3 Companies To Buy in the Apple Global Supply Chain 17

Apple’s global supply chain

Shares of Apple’s (AAPL) suppliers are spiraling downwards as the company announced lukewarm demand for its iPhone 8 and expects delays in the production of its much-anticipated iPhone X.

Apple currently sources 40% of its components from Taiwanese suppliers, and any reports of delays in deliveries or revisions in orders of these components by Apple mean trouble for these companies. A report by Digitimes stated that Apple has revised its orders related to the iPhone X by as much as 40% of its originally planned quantities.

Taiwanese suppliers to Apple like Largan Precision, Catcher Technology, Taiwan Semiconductor (TSM) and Hon Hai (2317.TW) have witnessed sharp selling pressures on their stocks as reports regarding lukewarm demand of the new iPhones emerged. Apple’s stock and subsequently its supply chain began to experience volatility. Stocks of these suppliers have dropped by nearly 25% since mid-September and may offer an attractive entry point for prospective investors.

Is the sell-off now over?

Largan Precision (3308.TW), lenses supplier to Apple lost 10% of its value in the two weeks (between Sep 12 to Sep 28) following the launch of the new iPhones. Catcher Technology (2474.TW), which makes metal cases for iPhones, dropped 19.5% in the same timeframe.

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Comparatively, stocks of big component makers Taiwan Semiconductor (TSM) and Hon Hai (2317.TW) fell 1% and 9.9% respectively. Hon Hai assists Apple in assembling its phones while TSMC provides chips and semi-conductors. LG Display (LPL), which provides displays has declined 4.7% while Goertek (002241.SZ), maker of acoustic parts slipped 6.8%. Pegatron (4938.TW) has also lost 14% over the same period.

The weak performance of Apple’s suppliers has also put pressure on Taiwanese stock indices. The Taiwanese benchmark TAIEX Index (TSE50) is down 2.6% as market sentiment on these component makers turns bearish. Comparatively, the iShares MSCI Capped ETF (EWT) has corrected 5% as stocks of Apple’s suppliers continue to display weakness. This ETF invests in 8 companies that generate their largest proportion of revenues from Apple.

Credit Suisse believes the recent sell-off has reached a tipping point and that news on the weak demand for iPhone 8 may be unreliable. Credit Suisse analyst Pauline Chen mentioned in a note to investors, “We would argue 8+ demand could also be better than feared, given (1) the narrowed price gap (to US$100, from US$120) to get a more mature dual camera in this generation with improving casing design (to avoid fingerprint on the back cover); (2) the improving camera quality, suggested by DXOMARK—iPhone 8+ score improved to 94 from 88 of iPhone 7+; and (3) increasing demand for large-size model—IDC data suggests 5.5″ iPhone accounted for 36% of the total iPhone mix in 2Q17, versus 25% in 1Q15.” Further, she expects to see upward revisions on demand for the iPhone 8 if supply of the iPhone X falls short.

Chen is particularly bullish on Catcher Technology and Largan. Rising demand for camera technology that the iPhone X boasts of will likely lead to a rise in Largan produced 3D camera lenses where it has a 50% market share. Chen has “outperform” ratings on Largan and Catcher Technology and expects upside of 9.3% and 13% respectively.

Companies to watch

Largan Precision

Largan Precision is one of the most profitable component makers for the iPhone. The company has a near monopoly in the manufacturing of high-end camera lens modules for use in Apple & Samsung’s smartphones and tablets. These 3D camera lenses are a key component of the iPhone X and are high-margin products for Largan. Currently, Largan operates at margins of 60%, nearly double that of Apple and significantly higher than its peers.

In the past five years, its turnover has nearly tripled. In 2016, the company reported revenues of $1.5 million.

Largan Precision has a market cap of $24 billion on the Taiwan Stock Exchange. Its share price has nearly doubled in the last two years, and is up 45% in 2017.

The stock has received 20 buy ratings, 7 hold ratings and 2 sell ratings from sell-side analysts and trades at a PE ratio of 29.4x, higher than the industry average.

Catcher Technology

Catcher Technology produces main casings for Apple’s iPhones. The company recently shared a positive outlook for its orders amid concerns of revisions. Catcher, however did not clear whether the existing orders were for the new iPhone models or the older models.

Catcher spokesman James Wu said in an interview with Unique Satellite TV, “We are the client’s main casing supplier. The order allocation for Catcher will only go up, not down.” After the iPhone launch last month, investors were concerned that Catcher might not gain orders for the iPhone X as the company changed from metal to glass casings. In 2016, the company reported revenues of $2.5 million.

Catcher Technology has a market cap of $8.3 billion on the Taiwan Stock Exchange and has gained 46% in 2017 so far. The stock has received 15 buy ratings, 10 hold ratings and 3 sell ratings from sell-side analysts and trades at a PE ratio of 12.5x, below the industry average.

Hon Hai

Hon Hai Precision, also known as Foxconn Technology, assembles the iPhone and other Apple devices and is a crucial supplier to Apple. The iPhone X is assembled by Hon Hai at its factory in the central Chinese city of Zhengzhou.

Jeff Pu, an analyst at Taipei-based Yuanta Investment Consulting estimates that Foxconn manufactured nearly 2 million units of the iPhone X in September and has estimated production of 10 million units in October. By end of 2017, he forecasts the company to assemble 40 million of the iPhone X, lower than his earlier estimate of 45 million units.

In 2016, the company reported revenues of $1.4 billion.

Hon Hai has a market cap of $60.8 billion on the Taiwan Stock Exchange and has gained 26% in 2017 so far. The stock has received 13 buy ratings, 6 hold ratings and 2 sell ratings from sell-side analysts and trades at a PE ratio of 12.3x, lower than the industry average.

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