Cowell (1415 HK) Buy (initiation) Target price: HK$5.20. Value stock set for continued earnings growth in 2016; initiate at Buy

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1 Equity Research Information Technology Cowell (1415 HK) Buy (initiation) Target price: HK$5.20 Value stock set for continued earnings growth in 2016; initiate at Buy Initiate at Buy While Appledependent component suppliers are likely to face nearterm headwinds on news flow of slowing iphone sales momentum, we initiate coverage of Cowell with a Buy rating as we believe a slower growth environment is already priced in (the shares are down over % from their peak in May, now trading at around 5x 2016E P/E). We expect Cowell to deliver lowteens EPS growth in 2016, underpinned by growth in sales of its existing fixedfocus selfie front camera modules to Apple, and new income streams from sales of rear camera modules to Apple starting from 1Q16. We set a 12 month target price of HK$5.20 (40%+ upside), based on a 2016E P/E target of 7x. Joseph Ho, CFA SFC CE No. AFP308 josephho@gfgroup.com.hk GF Securities (Hong Kong) Brokerage Limited 2930/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong Stock performance (HK$) Mar15 Jun15 Sep15 Source: Bloomberg Key data Nov 17 close (HK$) 3.70 Share in issue (m) 832 Major shareholder Kwak JoungHwan (45.0%) Market cap (HK$bn) 3.1 3M avg. vol. (m) W high/low (HK$) 8.85 /3.02 Source: Bloomberg New revenue stream in 2016 from sales of rear camera modules to Apple Cowell has been a key supplier of front camera modules to Apple since Apple is its single largest customer, accounting for 78% of group sales in 2014, followed by LG (19% of sales) and Samsung (2% of sales). In addition to front camera modules, we expect Cowell to start shipping rear camera modules to Apple in 1Q16. We see upside to the blended ASP as rear camera modules command a higher ASP than front camera modules. We forecast that Apple will allocate up to 5% of its rear camera module orders to Cowell in 2016, which translates into US$125m in sales for the year (about % of 2016 sales). Dual camera for the nextgeneration iphone? Dualcamera modules enable new features such as fastfocusing (using depth information), softwarebased optical zoom, and a large aperture effect. Smartphone makers including Huawei (Honor 6), LG (V), and HTC (HTC One) have already launched dualcamera smartphones in We expect market talk on Apple s possible adoption of dual cameras in the nextgeneration iphone to heat up in 1H16, which would lead to market interest on the camera modules industry, in our opinion. Midtolow teens EPS growth in 2016 We forecast net profit of US$69m (+30% YoY) and sales of US$1.1bn (+19% YoY) in 2015, assuming a 45%/55% sales split between 1H/2H and a moderate HoH improvement in GPM in 2H15 to about 13.6%, compared to 13.0% in 1H15. For 2016, we factor in new revenue from sales of rear cameras to Apple (assuming a 5% allocation) and midsingle digit volume growth for its existing camera modules business. Overall, we expect lowteens sales and EPS growth in Management is yet to finalize on its dividend policy. The stock would offer a dividend yield of over 5%, assuming a 30% payout ratio. Strong net cash position Cowell generates strong cash flow from its camera modules business with Apple. The company s Junend net cash rose to US$87m, up from US$9m at the end of 2014, driven by operating cash inflow and gross proceeds of about US$46m from its IPO in Mar 2015 (83.2m new Risks Key downside risks include: 1) high singlecustomer concentration; 2) share overhang (sixmonth lockup period for Hahn & Co [private equity], which holds a 26% stake in Cowell expired back in Sep 2015); 3) ASP pressure; 4) hiccups in shipments of rear camera modules to Apple, and; 5) component recalls due to product defects. Stock valuation Turnover (US$ m) YoY chg Net profit (US$ m) YoY chg EPS (US cents) YoY chg P/E (x) P/B (x) Dividend Yield ROE Net gearing n.a cash 2015E 1, cash 2016E 1, cash 2017E 1, cash Sources: Company data, GF Securities (HK)

2 Appledependent camera modules maker Koreanrun business Established by JoungHwan Kwak in 2002, Cowell is a major supplier of camera modules for mobile devices. The company has been a key supplier of front camera modules (the one used for selfies) for Apple since In 2014, Apple was its single largest customer, accounting for 78% of group sales, followed by LG (19% of sales) and Samsung (2% of sales). Cowell was the sixth biggest smartphone camera modules company globally by sales value in It listed on the HKEX on Mar 31, 2015, raising gross proceeds of about US$46m (83.2m new Figure 1: Global camera modules market share (2013) Figure 2: Cowell sales by customer (US$m) Samsung 2% Others 1% LG Innotek 15% LG 19% Others 47% SEMCO 12% Sunny Optical 5% Cowell 5% Sharp 6% LiteOn Partron 5% 5% Apple 78% Sources: IBS Source: Company data Figure 3: Cowell key milestones Sources: Company data 2

