Hon Hai: Reinitiating Coverage With Narrow Moat and Fair Value Estimate of TWD 104

We reinitiate coverage of Hon Hai with a no-moat rating and fair value estimate of TWD 104. We see the shares as fairly valued at this time. Hon Hai is the largest contract manufacturer of consumer electronics, communications, and computer products in the world and despite elements of scale-based cost advantage and switching costs, we believe its offerings are sufficiently commoditized to give it no moat. The company is synonymous with the Apple brand, with Apple generating just over half of Hon Hai’s revenue. Hon Hai has been challenged by fierce competition and a maturing smartphone end market, which has seen the group’s return on invested capital fall to 12% in 2022 from around 20% from 2003-07 as gross margins fell to around 6% from the low double digits over the same period. With the stagnation of the smartphone market since peak global smartphone sales in 2016, Hon Hai is looking to electric vehicle manufacturing to drive growth and lift margins. Management is targeting a gross margin of 10% by 2025 and we believe the shares would see substantial upside if it can get close to this target, given our estimate of the company only reaching 6.6% by this time, which is broadly in line with PitchBook consensus.