FY23 result a miss, de-spec and interest cost weigh on earnings

Sunny's FY23 result disappoints market, with revenue and net income came in at RMB31,681mn/1,099mn respectively (-4.6%/-54.3%Yoy). Sunny's topline was ~2% below Bloomberg consensus and our estimates, while net income arrived at the low-end of the profit warning alert in end- Jan. Sunny's FY23 net profit was also 19% below our estimates. Sunny's result miss was driven by the following factors: i) dampened smartphone end demand, which led to ASP and GM pressure. Blended GM came in 14.5% (vs. 1H23 at 14.9% and ~140bps lower than Bloomberg consensus) due to optoelectronics margin pressure; ii) higher interest expense and effectively tax rate offset higher interest and investment income.

High end product contribution stabilized in 2H23; Soft HLS and HCM shipment guidance, ASP and GM focused a good move

Handset related sales dropped 10.0% Yoy to RMB20.9bn on the back of weak smartphone end demand, de-spec and competition continue to post a drag on FY23 ASP and GM. Optical components (mainly HLS) and optoelectronics (mostly HCM) shipment volume arrived at 1,170mn/567mn units (-1.8%/+9.8% Yoy) respectively.

Sunny's optical components and optoelectronics' GM each slipped 6.0ppts/5.2 ppts Yoy to 28.4%/5.5%. On HoH basis, optical components' GM rebounded to 30% level in 2H23, which we believe Sunny benefit from the recovery in premium smartphone market. Meanwhile optoelectronic products' GM further slipped to ~4.0% based on our calculation. Management expects FY24E GM to improve, with HLS/VLS/HCM GM would be ~20%/~40%/5-6% respectively.

Though Sunny's FY23 high-end handset product mix (i.e. 6P+ lens, periscopes and large image size modules) was down Yoy, the contribution was largely stable HoH, we view this as a sign of stabilization in high end product shipment:

Sunny's high-end product contribution made good progress in recent years with increasing contribution from 6P+ lens (23.0%/24.7%/25.6%/32% in FY19-Y23), thanks to tapping into US smartphone client supply chain. Due to weak end demand, shipment was down 20% Yoy to 302mn units in FY23 (25.8% contribution vs. 25.7% in 1H23).

Periscopes and large image size (> 1/1.7") camera modules slipped 38.8% Yoy (vs.51.7% in 1H23) to 43.4mn units and took up 7.6% of HCM shipment volume (vs. 6%/10.3%/6.7%/13.7% in FY19-FY22).

Sunny provided a soft guidance on FY24E HLS and CCM shipment, in which HLS shipment to grow 5% Yoy (in-line with our expectation), while HCM shipment volume to be flattish Yoy, and Management would focus on improving product mix which would benefit both ASP and GM. Market views these set of shipment volume guidance as a conservative/soft one, and would hinder Sunny's near term share price rebound. Nevertheless, we still expect global smartphone shipment would gradually pick up in FY24E, mainly driven by top-tier clients' flagship model. We still expect Sunny's share allocation in US smartphone client (HLS + potential CCM orders) and Samsung (supplying flagship HCM) is still on upward trajectory, which would provide support to both ASP and GM.

We continue to expect the shipment pace would be similar to that in FY19-FY23, Sunny's YTD (3M24) HLS and HCM shipment reached ~26%/28% of latest guidance, both are slightly ahead of guidance (vs. ~23%/23% on average in FY19-FY23). We advise investors to pay close attention to monthly shipment figures before 1H24 result. Management remains positive on long term prospects (incl. variable aperture, hybrid lens, OIS and sensor-shift stabilization), meanwhile AI technology and foldables would lead the growth of high-end smartphones and promote a new round of replacement cycle in the medium term.

FY24E CAPEX guidance increase Yoy, still mainly on XR+auto; Continue to pave way for long term growth

Sunny continues to invest in product R&D and technology upgrades. R&D expense arrived at ~RMB2.6bn and accounted for 8.1% of total revenue (vs. 5.9%/6.6%/7.0%/8.4% in FY19-FY22). We still expect Sunny R&D expense would maintain at ~7-8% in FY24E/FY25E. Sunny FY23 CAPEX was down 20% Yoy to RMB2,488mn and guided FY24E CAPEX at ~RMB3.0bn (+20% Yoy, similar to FY22 level), in which ~40% would be used in XR and auto related segment (lens and CCM), while remaining will be allocated to HLS capacity expansion (for high-end clients) and development of motors in HCM, and expanding infrastructure in Vietnam (including new factories).

Automotive products: Conservative FY24E lens guidance, modules continue to deliver solid growth;

Continued R&D and comprehensive product offerings;

Vehicle related products (incl. both VLS+ vehicle camera modules) sales still managed to grow 28.6% Yoy to RMB5,283mn and accounted for 16.6% of total revenue (vs. 5.0%/8.1%/10.2%/17.3% in 1H20/1H21/1H22/1H23), on the back of VLS shipment grew 15.1% Yoy to 90.8mn units. Sunny guided FY24E VLS shipment to grow ~10% Yoy, and Sunny's 3M24 shipment arrived at ~28mn units (~28% of FY24E guidance vs. ~25% on average in FY19-FY23)

Sunny remains upbeat automotive business long term outlook, driven by project wins, and increasing no. of cam adoption accompanied by more compact design (e.g. COB packaging technology on automotive CCM) with added value (e.g. active defogging), pixel migration etc. Sunny shared that automotive CCM revenue was at RMB1.6bn in FY23 and targets to reach RMB2.0bn in FY24E (+25.0% Yoy). Despite near term headwinds, we believe Sunny would continue to benefit from increasing automotive CCM, LiDAR and ADAS penetration, thanks to their leadership in VLS (No.1 with >30% global market share) and leading supplier in automotive CCM.

Lower FY24E-25E EPS and introduce FY26E forecast; Diversification is still well on track with clear mid- term product roadmap; Accumulate on weakness, Maintain BUY

We lower Sunny's FY24E-25E EPS estimates by 22.4%/32.7%, due to lower sales and GM assumption, we continue to expect a mild recovery in FY24E driven by top-tier smartphone clients. We still view Sunny's leadership in HLS and HCM remains intact, and their strategy to diversify away from smartphones is well on track, with non-smartphone revenue contribution (with auto+XR accounted for ~60% of the non-smartphone sales) increased to >30% of total revenue in FY23 vs. 15.5% in FY20.

Sunny's share price having plunged ~30% after providing a soft shipment guidance during FY23 result, it is trading at FY24E 21.2x PE (>1s.d. below Sunny's 10-year average), we expect FY23-26E sales and net profit would grow 12.2%/34.5% CAGR on the back of i) gradual smartphone market recovery, ii) increasing share allocation in top- tier smartphone clients and iii) increasing non-smartphone contribution. We also introduce FY26E forecasts. Sunny's clear mid-term product roadmap would continue to play a part in Sunny's new growth engine, we maintain Sunny's rating at BUY with new TP at HK$49.37, which translates to FY24E 28.0x target PE (10-year average). Sunny remains one of our sector top pick, we continue to advise investors to accumulate on recent weakness and ride on smartphone market recovery.