The Friday night release of Hon Hai Precision Industry Co. results had many in the market wondering what a huge earnings miss meant for the next iPhone.
Second-quarter net income for Foxconn Technology Group's flagship unit was a whopping 25 percent below the average of analysts' estimates, spurring a decline of as much as 1.3 percent in Taiwan trading Monday. If you think it's hard to put a positive spin on such disastrous figures, then hold my avocado.
Reading between the lines -- the revenue and net income lines -- many noted a widening in operating expenses. Hon Hai didn't explain the numbers (it never does), but it looks like higher R&D and ramping-up costs, probably for the challenging new iPhone, forced the op-ex ratio up 34 basis points to the highest level in almost five years. That said, revenue itself was flat year-on-year.
While looking at those expenses, many missed the fact that gross margin widened 79 basis points, the fourth consecutive quarter that metric has climbed, with this improvement offsetting higher operating costs. On a pure numbers basis, gross profit climbed NT$7.3 billion ($240.8 million), while operating expenses rose NT$3.3 billion.
To really understand what's going on at an opaque and complicated company like Hon Hai, operating margin is the place to look, and in this case we saw a significant 45-basis-point expansion.
Despite this improvement, net income still missed by NT$5.8 billion. For that, we need to look at non-operating income. Once again, Hon Hai's curt announcement was no help. But Hong Kong-listed FIH Mobile Ltd., which is 64 percent-owned by Hon Hai and thus consolidated, was a little more verbose.
FIH, a maker of smartphones for almost everyone who isn't Apple Inc., had a massive non-operating loss because of one culprit: Snapdeal. FIH bought a 4.07 percent stake in Snapdeal's parent Jasper Infotech Private Ltd. in 2015 and valued its holding in the Indian e-commerce provider at $200 million one year ago. But Snapdeal hasn't been doing too well, so FIH was forced to write off $160 million -- 80 percent -- of the stake back in May. That's roughly NT$4.9 billion.
Investors currently price Hon Hai at 13 times estimated earnings for the year, lagging the 13.4-times ratio for trailing 12-month earnings and below the 15.8 for the benchmark Taiex index.
Last week I wrote that Masayoshi Son pulled off an impressive judo flip by morphing his wayward bet on Snapdeal into a new gamble on rival Flipkart Group. Unfortunately, FIH and Hon Hai have been caught short on Snapdeal, resulting in an unavoidable hit to earnings in the second quarter. Nothing to do with Apple, which brings in half of Hon Hai's revenue.
In fact, an improvement in operating margin despite higher expenses could bode well for Hon Hai during this year's iPhone push, as it indicates the kind of efficiency improvements Chairman Terry Gou has been working on for years.
Not even Tim Cook knows how many new iPhones Apple will sell this year, but be sure Hon Hai is poised to capitalize on the launch. Indian e-commerce? Not so much.
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