20130820-美银美林-Emerging_winner_in_mid-end_ASP_smartphone_market__new_Buy_33页_962kb

Summary of BofA Merrill Lynch Report on TCL COMM

Core Content

This report from BofA Merrill Lynch highlights TCL Communication (TCL COMM) as an emerging winner in the mid-end ASP smartphone market, particularly in China and overseas. The firm initiates coverage with a Buy rating and a Price Objective (PO) of HK$5.5, which is based on a 12x 2014E P/E multiple, suggesting the company is undervalued compared to its peers.

Main Points

1. Investment Rationale

• Rising mid-end smartphone market: TCL COMM is expected to benefit from the growing demand for mid-end smartphones in China and overseas.
• Strategic positioning: The company is focusing on mid-end smartphones (ASP of US$130–320) with features such as 4.5"-4.7" displays, 8MP CMOS modules, and dual to quad-core APs, which are more attractive in terms of cost-to-performance.
• Growth drivers: The report identifies rising ASP, robust shipment growth, and margin expansion as key factors for earnings growth.

2. Earnings Growth Expectations

• Smartphone shipment growth: Expected to reach 15mn units in 2013E and 23mn units in 2014E, up from 6.5mn units in 2012.
• EPS growth: Projected to increase significantly in 2014E, with a 99.3% YoY growth in 2013E and 35.2% YoY growth in 2015E.
• Margin improvements: Gross margin is expected to rise to 17% in 4Q13 and 20% in 2014E, while operating margin is projected to improve to 2.9% in 2014E and 3.5% in 2015E.

3. Valuation

• Current P/E: TCL COMM trades at 9x 2014E P/E, which is 25% below the peer average of 12x.
• Valuation potential: The discount is expected to narrow due to significant earnings growth and market share gains.
• Free Cash Flow (FCF) improvement: FCF is projected to improve significantly in 2014E and 2015E, with positive figures expected.

4. Competitive Position

• Outperforming global and domestic competitors: TCL COMM is positioned to outpace global-tier brands with more attractive ASP and domestic brands with better quality and global brand exposure.
• Market share: The company is expected to gain 0.9% in 2013E and 1.6% in 2014E in the China market.

5. Risk Factors

• Poor execution: The company faced losses in 3Q12 due to increased R&D and operating expenses without achieving economies of scale.
• Inventory risk: Potential slowdown in China smartphone demand or a weaker domestic economy could lead to inventory build-up.
• ASP erosion: Intense competition in the mid-end market could lead to price pressures.
• Supply chain uncertainty: Key components like camera modules and VCMs are critical for time-to-market and could pose risks.
• Market data inaccuracy: The market lacks transparency, and incorrect data could impact product strategy.
• High net debt-to-equity ratio: At 237% in 2011A and 2012A, though expected to improve due to better FCF.

Key Financial Metrics (2011A–2015E)

*For full definitions of iQmethodSM measures, see page 30.

Market Share and Sales Mix

• Smartphone/Feature Phone Contribution (2013): 81% / 19%
• Market share in 1Q13: 2.0%
• Smartphone shipment growth: Expected to grow 133% YoY in 2013E and 51% YoY in 2014E.
• China market share growth: Expected to rise 0.9% in 2013E and 1.6% in 2014E.

Valuation and Price Objective

• PO of HK$5.5 is based on a 12x 2014E P/E multiple, reflecting the company's expected earnings growth and improved valuation relative to peers.
• P/E band: TCL COMM is expected to see a P/E expansion due to potential earnings improvement.
• P/B ratio: 2.0x, indicating the company is undervalued relative to book value.

Strategic Focus and Product Positioning

• Product migration: From low-end feature phones to mid-end smartphones with higher ASP and better specifications.
• Brand exposure: Proactive marketing campaigns, such as those tied to popular movies like Iron Man 3 and Transformer 3, have enhanced brand visibility overseas.
• Economies of scale: Targeting 1mn units per month is expected to improve supplier bargaining power and margin expansion.

Conclusion

TCL COMM is positioned to benefit from the growing mid-end smartphone market in China and overseas. The company's strategic shift to mid-end smartphones, coupled with improved cost control and economies of scale, is expected to drive significant earnings growth and margin expansion. Despite current valuation discounts and potential risks, the firm's strong growth trajectory and competitive positioning justify the Buy rating and the Price Objective of HK$5.5.