Computing and Server Tailwind Drove Better Than Expected Q2 Results for Hon Hai; FVE Maintained

Hon Hai’s second-quarter results beat our expectations, largely due to better than expected computing and server profitability. Although second-quarter sales declined 2.7% year on year, enterprise and computing sales grew 10.1% and 16.7%, respectively, driven by solid work-from-home and remote learning demand, which will persist through third quarter, according to management. Meanwhile, operating income jumped by 44.5%, as gross margin expanded to 5.9% from 5.3% in the same period last year. In our view, the firm’s impressive margin expansion was primarily due to: 1) strong profitability recovery at Foxconn Industrial Internet, or FII, which saw its second-quarter gross margin increase by 200 basis points to 7.6% from the previous year, driven by margin enhancement due to solid network server sales; 2) computing margin improvement; and 3) contribution from coronavirus-related subsidies from customer and local government. While we recognize that the last factor is more of a one-time contribution, management mentioned that overall gross margin increased relative to June quarter last year even excluding subsidies.