Investment suggestion

We move Fuzhikang out of the firm to buy, but still give a recommended rating.

Reasons

The initial results for fiscal year 2015 were lower than expected, mainly due to lower-than-expected gross profit margins. Fuzhikang achieved a performance of US $215 million to US $235 million at the beginning of 2015, with a median lower than CICC's forecast of 12.9%. We believe that Fuzhikang's lower-than-expected performance in the second half of 2015 is mainly due to the transformation of Xiaomi's high-end series of smartphones, and we underestimate the negative impact of Mi4/ Xiaomi Note shipments and Mi5 launch delays.

The negative effects of Sony, Motorola and Xiaomi on gross margins are manageable. We believe that Huawei's strong growth and Fuzhikang's expansion from parts to ODM will offset the potential uncertainties of Sony, Motorola and Xiaomi. In addition, other successful mobile OEM, such as OPPO, VIVO, Meizu, etc., are contributing more and more, which will contribute additional increments. In addition, Mi 5 will bring momentum in the first half of 2016.

The beneficiaries of two major trends. We expect Fuzhikang to represent two major trends in the manufacture of smartphones in China, including: 1) model upgrades, such as metal casings, and 2) exports to meet the needs of emerging markets. the main supporting factors include its position in mid-and high-end manufacturing and its early capacity layout in India.

Profit forecast and valuation

The target price was lowered from HK $6.22 to HK $3.50 (based on 0.86x/0.82x 2016e/17e BVPS) due to concerns about gross profit margin by 12.7% and 8.3% per share in 2015. Fuzhikang plans to maintain a dividend payout ratio of 25%, higher than our forecast of 20%. We take it out of the firm and buy it and give it a recommended rating.

Risk

Sales growth slowed and competition led to a decline in average sales prices.