Innolight has released its 3Q23 results, with resilient growth in both revenue/NP at 14.9%/89.5% YoY and 39.7%/88.4% QoQ, respectively. The strong revenue growth was driven by substantial global demand for 400G and 800G optical transceivers. Notably, the Company's gross margin showed consistent improvement across the first three quarters of 2023, climbing from 29.5%/31.1% in 1Q/2Q to 33.5% in 3Q. The results were in line with our previous expectations (link) that Innolight is one of the true AI beneficiaries, and we expect AI-related revenue to contribute more in Innolight’s revenue starting from 3Q. We continue to believe Innolight’s AI revenue growth will accelerate in the next few quarters. Maintain BUY rating with unchanged TP of RMB109.3.

New incentive program showed Company’s confidence in 2024-27 top line and bottom line growth. Innolight announced its new incentive plan on 22 Oct. The performance metrics include 1) minimum revenue targets of RMB13.5bn/RMB17.0bn/RMB20.5bn/RMB23.5bn for 2024-27; 2) minimum net profit targets of RMB2.65bn/RMB2.97bn/RMB3.31bn/RMB3.41bn for 2024-27. The 2024 targets translate into 40.0% growth in revenue and 116.5% growth in net profit from RMB9.6bn revenue and RMB1.2bn net profit in 2022. The 2025-27 targets translate into 25.9%/20.6%/14.6% YoY growth in revenue and 12.1%/11.4%/3% YoY in net profit growth.

True AI beneficiaries apart from Nvidia start riding the tailwind. We have noticed discrepancies in 3Q performances of several optical transceiver peers. This underscores Innolight's position as a market leader and further solidifies its status as a true beneficiary of the ongoing AI momentum, a point we previously highlighted in our report (link). We believe these true beneficiaries in AI value chain will gradually deliver a positive outcome in 2023/24E.

Maintain BUY with unchanged TP of RMB109.30. Looking ahead, we expect the Company to maintain its robust performance, driven by the production ramp-up of 800G optical transceivers and better-than-expected demand for 400G products. We will continue to monitor Innolight’s clients’ comments on their capex outlook as the overseas hyperscalers are expected to announce earnings results soon. Upside catalysts: 1) faster-than-expected ramp-up of 800G, and 2) slower-than- expected decline of non-AI revenue. Downside risks: 1) continuous rise in interest rates, 2) intensified geopolitical tensions, and 3) lower-than-expected production.