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CSCI-Technology-Q Technology (1478 HK)：Persistent industry headwinds - 20180828

Persistent industry headwinds

• Q Tech’s 1H18 results came in below both our and the street estimates with its revenue sliding 11.0% YoY and a surprise RMB51.3mn loss in 1H18 vs a RMB201.8mn profit in 1H17.  
• In spite of solid CCM/FPM shipment growth of 23.6%/31.9% YoY, Q Tech’s gross margin nosedived to 1.2% in 1H18 from 12.1% in 1H17 amid fierce competition.     
• We cut out FY18E/FY19E revenue/profit estimates by 22.0%/28.8% and 110.6%/89.6% respectively and lowered our DCF-based price target to HKD5.30. Maintain Hold.

A worrisome set of 1H18 headlines. As was flagged earlier in its profit warning, Q Tech’s 1H18 headlines saw major headwinds in the face of 1) ‘price war’ in the CCM/FPM markets, 2) industry consolidation both in downstream customers and upstream suppliers, and 3) RMB depreciation. Revenue slid 11.0% YoY, primarily dragged by weak CCM/FPM ASP (declined by 18.9%/54.4% YoY). Gross margin contracted to a trivial 1.2%, mainly due to 1) a deteriorating product mix (5MP or below CCM accounted for 46.5% of total CCM shipments, up from 27.7% in 1H17), 2) price hike of raw materials (lens sets, CMOS sensor and VCM), and 3) intensifying competition among module makers. 

A ‘decisive battle’ looms. The CM/FPM market segments appeared to have entered a phase of ‘decisive battle’, as both smartphone vendors and upstream suppliers (Lens, VCM and CMOS sensor for CCM and fingerprint IC for FPM) are in a shake-up phase, in our view. Despite overcapacity, leading players have continued to add more capacity to prevail the ‘price war’. The industry headwinds will continue to weigh on module makers’ ASP and GPM over the coming two years, in our view.      

Making inroads in Huawei’s mid-range products. Q Tech attributed the deteriorating product mix primarily to a bulk of ultra-low-end (less than 3MP) orders from Huawei, in a bid to win Huawei’s high-end orders but at the expense of near-term losses. Given that Q Tech has started to make inroads into Huawei’s mid-range products, we believe Q Tech’s product mix will likely improve gradually during 2H18-FY19E.  

New products to drive margins. In Jul-18, Q Tech announced that its 3D structured Light Modules (for OPPO Find X) and under-glass FPM (for vivo’s NEX) have begun mass production. In spite of the trivial contribution in 2H18, these high-margin products would drive Q Tech’s ASP and GPM higher from FY19E onwards. Besides, the company is also accumulating a broad range of frontier technologies such as triple-cam, dual-cam structured light and ToF.    

Not yet a time for bargain hunting. In view of the growing pressure on ASP and GPM, we have cut our FY18E/FY19E revenue and profit estimates by 22.0%/28.8% and 110.6%/89.6% respectively and lowered our DCF-based target price to HKD5.3 (from HKD11.0). Maintain Hold.