• 2009 to be another tough year; stay Neutral: With high exposure to corporate market (desktops, networking) and discretionary consumer products (MP3 player, game console, DSC), we expect Hon Hai's earnings to decline sharply in 2009. In addition, weaker end markets and loosening labor supply in China should make the benefits of new lowcost locations less attractive. Working capital issues also continue to weigh down the near-term outlook, leading to potential dilutive fund raising. We cut FY09/10E EPS by 13/12% and reduce our DCF based Jun-09 PT to NT$58. Key risk is sharp recovery in end markets. 

• The cash flow conundrum: Hon Hai should cut capex sharply and turn free cash flow positive from 2009. We feel Hon Hai should (1) pay more cash dividends, (2) invest in new growth markets to take growth back to 30% levels or (3) pay down its debt. We do not expect growth to return to the pre-2008 levels and hence believe increased dividend payout or lowering debt levels are realistic solutions. In this backdrop, we are concerned by Hon Hai's intention to raise more capital (potential GDR issue/CBs) and worry it imply a worsening working capital environment.

 • Recovery slow, to settle at much lower growth post downturn: We also expect the recovery to remain slow, since Hon Hai’s relatively weaker balance sheet may not enable them to capitalize on new opportunities as fast as peers. Particularly, we expect cash rich notebook ODMs to enhance their vertical integration footprint and narrow the gap. We also do not see significant new end markets which could take the growth rates back to the 30+% rates seen before 2008. 

• Execution issues weigh down in the near-term: Our checks indicate multiple execution issues with key customers in the past few months due to relocation and enforcement of stricter working capital norms. Relocation of facilities, when the OEMs are trying to shorten the supply chain could result in more execution issues, in our view

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