"Super Replacement Cycle" True or Not?

Recently, the stock price movements in the A-share consumer electronics sector, especially in Apple supply chain stocks, have been prominent, with GoerTek showing a trend of strengthening. The reasons are twofold: firstly, the second-quarter shipments in the Apple supply chain were better than the market's pessimistic outlook at the beginning of the year; secondly, Apple twice raised its inventory targets for new products, leading to revenue growth expectations and driving Apple's share price to new highs.

Against this backdrop, related Apple supply chain companies have also returned to investors' radar. Recently, Guo Mingqi, an analyst at TF International Securities, wrote that starting in the second half of the year, iPhone orders will gradually return to Sunny Optical (02382.HK), and it is expected to become Apple's new CCM supplier in 2025, with mass production and shipments of CCMs for the new M5 series MacBook models in Vietnam.

Regardless of the certainty of this prediction, if we assume the institution's forecast is correct, how much will Sunny Optical benefit? What facts does the institution base its prediction on? And what has Sunny Optical done right?

Returning to the "Apple Supply Chain": Higher Ceiling of Benefits for Sunny Optical?

Originating in 1984, Sunny Optical officially entered the Apple supply chain in 2021, primarily providing front-facing cameras for the iPhone 13. During this year, its share price rose by 45%, reaching an all-time high of HK$257.56 per share, and its market value peaked at over HK$280 billion.

However, from a financial perspective, joining the "Apple Supply Chain" did not seem to bring significant revenue growth to Sunny Optical. Financial reports show that Sunny Optical's revenue in 2020, 2021, and 2022 was 38.002 billion yuan (RMB, the same below), 37.497 billion yuan, and 33.197 billion yuan, respectively, showing a declining trend year by year; the corresponding operating profit also increased slightly from 4.872 billion yuan in 2020 to 4.988 billion yuan in 2021 before plunging by more than half year-on-year to 2.408 billion yuan in 2022.

In fact, this is primarily due to the fact that the demand curve for global smartphones had already reached a turning point of unilateral decline at that time. According to Canalys statistics, global smartphone shipments in 2022 fell by 11.3% year-on-year from 2021, hitting a decade-low, and further declined by 4% to 1.14 billion units in 2023.

However, as we enter 2024, unlike when Sunny Optical first entered the "Apple Supply Chain" slightly behind the curve, if Sunny Optical does indeed return to the Apple supply chain this time, its benefits, at least in terms of revenue and profit, will likely be stronger than in 2021-2022.

On the one hand, the core expectation for Apple's products lies in the "Super Replacement Cycle" fueled by AI technology, which will stimulate significant new demand, especially as its demand scenarios extend beyond mobile phones and PCs to include accelerating commercialization of new application scenarios such as VR, AR, and XR.

At the same time, high technology has also endowed these mobile consumer electronics products with higher value. With both demand and value increasing, Sunny Optical, which is expected to enter this product supply chain early, will naturally benefit more.

On the other hand, in intelligent scenarios, optical components play a crucial role as the "eyes," and under high requirements, Apple is willing to accept a higher cost threshold in this area, giving suppliers stronger bargaining power and improved profitability. Especially considering that Sunny Optical ships both CCMs and lenses, profit growth becomes more likely after product integration.

In this regard, Guo Mingqi's analysis also suggests that becoming a new Apple CCM supplier means that revenue doubling will become an achievable long-term operating goal for Sunny Optical, and vertical integration will enable profit growth.

Lessons Learned, Sunny Optical Attempts to Retell the Story of "High Quality"

Of course, all of this is based on the premise that Sunny Optical can maintain high-quality delivery of its products. And Sunny Optical should have some insight into this.

Back in 2023, Sunny Optical lost iPhone lens orders due to production issues, resulting in a significant reduction in its share of Apple's optical supply. Its revenue volume also declined that year. Financial reports show that Sunny Optical's total revenue in 2023 fell by 4.6% year-on-year.

Therefore, to regain recognition, one must start by reflecting on one's fall.

Firstly, align with cutting-edge product trends. According to current reports from foreign media, the iPhone 16 series, expected to launch in September following past precedents, will see upgrades in hardware and software. TF Securities speculates that in terms of the crucial "selling point" of imaging, the iPhone 16 Pro and Pro Max will come standard with the top-end quad-prism camera introduced last year in the iPhone 15.

According to available information, the quad-prism camera is essentially a periscope solution whose core principle involves using a folded glass structure behind the lens to reflect light multiple times, thereby achieving longer focal lengths and higher optical zoom ratios. This "internal zoom" method allows phones to enhance their imaging capabilities while maintaining a thinner profile.

In fact, this is similar to the periscope telephoto lens technology and variable aperture technology used in Huawei's P70 series, the imaging flagship model released in the first half of the year.

Thus, given the pivotal positions of these two giants in the global mobile phone market, it can be foreseen that this periscope telephoto camera will cover more brands and models in the near future.

From a supply chain perspective, according to Guo Mingqi, both Apple and Huawei's periscope lenses are currently primarily supplied by Largan Precision. However, Sunny Optical, which is also a supplier to these two major manufacturers, has already launched 5X and 10X periscope zoom modules and was the first in the industry to mass-produce periscope camera modules in 2023.

Secondly, technology is the core foundation. From a technological perspective, the long-range experience pursued by the quad-prism camera implicitly involves the miniaturization and thinning of camera module technology.

