Company Reports

China-based Sunny Optical’s revenue and earnings are largely derived from manufacturing camera lenses and modules. Before 2015, lower-margin modules, as well as glass lenses for digital single-lens reflex cameras, made up the majority of Sunny’s earnings, however, the fortuitous acquisition of Konica Minolta’s China optical lenses business in April 2014 allowed the company to break into the plastic lenses segment. Since then, Sunny’s market share in the handset lenses segment has increased significantly, and it is now the largest player by shipment volume. This strong growth coincided with the ascension of China’s smartphone brands, namely Huawei, Oppo, Vivo, and Xiaomi, which make up more than half of Sunny’s revenue.

We lowered our fair value estimate for Sunny Optical to HKD 60. Its disappointing profitability in the December quarter and sluggish 2024 guidance suggest that lower-end competitors, such as AAC Technologies in lenses and Q Technology in camera modules, are catching up. This led us to assume lower structural revenue growth and gross margins for its smartphone-related products. However, we believe Sunny’s share price decline of more than 20% after its results is an overreaction because smartphone revenue is becoming less important, and our long-term view on vehicle electrification and mass adoption of extended reality headsets remains intact. Hence, we continue to view the stock as undervalued.

We are disappointed by Sunny Optical’s profit warning, which expects its 2023 net income to decline by 50% to 55% year on year, corresponding to CNY 1.08 billion to CNY 1.20 billion.

We have fine-tuned our forecasts but kept our fair value estimates for both Sunny Optical and AAC Technologies unchanged at HKD 107 and HKD 17, respectively, as we remain cautiously optimistic about a recovery in smartphone demand and camera upgrades in 2024. While we believe in a meaningful recovery in 2024 based on upbeat industry data and excitement over Huawei’s next flagship smartphone launch, we reckon Sunny’s shares are undervalued as Sunny should capture the most of the direct benefits from the camera arms race between Huawei and Apple in the long run, which is not fully priced in. On the other hand, we believe AAC’s shares are overvalued as we are concerned that AAC’s less advanced product mix is not enough to benefit from the recovery of the high-end market and will continue to suffer from increased competition, while the market is too optimistic about the recovery. We think artificial intelligence in digital photography is neutral to smartphone camera makers.

China-based Sunny Optical’s revenue and earnings are largely derived from manufacturing camera lenses and modules. Before 2015, lower-margin modules, as well as glass lenses for digital single-lens reflex cameras, made up the majority of Sunny’s earnings, however, the fortuitous acquisition of Konica Minolta’s China optical lenses business in April 2014 allowed the company to break into the plastic lenses segment. Since then, Sunny’s market share in the handset lenses segment has increased significantly, and it is now the largest player by shipment volume. This strong growth coincided with the ascension of China’s smartphone brands, namely Huawei, Oppo, Vivo, and Xiaomi, which make up more than half of Sunny’s revenue.

Following Apple’s launch event, we make no change to our forecasts and fair value estimates for Apple's suppliers like TSMC (TWD 850), Sunny Optical (HKD 107), Luxshare Precision (CNY 41.50), Largan (TWD 2,500), and AAC Technologies (HKD 17). We think the launch is slightly negative to the supply chain. This is due to possible renewed fears that Apple is increasing pressure on its suppliers to maintain its profitability, at the latter's expense. No-moat Luxshare and AAC should bear the brunt of such pressure, in our view. Sentiment may worsen further as China says it has noticed “security incidents" concerning Apple's iPhones, reinforcing worries that China may extend its iPhone usage ban to groups beyond civil servants.

In 2022, battery electric vehicles represented nearly 10% of global auto sales, up from a little less than 6% in 2021. Much of the growth occurred in China, which has been a leader in EV sales over the past decade. However, with national EV subsidies in China expiring in 2022 and far lower sales in the U.S. and Europe, the market questions if EV sales can continue to grow without subsides.

