Hon Hai, Foxconn squeezed on demand, rising salaries

Foxconn's handset unit is seeing lower demand as parent Hon Hai's earnings fall short of expectations.

Hon Hai and its Foxconn unit are feeling the financial squeeze as labor costs increase and customers---notably handset makers---are paring orders.

Foxconn is Apple's primary manufacturer and an effort to improve working conditions has led to higher labor costs.

In an exchange filing via Bloomberg, Hon Hai said that its first quarter net income came in at NT$14.9 billion, up from NT$14.4 billion a year ago. The bad news for Hon Hai? That profit was lower than estimates.

Specifically, Foxconn raised wages 25 percent in February. The unit is also building factories.

In addition, Foxconn International Holdings, which makes handsets as a third party manufacturer, said it will show a "significant increase in consolidated net loss" in the first half of 2012 compared to the same period a year ago.

Also see: Apple's Foxconn flap may pinch contract manufacturersApple's supply chain: A profile of a Foxconn factory employeeNew Foxconn regulations will ripple through Apple's supply chainSupply chain wars: Hon Hai's Sharp investment helps Apple vs. SamsungWith Apple's new iPad, supply chain is the hero

According to a profit warning PDF put out by Foxconn International:

The Board believes that the expected significant increase in consolidated net loss of the Group for the six months ended 30 June 2012 was primarily attributable to lower demands from some of the Group’s major customers thus resulting in lower sales of the Group’s products, and decline in the Group’s gross profit margins principally as a result of unfavourable pricing changes and increased costs associated with product migrations.

Worries about Hon Hai and Foxconn have been percolating among analysts in Asia. For instance, Macquarie analyst Daniel Chang noted that Apple's iPhone inventory levels were up in its most recent quarter.

Those inventory levels, which aren't worrisome for Apple per se, translate to fewer orders for Foxconn. Chang said in a research note:

Apple reported 1Q12 iPhone shipments at 35.1m units, which was inline with our shipment estimate for Hon Hai and Pegatron. However, we found Apple’s comment about iPhone inventory rising to 8.6m units a bit concerning. In addition, based on several iPhone related component makers’ 2Q12 tone, we see downside risk to our iPhone assumption for Hon Hai. We expect Hon Hai’s 2Q12 iPhone shipments to drop below 20m units (-40% QoQ) and much lower than the street’s 24-26m forecasts.