanics (~33% of 1H24 revenue): Revenue grew 1.1% Yoy to RMB3,660mn with GMrose 3.6 ppts Yoy to 22.9%, thanks to breakthrough in metal hinges (shipment >500k units), heat dissipation components (revenue doubled Yoy to RMB150mn) and metal casings. Management noted that haptics and precision mechanics’ GM each improved by 3-6 ppts Yoy, in which GM of electromagnetic drives/ precision mechanics and heat dissipation was ~30%/18%/30% respectively.

Management expects segment revenue would accelerate driven by haptic upgrade demand, while heat dissipation products annual revenue would reach RMB1bn in the next 3 years driven by AI phone. AAC’s x-axis haptics motor have been adopted in more models launched by major global smartphone brands, and have been expanding into other non-smartphone products including trackpads, game controllers, intelligent vehicles and XR devices.

Market has been anticipating that AAC would be one of the beneficiaries’ of the new solid-state button design , which would give them incremental shipment volume (increase from 1 to 3 Taptic Engines being used in each iPhone).

Apple sticked to its classic volume button design on the iPhone 15 Pro (Pro+Pro Max) models (vs. solid-state/ immovable button design that provide haptics feedback), as the new solution would have a much more complex design. It is now expected that the solid-state button design might be adopted in iPhone 16 Pro models, according to our latest channel check. In addition the rumoured new Capture Button that will be available on all iPhone 16 series, to handle the video-taking capabilities of the device. The new Capture Button will be a solid-state capacitive button, with haptic feedback provided by an in-built Taptic engine, which users can swipe along the button to zoom in and out, while shooting photographs and videos, working in a similar way to the volume control on Apple AirPod Pros.

Optics (~20% of 1H24 revenue): Revenue grew 25.0% Yoy to RMB2,210mn due to improved industry and competitive landscape, which drove both shipment and ASP in lenses and CCM, hence driving blended GM turned positive at 4.7% (+21.7 ppts Yoy), in which lens and CCM GM came in at 16.7%/5.7% respectively (+16.7ppts/+11.8ppts Yoy). Management also shared that 1G6P hybrid lens shipment grew ~40% Yoy to 1.4mn units, 6P lens accounted for >15% of total shipment, while also winning 7P lens projects, their WLG technology has also gained positive feedback from smartphone OEMs for its outstanding optical performance. For WLG, 10mn/>1mn units will be for smartphone and non-smartphone (e.g. auto, drones and wearable camera etc.). AAC proactively collaborates with clients in developing optics products (e.g. telephoto lenses, micro prisms) for future adoption in more high-end and flagship models.

Management expects CCM shipment and revenue would each grow by 20/40% in FY24E, which we view higher ASP products to drive revenue growth. We believe better improved industry dynamics, healthy inventory level and economy of scale pave way for improved product mix which would drive both ASP and GM, optics’ profitability would further improve in 2H24E/FY25E, AAC would be capable to narrow the GM gap with leading players in lenses and CCM. AAC also expects optics’ net profit to turn around in 4Q24.

FY24E-26E earnings to grow 17% CAGR; Improved earnings visibility + enters new round of earnings upcycle; Upgrade to BUYWe expect AAC’s sales and net profit to grow 10.5%/17.0% CAGR in FY24E-26E respectively, on higher sales forecasts on AAC’s core business segments, accompanied by higher GM assumption, as well as contribution from PSS. AAC is trading at 18.5x FY25E PE (~AAC’s 5-year average) As we see AAC’s earnings visibility to improve and about to enter a new round of earnings upcycle from FY24E, we upgrade AAC’s rating from NEUTRAL to BUY with new TP at HK$37.24, which translates to 22.0x FY24E target PE (~1 s.d above AAC’s 5-year average).

Risk Factors

Downside risks include: 1) Slowdown in flagship smartphone shipment in Android and iOS ; 2) Slower than expected ramp up in optics segment and SLS upgrade in Android camp and 3) AI triggers components upgrade not as expected