Hon Hai drops; poor end of the iPad value chain

Reuters News
Posted: Apr 30, 2012 4:18 AM
Hon Hai drops; poor end of the iPad value chain

TAIPEI (Reuters) - Shares in Hon Hai Precision Industry Co Ltd took a beating on Monday after lackluster quarterly profits, in sharp contrast to the booming fortunes of its main client, Apple Inc, highlighting one of the main downsides of life as a maker of others' high-end products.

Hon Hai's first-quarter net profit - up 3.6 percent to T$14.92 billion ($509.2 million) - was well below the previous quarter and missed analysts' forecasts by more than a third, according to Thomson Reuters Starmine data. Last week, Apple reported quarterly profit 22 percent above estimates, propelled by strong sales of the gadgets Hon Hai makes: iPhones and iPads.

The divergence illustrates the margin pressure contract makers face as opposed to the brand companies at the top end of the value chain.

"Competition for contract makers is very heavy. They have to make concessions on margins and cut prices in order to win orders," said Jamie Wang, Taipei-based analyst for technology research firm Gartner. "This is the case especially for Apple's contract makers because everyone wants to squeeze into its supply chain."

Hon Hai said its January-March operating margin slid to 0.9 percent, while Apple's was close to 40 percent. Hon Hai's operating costs rose 28.6 percent from a year earlier and its cost of sales increased 43.3 percent. Gross margin at Apple of 47 percent was almost 12 times Hon Hai's.

Hon Hai shares opened down the maximum 7 percent allowed in a session and remained at that level - a 3-month low - until the close. It was the stock's biggest one-day drop since November 2008.

In the past two years, Hon Hai's net profits have surprised the market on the downside in five quarters, compared to Apple's once, Starmine data shows. The Taiwanese maker has reported four quarterly profit declines in the same period, while California-based Apple has posted rises in all. Hon Hai gets about 45 percent of its business from Apple.


Analysts attributed the big miss in the first-quarter mostly to Hon Hai's rising salary costs.

The company has been spending heavily in the last year as it fights perceptions its sprawling plants in China are sweatshops with poor conditions for its million-strong labor force. It regards the criticism as unfair.

The Foxconn Technology Group, of which Hon Hai is the flagship listed unit, announced in mid-February it had raised wages for workers by 16-25 percent. In late March, it reached an agreement with Apple to hire tens of thousands of new workers to reduce overtime work.

At an event on Saturday unrelated to its earnings announcement, Chairman and founder Terry Gou acknowledged the difficulties of the company's business model.

"Labor cost is a problem everyone faces. Every Chinese city has a regulation on minimum wages ... we're paying more than other companies, it's hurting our profit," he said.

The higher labor costs would be passed on to Apple in a price hike from Hon Hai, but would only take effect from April, according to a report by HSBC, weighing on margins in the first quarter.

Hon Hai has been trying to cut rising Chinese labor costs in the past two or three years, and has been relocating plants to areas of China where wages are lower.

"Hon Hai is a manufacturer; its margins have not been doing well in the past few years because of the relocation costs in China, even though its revenue has been good," said an analyst from a European brokerage, who declined to be named. "But we should see more correlation between Hon Hai and Apple's results from this year as Hon Hai's relocation is coming to an end."

Other reasons for the weak first quarter included a worse than expected loss from affiliate Foxconn International Holdings and low yield rates on the new iPad in January and February, analysts said.

Hong Kong-listed Foxconn International, the world's top contract handset maker, has warned of a substantial increase in its net loss for the first half of 2012 on lower demand from some of its main customers.

In the second quarter, analysts expected margin improvement would be mild as the company spends more in preparation for the iPhone 5 launch in the following quarter, while a pick-up in operating profit margin would be seen from the third quarter, driven by a ramp-up of the new iPhone.

(Reporting by Jonathan Standing and Clare Jim; Editing by Jonathan Hopfner and Ian Geoghegan)