中航光电(002179)

Order momentum picking up; Buy on multi-year earnings upcycle ahead

We visited Jonhon Optronic's Luoyang headquarters last week and came backwith positive takeaways. Despite lagging revenue conversion in 3Q, the strongpick-up in new orders, along with new capacity expansion, should accelerateearnings growth to 26% yoy in 2H17 (vs. 11% in 1H17) and 30%+ starting2018. With similar drivers ahead, the 2013-15 earnings upcycle - when the stockoutperformed its benchmark (SZCOMP) by 100% on strong earnings growth -looks likely to be repeated. We raise our target price by 23% to Rmb43 andmaintain Buy.

Strong new order pipeline

Management guided for a back-end loaded 2017 at the beginning of this year andexpects growth for defence and NEV to speed up in 2H. Since the beginning of3Q, the company has indeed been seeing a strong new order pipeline from itscustomers for both segments though the actual signing of contracts may come abit later than expected due to military reform (hence organizational reshuffle) andstricter subsidy scheme (hence reevaluation of subsidy eligibility required). Givencapacity constraints (for NEV) and defense customers' delivery schedules, webelieve deliveries could be very skewed towards 4Q17 with revenue conversionof some orders potentially delayed to 1H18.

Multi-year earnings upcycle in sight, with upside potential

During a 5-year plan (FYP) period, Jonhon's earnings growth tends to pick up fromthe third year and accelerate sharply into the final two years. With acceleratingweapon modernization, next-generation mobile network (5G in this FYP period),vehicle electrification and new capacity expansion, we project a 33% earningsCAGR over 2017-19 (vs. a 29% CAGR over 2012-14). T aking into account thehigh base, our current projection assumes constant growth acceleration (30%+) towards 2020 but we see upside potential from: 1) successful developmentof integrated systems for defense applications (high value and high margin);2) overseas expansion; 3) new products (e.g., high-speed backplane connector ,liquid cooling system, etc.); 4) further penetration into T esla's supply chain. Theseadditional growth drivers, if they materialize, could potentially push 2019-20earnings growth to a level comparable to that of 2014-15 (+39-67%).

Lowering earnings but lifting target price by 23%; risks

Our earnings estimate cuts of 4-6% for 2017-19 reflect: 1) delayed revenuerecognition for NEV and defense business for 2017; 2) lower telecom growth,driven by slower-than-expected Huawei business; and 3) better-than-expectedmargin performance in 1H17, driven by stringent cost control and favorableproduct mix. Despite the earnings decrease, we raise our target price by 23% toRmb43 as we roll forward our valuation time frame. We base our target price ona 2018E P/E of 30x, supported by an earnings CAGR of 33% over 2017-19E. Keyrisks: further delay in military orders and higher-than-expected opex.