3 3Q09 4Q09 1Q 2Q 3Q 4Q 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15E 1Q16E Company report Figure 4: Cowell shareholding structure Figure 5: Cowell shareholding structure Public 29% Hahn & Co (Private Equity) 26% Kwak Joung Hwan (Founder) 45% (m shares) Before IPO After IPO After overallotment Mr. Kwak 374 % % % Hahn & Co 374 % % % Public % % Total 748 % 832 % 832 % Sources: Company data New revenue stream from sales of rear camera modules to Apple in 2016 Continued growth for its existing product portfolio Cowell s existing camera modules are mostly flipchip based front cameras for Apple and front/rear camera modules for LG and Samsung. We expect shipments of these camera modules to reach 2m units in 2015, up 9% YoY from 193m units in ASP was US$5.0/unit in 1H15, and we assume 5% volume growth and an unchanged ASP for New income stream from sales of rear cameras to Apple in 2016 We see upside to shipment volume and ASP in 2016 as we expect Cowell to start shipping rear camera modules to Apple in 1Q16. Orders will initially be mostly for the iphone 6/6+. This is a good starting point, and we expect Cowell s products to be included in new models going forward. The cost of camera modules (front and rear cameras) for the iphone 6/6+ is about US$16. and US$17. (see Fig 9). In our forecasts, we assume US$ per unit for rear cameras and that Apple will allocate up to 5% of its rear camera module orders to Cowell in This translates into US$125m in incremental sales for 2016 (see Fig ). Figure 6: Apple iphone shipments Figure 7: Apple iphone shipments (m units) % % 26% 23% 13% 5% E 2016E 120% % 80% 60% 40% 20% 0% iphone 4 (20.6) iphone 4s (2011.) iphone 5 (2012.9) iphone 5s (2013.9) iphone 6S/6S+ iphone 6/6+ (2015.9) (2014.9) iphone shipments (m units) YoY chg Sources: Apple, GF Securities (HK) 3

4 Figure 8: Apple iphone 6 camera modules Figure 9: Apple iphone 6/6+ cost analysis (US$) iphone 6 iphone 6+ Assembly & Test Supporting materials Other NonElectric Power Mgt Base band + XCR Processor SDRAM NAND Connectivity Camera (front + rear) Battery Display/touch panel/glass Total Sources: teardown.com Source: Company data, GF Securities (HK) Figure : Cowell revenue forecasts (US$m) E 2016E 2017E (1) Camera modules ,058 1,111 1,166 (2) Optical components (3) Apple rear camera modules Total sales ,057 1,255 1,448 YoY chg n.a. 63% 54% 9% 19% 19% 15% Assumptions Existing camera modules shipments (m units) YoY chg n.a. 39% 35% 2% 9% 5% 5% ASP (US$) (1) Camera modules sales (US$m) ,058 1,111 1,166 Apple iphone shipments (m units) YoY chg 0% 46% 13% 26% 23% 5% 5% order allocation 0% 0% 0% 0% 0% 5% % Rear CCM shipments (m units) ASP (US$/unit).0.0 (3) Apple rear camera modules sales (US$m) Sources: Company data, GF Securities (HK) Figure 11: Cowell existing camera modules business Figure 12: Cowell new rear camera modules sales to Apple E 2016E 2017E E 2016E 2017E Camera module shipments (m units; LHS) Rear camera modules to Apple (m units, LHS) ASP (US$ per unit; RHS) ASP (US$ per unit; RHS) Source: Company data, GF Securities (HK) 4

5 Dual camera for the nextgeneration iphone? Talk of Apple s possible adoption of dualcameras to heat up in 1H16 Dualcamera modules enable new features including fastfocusing (using depth information), softwarebased optical zoom, and a large aperture effect. Smartphone makers including Huawei (Honor 6), LG (V dual front cameras), and HTC (HTC One) have had dualcamera smartphones since We expect market talk on Apple s possible adoption of dual cameras in the nextgeneration iphone (in the usual new product announcement event in Sep) to heat up in 1H16, which would lead to market interest in the camera modules industry, in our opinion. Apple patent application Apple already filed a patent application for a "small form factor telephoto camera" that describes ways of using dual cameras to offer focal ratios from approximately 2.4 to.0x in small and thin devices. The design would allow the use of a telephoto camera alongside a wideangle module to simulate an optical zoom lens, using a softwarebased algorithm. The advantages over a conventional optical zoom lens in digital compact cameras are that this solution requires less space and allows for the use of fast apertures on both cameras. Our basecase scenario forecast The dualcamera industry trend will drive upside on ASP and our sales and earnings forecasts for Cowell. To be conservative, our current forecasts are our basecase scenario do not incorporate this factor. Figure 13: HTC dualcameras in the HTC One (M8) Figure 14: Huawei dualcameras in the Honor 6 Sources: HTC Solid financials positive net cash position Cowell generates strong cash flow from its camera modules business with Apple. The company s Junend net cash rose to US$87m, up from US$9m at the end of 2014, driven by operating cash inflow and gross proceeds of about US$46m from its IPO in Mar 2015 (83.2m new Figure 15: Cowell cash flow from operations Figure 16: Cowell net cash/(net debt) position* H14 1H15 Net cash position (US$ m) (20) (40) (60) (80) () 87 9 () (76) Net cash position (US$m) Sources: Company data Sources: Company data, *including pledged deposits 5

