Inari Earnings Preview: Efficiency Gains to Mitigate Q3 Seasonality

Inari's Q2FY24 performance fell short of expectations, with normalized earnings dropping by 20.7% year-over-year to RM93.9m. According to midf Research, this downturn is attributed to the additional costs incurred for upgrading to new products, establishing new technology development setups, and the hike in electricity rates.

Furthermore, the instability in the electricity supply has resulted in losses in work-in-progress (WIP) items, culminating in a year-over-year contraction of 11.7% in H1FY24 normalized earnings. These challenges have collectively dampened the financial outcomes for the period, reflecting the impact of operational disruptions and rising overheads on Inari's profitability.

Kenanga Research has observed that INARI's second quarter of fiscal year 2024 (Q2FY24) was marred by power surges, leading to a notable decrease in efficiency levels. The disturbances were significant enough that, without them, the company may have exceeded RM90 million in net profit, rather than the RM86 million it actually reported. Nonetheless, INARI has taken robust measures to address these issues, recalibrating its machinery to achieve the desired yield rates successfully.

As INARI entered its historically quieter third quarter of fiscal year 2024 (3QFY24), coinciding with the Chinese New Year holiday season, these improvements in operational efficiency are anticipated to soften the blow of seasonal headwinds. During this period, the production of radio frequency (RF) filters is expected to operate at a utilization rate slightly below 80%, a dip from the close to 90% rate seen in the preceding quarter. Despite this anticipated seasonal lull, Kenanga Research maintains a positive outlook on INARI's ability to sustain strong performance through enhanced productivity measures.

JP Morgan maintains a neutral stance on INRI, taking into account the significant penetration of 5G iPhones and the company's valuation, which is deemed fair at 32x one-year forward P/E. This appraisal is consistent with INRI's two-year compound annual growth rate (CAGR) forecast of 14% over FY23-25E. Furthermore, INRI's status as the largest and most liquid tech stock in Malaysia positions it as a tech beta proxy.

INRI stands as a pivotal OSAT (Outsourced Semiconductor Assembly and Test) partner for Broadcom's RF (radio frequency) filter operations, which, in turn, supplies major smartphone manufacturers like Apple and Samsung. Despite this strategic partnership, the limited growth in RF dollar content for upcoming iPhone models, coupled with projected flat iPhone shipment volumes in FY24/25E, provides scant incentive to invest in INRI.

However, the company's substantial net cash position, amounting to 16% of its market capitalization, coupled with its current valuation of 32x one-year forward P/E (or 26x excluding cash), does offer some degree of downside protection. Additionally, as one of the largest OSATs in Malaysia and ASEAN, INRI is well-positioned to benefit from supply-chain relocations. Despite an anticipated seasonal RF slowdown, the company is likely to sustain positive investor interest due to its robust market placement.

According to Kenanga Research, INARI has started low-volume production via a single line for its memory customer which is expected to be increased to four lines by June 2024. The group hinted that this memory venture will eventually allow the group to tap into the AI race as memory is one of the key components complimenting the core graphical processing power.