Following the company's sluggish first-half results, we have lowered our fair value estimate for Sunny Optical to HKD 107 from HKD 125 due to the slower recovery in smartphone shipments and worse-than-expected product mix. However, even after lowering our 2023 sales and EPS forecasts by 4.6% and 34.0%, respectively, we remain optimistic in the medium term that Sunny will benefit from the rebound of midrange smartphone sales and camera upgrades starting in 2024. We believe that Sunny’s shares are undervalued, as the market is still skeptical about the smartphone lens turnaround.

China-based Sunny Optical’s revenue and earnings are largely derived from manufacturing camera lenses and modules. Before 2015, lower-margin modules, as well as glass lenses for digital single-lens reflex cameras, made up the majority of Sunny’s earnings, however, the fortuitous acquisition of Konica Minolta’s China optical lenses business in April 2014 allowed the company to break into the plastic lenses segment. Since then, Sunny’s market share in the handset lenses segment has increased significantly, and it is now the largest player by shipment volume. This strong growth coincided with the ascension of China’s smartphone brands, namely Huawei, Oppo, Vivo, and Xiaomi, which make up more than half of Sunny’s revenue.

Sunny Optical announced a profit warning indicating that its first-half net profit will be 65% to 70% lower than the previous year, which we believe is due to the significant discounting of its average selling prices to clear inventory. While we are disappointed with the magnitude of the decline as vehicle-related shipments have increased and high-end smartphone shipments have been resilient, we see some positive signs as we look into the second half. There are growing indications, notably from MediaTek, Largan Precision, Win Semiconductors, and Q Tech, that the inventory correction in Android and upper-midrange smartphones is largely complete, and that orders from smartphone brands are starting to pick up. However, we reckon it would unlikely be enough to compensate for the first-half decline to achieve our 2023 earnings forecasts. We hold our fair value estimate for Sunny at HKD 125 for now and will update our estimates once it holds its semiannual earnings briefing in late August.

We have fine-tuned our earnings forecasts and maintained our fair value estimate for Sunny Optical at HKD 125. After attending the company’s investor day, we are more confident in growth opportunities in the vehicles sector, which will offset weaker-than-expected smartphone and extended reality headset shipments in the meantime. Over the longer term, we have better visibility that Sunny will maintain a significant market share, driven by increasing demand for cameras used for various sensing and vision applications in the automotive sector. We view Sunny’s shares as undervalued due to the continued malaise in smartphone shipments, but we believe momentum will bottom out, driven by the launch of Apple's iPhone 15 and new Android models stimulating demand for replacement handsets later this year through 2024.

China-based Sunny Optical’s revenue and earnings are largely derived from manufacturing camera lenses and modules. Before 2015, lower-margin modules, as well as glass lenses for digital single-lens reflex cameras, made up the majority of Sunny’s earnings, however, the fortuitous acquisition of Konica Minolta’s China optical lenses business in April 2014 allowed the company to break into the plastic lenses segment. Since then, Sunny’s market share in the handset lenses segment has increased significantly, and it is now the largest player by shipment volume. This strong growth coincided with the ascension of China’s smartphone brands, namely Huawei, Oppo, Vivo, and Xiaomi, which make up more than half of Sunny’s revenue.

We held our fair value estimate for Sunny Optical at HKD 125 following the company’s mixed 2022 second-half results as stronger Apple-related growth offset weaker-than-expected 2023 vehicle and metaverse-related guidance. Increasing involvement in Apple’s supply chain should be a boon for Sunny in shipment volume and pricing. Its shares are still undervalued as Apple, vehicles, and the metaverse remain the most significant growth drivers, in addition to the recovery in demand for Chinese smartphones.

China-based Sunny Optical’s revenue and earnings are largely derived from manufacturing camera lenses and modules. Before 2015, lower-margin modules, as well as glass lenses for digital single-lens reflex cameras, made up the majority of Sunny’s earnings, however, the fortuitous acquisition of Konica Minolta’s China optical lenses business in April 2014 allowed the company to break into the plastic lenses segment. Since then, Sunny’s market share in the handset lenses segment has increased significantly, and it is now the largest player by shipment volume. This strong growth coincided with the ascension of China’s smartphone brands, namely Huawei, Oppo, Vivo, and Xiaomi, which make up more than half of Sunny’s revenue.