6 Valuation cheap on an absolute basis as well as vs regional peers Trading at a discount to industry average Cowell is trading at 5.0x 2016E P/E, a discount to the industry average of 12.2x 2016E P/E for regional camera module makers. Among HKlisted peers, Sunny Optical (2382 HK, Buy) is trading at a premium to the industry average. In our view, the premium is supported by: 1) its premium customer mix including leading smartphone makers (Huawei, Xiaomi); 2) a more comprehensive product offering (Sunny Optical is also engaged in the production of lenses for its inhouse use as well as sales to external customers; 3) more diversified application exposure (smartphones and automotive sector), and; 4) lower customer concentration (compared to Cowell and Q Tech). Slower growth in iphone shipments already priced in Appledependent component suppliers are likely to face headwinds on news flow of slowing iphone sales momentum. Nonetheless, we initiate coverage of Cowell with a Buy rating as we believe a slower growth environment is already priced in (the shares are down over % from their peak in May, now trading at 5x 2016E P/E). We set a 12month target price of HK$5.20 (40%+ upside), based on a 2016E P/E target of 7x. Management is yet to finalize on its dividend policy. The stock would offer over 5% dividend yield, assuming a 30% payout ratio. Figure 17: Valuation 2016E P/E peer comparison Shenzhen O film Sources: Bloomberg Average 12.2 Sunny Optical LG Innotek Partron Q Tech Cowell Figure 18: Peer comparison HKlisted camera module makers Customer concentration Key customers Sunny Optical Cowell Q Tech Huawei Xiaomi Oppo Apple LG Samsung Vivo ZTE Lenovo Top customer (% of sales) 16% 78% 25% Top 5 customers 55% 99% 72% Key products Camera modules P P P Camera lens P O O Applications Smartphone P P P Automotive P O O Source: Company data, GF Securities (HK) Figure 19: Peer comparison shipment volume (m units) Figure 20: Peer comparison gross profit margin Sunny Cowell QTech E 1H14 1H15 Sunny Optical Cowell Q Tech H15 Sources: Company data 6

7 Figure 21: Valuation peer comparison Share price Market Cap P/E (x) P/B (x) EPS growth Sales growth Div yield YTD* Stock code Local CCY (US$m) 15E 16E 15E 16E 15E 16E 15E 16E 15E 16E Shenzhen Ofilm CH , Sunny Optical 2382 HK , LG Innotek 0170 KS 91,700 1, (2) (18) Partron KS 9, (16) (16) Cowell 1415 HK (13) Q Tech 1478 HK (47) (17) Average Sources: Bloomberg, GF Securities (HK), * from IPO price for Cowell and Q Tech Risks Figure 22: Financial statements Key downside risks include: 1) high singlecustomer concentration; 2) share overhang sixmonth lockup period for Hahn & Co (private equity), which holds a 26% stake in Cowell expired back in Sep 2015; Chairman Kwak s holding in Cowell is subject to a oneyear lockup requirement which expires on Mar 31, 2016; 3) ASP pressure; 4) hiccups in shipments of rear camera modules to Apple, and; 5) component recalls due to product defects. Income Statement Balance Sheet Year end Dec (US$ m) E 2016E 2017E Year end Dec (US$ m) E 2016E 2017E Existing camera modules business ,058 1,111 1,166 Cash/ST Investments Rear camera modules (Apple) Account receivables Optical components Inventory Turnover ,057 1,255 1,448 Other Current Assets YoY chg Total current assets Gross profit Prop, plant and equipment Other income/gains Intangible assets Listing expenses (3) Other LT Assets Selling & distribution exp. (6) (7) (5) (6) (7) Total Assets Admin exp. (29) (37) (49) (56) (62) Other expenses (1) 0 2 ST Debt Operating profit Trade payables Finance costs (5) (3) (2) (2) (2) Other Current Liabilities 15 Share of profits Total current liabilities Pretax income LT Debt Taxation (14) (14) (17) (20) (23) Other LT Liab MI Minority Interests Net profit Shareholders' Equity Total Equity & liabilities Cash Flow Statement Financial Ratio Year end Dec (US$ m) E 2016E 2017E E 2016E 2017E Pretax profit Margins Tax Paid (14) (14) (17) (20) (23) Gross margin Depr/Amort EBITDA margin Change in working capital (20) (18) (17) EBIT margin Others (35) Net margin Operational cash flow Return/Profitability Capex (16) (22) (45) (30) (30) ROA Assoc, MI, Invsmt (0) (1) ROE Investment cash flow (16) (23) (45) (30) (30) Balance sheet Net Change in Debt (0) (30) Net gearing 36.0 cash cash cash cash New Capital 43 Current ratio (x) Dividend (24) (28) Working capital Others 1 2 Days receivable Financing cash flow 1 (28) 43 (24) (28) Days inventory FX and others (7) Days payable Chg in Cash Others Beginning cash Effective tax Ending cash Dividend payout ratio Sources: Company data, GF Securities (HK) 7

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