Hon Hai Precision Industry's decision to move away from major client Apple and the lower-value electronics contract manufacturing business is a long-term bet that will improve margins and offset rising labour costs, analysts say.
The Taiwanese company, better known by its trading name Foxconn, is building an integrated service package ranging from electronic devices to software applications and cloud computing as it strives to become more consumer-driven.
This strategic shift is in its early days: Hon Hai still draws an estimated 40 per cent to 50 per cent of its revenue from assembling iPhones and iPads, a slight decline from 60 per cent a year ago. But analysts said the move was likely to boost profit margins this year and in the longer term for the world's largest assembler of electronic devices as well as balance out rising wages and costs at its factories on the mainland.
"Its enlarging scale will help Hon Hai's margins in [the third and fourth quarter]," said Kylie Huang, an analyst at Daiwa Securities.
"This has a leverage effect: in the very long run, working closer with the carriers will help Hon Hai to understand the needs of consumers when introducing TVs, tablets, game consoles and smartphones," she added, citing the fourth-generation mobile licences the company recently bought.
Hon Hai yesterday announced a better-than-expected net profit of NT$30.75 billion (HK$8.05 billion) for the third quarter, higher than a median forecast of NT$25.99 billion by 13 analysts polled.
The figure compared with a net profit of NT$16.98 billion in the previous quarter and NT$30.26 billion a year earlier.
Operating profit margin rose 1.36 percentage points from the previous quarter to 3.46 per cent. The margin in the third quarter of last year was 3.4 per cent.
Apple, Hon Hai's largest client, last month forecast gross margin for the fourth quarter that missed analyst estimates because of higher costs for introducing the new iPhone and iPad. Hon Hai's margins usually move in an inverse direction to those of Apple.
Improved production efficiency may allow Hon Hai to reduce costs, which could result in improved operating margins, according to JPMorgan Chase.
"Hon Hai has gone through a smoother learning curve compared to a year ago, hence the company should enjoy better yield," Gokul Hariharan, an analyst with JPMorgan in Hong Kong, wrote in a report released on Sunday.
So far this year, Hon Hai has teamed up with mainland online and mobile video provider Le TV in a bid to sell large internet-enabled televisions on the mainland.
The company is also setting up a factory in the United States to build televisions there.
In June, Hon Hai announced a partnership with Mozilla to launch devices that run on the US company's Firefox operating system.
It also recently bought a licence for the faster, internet-enabled 4G mobile network in Taiwan, a US$311 million investment aimed at linking its software and devices.
Hon Hai is also reaching out to regional clients to diversify its revenue sources, a move analysts said would help its expansion drive.
"We believe Hon Hai is actively addressing this issue, focusing on developing business partners among Chinese handset makers and investing in technology and channel business, aiming to move up the value chain," Goldman Sachs analyst Lin Liang-chun said in a report.