We cut our fair value estimate for Sunny Optical to HKD 125 from HKD 180 with a Morningstar Uncertainty Rating of Very High from High after refreshing our model following the company's profit warning announcement. We updated our previous forecasts published last August to reflect a later smartphone recovery and tamer growth in the automotive lens market. Despite the risks, the company is likely one of the key beneficiaries of an Android recovery, beginning in the second half of 2023, as camera specification upgrades resume. In addition, our valuation reflects the company’s strong position to capture the long-term automotive electrification trend and cost competitiveness to move up the smartphone lens value chain. We believe smartphone-related shipments should bottom out in the first half before experiencing a gradual recovery in the second half of 2023. Although demand for iPhones may disappoint in 2023, Sunny would likely ramp up Android shipments as COVID-19 infections in China wane and Chinese consumer spending recovers. Sunny should report its 2022 full-year results in the third week of March. Despite the profit warning, we expect management to guide toward an improving smartphone outlook while adjusting down its aggressive vehicle expectations.

China-based Sunny Optical’s revenue and earnings are largely derived from manufacturing camera lenses and modules. Before 2015, lower-margin modules, as well as glass lenses for digital single-lens reflex cameras, made up the majority of Sunny’s earnings, however, the fortuitous acquisition of Konica Minolta’s China optical lenses business in April 2014 allowed the company to break into the plastic lenses segment. Since then, Sunny’s market share in the handset lenses segment has increased significantly, and it is now the largest player by shipment volume. This strong growth coincided with the ascension of China’s smartphone brands, namely Huawei, Oppo, Vivo, and Xiaomi, which make up more than half of Sunny’s revenue.

We fine-tuned Largan’s earnings forecasts and maintained our fair value estimate of TWD 2,600. We retain our long-term expectation of a modest gross margin recovery to 58.8% in 2027 from 54.7% in 2022 due to the company’s ability to maintain its leading position in supplying advanced smartphone camera lenses. We think its strategy of prioritizing cutting-edge smartphone lenses should prevail, ceding some lower-value shipments of iPhone lenses but continuing to capture the largest share in dollar amount. As the primary supplier of main rear lenses and Pro lenses, we posit Largan can maintain high profitability. We slightly lifted our gross margin assumption while cutting our revenue growth forecasts, leaving our fair value estimate unchanged. We also maintain our view that Largan’s shares are undervalued as the market is overlooking its long-term resiliency. Meanwhile, we think that Android-heavy peers like Sunny Optical may outperform Largan in the short run as we expect China’s consumption to rebound after the reopening following a prolonged Android weakness. Sunny should announce its full-year results later in March, and we expect results to be unsurprisingly lackluster but guiding toward an improving smartphone outlook.

We retain our fair value estimate of HKD 180 for narrow-moat Sunny Optical, corresponding to 30.2 times price to our 2023 EPS estimate. This is as the worst of the smartphone demand rout seems to be behind us, but we remain cautious on 2022. We estimate the smartphone segment to recover over 2023 gradually instead of a more immediate bounce. Despite the cut in full-year guidance on smartphone camera parts being deeper than expected—due to competition in the low end from AAC Technologies and Q Technology—Sunny continues to gain market share from the iPhone lens incumbent, Largan Precision. Our more bullish 2023 and 2024 projections than PitchBook consensus are supported by our confidence in Sunny’s execution to seize long-term opportunities in smartphone and automotive camera upgrades and metaverse optics. Despite being undervalued, we think the share prices of smartphone lens makers would only converge to our fair value estimates in 2023 as improving monthly shipments further clear the fog around smartphone recovery.

We trimmed our fair value estimate for narrow-moat Sunny Optical to HKD 180 from HKD 190 as it experiences more significant headwinds from having greater exposure to the Android and Chinese market than we had expected in March. Sunny’s recent shipment data underperformed its peers that either have more exposure to the iPhone, which is currently more resilient; or to lower-end handsets. Sunny may possess greater risk in the near term as Chinese middle-class consumers’ appetite for electronic goods vanishes due to the recession concerns. Therefore, we cut our 2022 handset lens sets and handset camera modules shipment estimate for Sunny Optical on fewer cameras per phone and market share loss.