Source: Sunny Optical's official website

Sunny Optical has already supplied miniaturized reflective periscope modules to some customers. Its high-precision optical assembly technology enables sub-micron optical alignment, making in-group focusing products possible; its packaging technology has also been miniaturized, and relying on this advantage, its full-color 0.4cc and monochrome 0.2cc products have achieved mass production, even extending their application scenarios to the XR and IoT fields, which have more urgent requirements for miniaturization.

It is reported that in new scenarios such as Vision Pro, where optical device performance requirements are higher, Sunny Optical has been the first to reap the benefits and has become the preferred supplier of VR products for globally renowned brands such as Meta and Pico. This demonstrates its confidence in product integration design, miniaturization design, and optical performance.

Finally, the "industrial cluster effect" cannot be ignored. In response to uncontrollable risks and the trend of global component outsourcing industries gradually shifting to Southeast Asia, Sunny Optical proposed to the Vietnamese government last March to build an industrial center worth $2 billion to $2.5 billion, while Apple has also long planned to produce MacBooks in Vietnam, enhancing the possibility of increased cooperation between the two spatially.

Perhaps it is precisely based on these core competencies and industrial opportunities that the market can infer that Apple is likely to re-select Sunny Optical this time and potentially allow it to enter the MacBook optical lens supply chain.

In the Age of Ascendance, Sophistication and Autonomy are the "Roots" of China's Supply Chain's Survival in Desperate Situations

From a broader perspective, what is most noteworthy is not just the on-off relationship between Sunny Optical and Apple but rather the ups and downs and qualitative changes experienced by Chinese companies within the "Apple Supply Chain" in recent years.

Looking back, it can be seen that Sunny Optical is not the only company that has almost been kicked out of the supply chain. According to Apple's list of the top 200 suppliers for fiscal year 2021, mainland China was its largest supply region, with over 50 suppliers. However, since 2021, many domestic companies have been kicked out of the Apple supply chain or suffered order cuts.

Specifically, in 2020, the fifth year after O-Film entered the "Apple Supply Chain," it received notice of being included on the Entity List, and the following year, it was removed from the Apple supply chain, subsequently experiencing a sharp decline in performance and years of losses.

In 2022, GoerTek suddenly received notice from a major overseas customer that production of a smart acoustic device had been suspended, leading to a near-collapse in its performance that year, with over RMB 1.7 billion in impairment losses.

In 2023, Wintek, which had been rumored to have quality issues that might lead to order cuts from Apple, proactively announced that it would stop supplying Apple. Its net profit fell by nearly 70% in the first quarter of 2024.

From these typical cases, it can be seen that the reasons for the significant setbacks in the Apple business of these long-time suppliers include both uncontrollable systemic risks and internal shortcomings. However, there is a commonality: as one of the most growth-oriented companies in the world at the time, Apple represented a vast "gold mine," and as such, these companies focused their operations heavily on Apple, leading to a high degree of dependence and weak risk resistance, with any fluctuations in cooperation causing significant declines in performance.

However, as the saying goes, "In the horse race of Tianji, who knows whether it is good or bad fortune?" The path to growth always involves some stumbles. After this experience, most domestic "Apple Supply Chain" suppliers that have survived the painful period have summed up some reflections and made changes in various aspects.

Firstly, products must withstand scrutiny. From a broader trend, based on factors such as China's industrial transformation, labor costs, and the global environment, Apple's supply chain has begun a series of "de-China" moves in recent years, but these have primarily focused on low-tech areas. For companies like GoerTek, BYD Electronics, and Changying Precision, which rely on technology and products, Cook's attitude suggests that Apple is still constrained by them.

Behind this is the continuous refinement of their products and operations over the years. In 2023, GoerTek and Changying Precision invested RMB 4.716 billion and RMB 8.189 billion, respectively, in R&D. It can be seen that the strength of the "Apple Supply Chain" halo is still determined by the quality and strength of a company's production, and Sunny Optical's return is one of the best examples of this.

Secondly, diversification of operations. To reduce dependence on Apple, domestic Apple supply chain companies have gradually pursued diversification strategies in recent years. For example, Sunny Optical has withstood this downcycle in the consumer electronics industry thanks to its diverse layout encompassing mobile phones, automobiles, security, AR/VR, and other fields; GoerTek has transformed into the VR/AR sector, Lens Technology has explored new energy vehicles, smart headsets, and photovoltaics, and L&P Technology has ventured into the automotive and photovoltaic sectors.

Thirdly, building a Chinese autonomous chain leader that rivals or even surpasses Apple. To strengthen the absolute discourse power of the chain leader over the entire supply chain and ensure its security and vitality, Apple periodically "reshuffles" its supply chain.

However, for suppliers, this is always a sword hanging over their heads, difficult to control. Therefore, a domestic chain leader that can rival Apple is a necessary choice for the industry's overall strength. Huawei's return after two years has made this possibility a reality, and O-Film has been pulled out of the "quagmire" after being abandoned by Apple.

It can be seen that in this round of consumer electronics recovery, the rise of China's supply chain, which was once constrained, is evident. However, the true constraint behind a supply chain can only be broken through the concerted efforts of the entire industry.

This represents that in the new era of ascendance, China's supply chain and even the entire Chinese manufacturing sector need to continue moving towards a core principle – autonomy and sophistication.

Source: Hong Kong Stocks Research Society