AI server "one-stop" capability is unique! Morgan Stanley: The market still underestimates Foxconn

Contract manufacturing leader Foxconn (parent company of Hon Hai) may become the next star to shine in the AI wave.

Despite a 62% surge in its Taiwan stock price this year, Morgan Stanley pointed out that the market has not fully recognized its potential in AI services, lagging behind peers such as Wistron, Quanta Computer, and Gigabyte Technology in the AI services ODM industry.

Morgan Stanley stated that Foxconn has recently won AI service projects with its innovative CMMS model, expecting this project to contribute 12% of profits by 2025, with a 20% year-on-year profit growth.

On the other hand, the iPhone assembly business has performed better than expected, with the upcoming new iPhone models possibly incorporating AI features. This could lead to increased shipments due to replacement demand. Morgan Stanley predicts that Foxconn's iPhone assembly share will remain around 60% in the next two years.

Given the strong profit growth prospects for Foxconn in 2025, Morgan Stanley reiterated its overweight rating on Foxconn and raised the target price to NT$210, representing a 23.5% upside potential from the current level, corresponding to a 15.6 times 2025 forward PE ratio. Foxconn's current 12-month forward PE ratio is 12.6 times, lower than the industry's 15-20 times PE ratio.

CMMS Model Expected to Boost Profits in AI Services Business

Morgan Stanley believes that Foxconn has leveraged its CMMS (Component Modularization Rapid Shipping and Service) operating model to win the assembly projects for NVIDIA's GB200DGX/MGXNVL72/36 flagship and the service rack integration work.

In addition to service assembly/rack integration, Foxconn is also responsible for the main circuit board assembly of the GB200NVL72/36 service rack (computing board, switch tray, smart NIC, DPU, etc.).

This will enable Foxconn to generate incremental profits by providing various types of circuit board assembly. In handling the assembly of GB200 service racks, Foxconn possesses stronger technical know-how and assembly capabilities, standing out in the AI services ODM industry and contributing to increased profit.

Morgan Stanley predicts that with the increasing shipment volume of GB200-related service racks (DGX in the first half of 2025, MGX in the mid-2025), Foxconn's AI service revenue and profit in 2025 will grow by 30% and 126% year-on-year, respectively.

We expect Foxconn's AI business revenue to reach $25.6 billion next year (a 30% year-on-year increase), with 46% coming from NVIDIA's HGXGPU service and 54% from the GB200NVL72/36 service rack solution Due to its CMMS model, we expect Hon Hai Precision Industry's AI business profit to increase by 126% year-on-year to reach $1.8 billion, with 40% coming from high value-added circuit board assembly and 35% from large-scale GB200 rack integration work.

According to Morgan Stanley's calculations, by 2025, Hon Hai is expected to generate $1.833 billion in profit from AI server business, accounting for 12% of the total profit. Among them, circuit board assembly related to GB200, which has high added value, will account for 40% of the related profit, followed by rack assembly work related to GB200, accounting for 35% (benefiting from revenue scale expansion).

The iPhone assembly business is expected to perform better than expected. Morgan Stanley believes that the upcoming new iPhone models may incorporate AI functions, potentially leading to increased shipments due to replacement demand. Hon Hai's supply share is expected to remain around 60% in the next two years.

From January 2023 to February 2024, compared to ODM peers in the server service industry, Hon Hai's stock price performance was poor. One important reason is the market's concern that its iPhone assembly business may lose momentum due to Luxshare Precision's market share growth and iPhone shipment saturation.

Based on Hon Hai's maintenance of iPhone assembly share and overall iPhone shipment prospects this year, management recently stated that its consumer business is expected to remain flat year-on-year, which is much better than the market's concerns of a possible 10-15% decline year-on-year.

We now expect Hon Hai's iPhone assembly share to remain around 60% in the next two years—Luxshare Precision's share growth mainly comes from the transfer of assets related to Wistron. Our iPhone shipment expectations are consistent with analyst Erik Woodring's forecast covering Apple, with a 6% year-on-year decline expected this year and a 9% year-on-year increase in 2025. Therefore, iPhone assembly revenue will be quite stable, with an expected revenue of NT$320.1 billion this year and NT$303.2 billion next year, representing year-on-year declines of 4.9% and 5.3%, respectively.

Additionally, Morgan Stanley highlights recent stock price catalysts: 1) Reporting on the latest developments in the AI server business at the 2024 first quarter earnings conference on May 14; 2) NVIDIA GB200 server rack demonstration at the China Taipei International Computer Show from June 4-7; 3) Potential AI feature introductions at the Apple Worldwide Developers Conference from June 10-14