O-Net Technology:A diversified high tech leader

We recently have an operational update meeting with O-Net’s management. Due to tight optical component supply in 1H16 and robust market demand throughout 2016, equipment manufacturers aggressively piled up their inventory in 2H16, together with China telcos’ cautious CAPEX spending in FY17E, their procurement slowed down in 1Q17, which led to A-share listed peers’ stock price dropped ~9% on average YTD. Management mentioned that Huawei, ZTE and Fibrehome (600498 CH) together accounted for ~7-8% of O-Net’s sales, though facing a challenging 1Q17 in China market, O-Net’s YTD operation is still on track, while orders from Huawei improved in Apr 2017 vs. 1Q17. We expect China orders to improve in 2H17E, together with launch of new products in 2H17, Datacom segment would grow at least double in FY17E (vs. +409% in FY16).

O-Net’s FY16 revenue and EPS came in at HK$1,598mn and HK$130mn, up 40.8% and 58.2% Yoy, driven by GM expansion (FY16: 35.6% vs. FY15: 31.6%) and operating leverage (SG&A % down 80 bps to 15.1% of sales). We attributed the GM expansion to 1) launch of new Datacom products in 2H16 (with GM 300-500 bps higher than telecom products) and 2) other high margin segments began to contribute to O-Net’s revenue such as both automation and sensing, and coating business.

Machine vision & sensing and coating business continue to ramp up

Riding on smartphone players’ latest design and specs, O-Net’s anti-reflective and anti-fingerprint coating services have been well-received by top Chinese smartphone brands. Moreover, their coatings can also be used for glass casing processing, which we believe would be another potential growth engine in the medium term. O-Net’s machine vision systems and fibre sensor segment will continue to grow in 2017, through launching a new series of machine vision systems and fibre sensor products to penetrate the intelligent, digital and networked manufacturing market, which will place O-Net among the first automation solutions providers in the Industry 4.0 in China.

Global autonomous driving is widely expected to a new blue ocean in the next 5-10 years, through leveraging on its industry expertise and existing R&D and manufacturing platform, O-Net is able to become a first mover in LiDAR, in both key components and the whole LiDAR modules. O-Net has started co-operation with major players/developers including Internet giants. However, management continue to see minimal contribution from LiDAR in FY17E.

Though facing near term hiccups in China market, O-Net’s medium term fundamentals remain intact, we expect O-Net’s EPS to grow at 45.1% CAGR in FY16-18E, driven by the launch of new active optical components, ramp up of automation & sensing, and coating business. After having slumped ~50% from its 52-week high since end-March, O-Net’s valuation has now reached an attractive level, trading at 14.2 FY17E PE (~50% discount to China and international peers at average 25.2x P/E). Due to recent fragile sentiment surrounding tech. sector, we arrive O-Net’s TP at HK$4.74 based on FY17E EPS, hence implies 17.6x forward PE and 30% discount to peers). We advise investors to accumulate in recent price weakness.