We believe the worst is over for the industry after a difficult start to the year. As the inventory overhang situation continue to dissipate, we see flattish growth for the second quarter before moving into a robust recovery phase in 2H 2023. Led by the evolving developments in artificial intelligence, we think other industries will follow suit and become more technology-driven, which will lead to rising demand for Internet of Things (IoT), cloud computing, automated manufacturing and other services in the future. Maintain Overweight on the sector, with our top pick Inari Amertron.

• China set to extend NEV tax incentives as sales growth slows. Following a State Council meeting chaired by Premier Li Qiang, China is prepared to increase incentives for EV purchases as part of broader attempts to boost the sluggish New Electric Vehicle (NEV) sales. An extension is being considered for low- or zero-emission cars for another four years. One of those measures may be extending the purchase tax breaks for Electric Vehicles (EVs) and plug-in hybrids that cost less than 300,000 yuan (USD42,400).
  
  To recap, China has been promoting its EV industry for more than a decade with generous incentives to consumers and subsidies to automakers. Buyers received discounts of as much as 60,000 yuan at one point for purchasing EVs. While new cars are generally subject to a 10% purchase levy, this has not applied to NEVs since 2014 and was recently extended through the end of 2023.
  
  We believe the latest stimulus measures are likely to give a boost sentiment in the car market, which will benefit the Malaysian Outsourced Semiconductor Assembly and Test (OSAT) and Automated Test Equipment (ATE) companies that have exposure to China’s automotive industry. According to China Passenger Car Association, passenger vehicle sales continued gaining momentum in May with YTD sales rising 2% to 7.29m units. Retail sales of NEVs surged 82% YoY to 483,000 units in May, bringing the YTD sales to 2.33m units, up 43% YoY. The association attributed the strong growth mainly to sales promotions during the holiday in May and consumption subsidy policies introduced by the central and local governments.
   
• Spending spree on silicon carbide. Silicon carbide (SiC) is a type of semiconductor material made from the fusion of pure silicon and pure carbon molecules, and then mixed with other elements, according to the specification of the end-application. Silicon carbide is more expensive and difficult to produce than the traditional silicon, but it has excellent electrical conductivity, durability and resistance to heat. Given that silicon carbide is a crucial component of EVs, charging stations, electrical power systems and data centres, the silicon carbide market has enormous potential over the next 10 years. More automotive semiconductor companies are following Wolfspeed in investing billions of dollars to develop SiC as SiC semiconductors become more widely used in EV systems. These companies include ST Microelectronics, Bosch, Rohm Semiconductor, Infineon Technologies, Onsemi and Renesas Electronics. We think local OSAT and ATE players are likely to benefit from the increasing capex from the global automotive semiconductor players.
   
• Second consecutive monthly rise in global chip sales. According to the Semiconductor Industry Association (SIA), global chip sales registered a second monthly gain of 0.3% in April to USD39.95bn (refer to Figure 2). The gain in monthly sales were led by China (+2.9%) and Japan (+0.9%), though partially offset by Europe (0.6%), US (-1%) and the Asia-Pacific (-1.1%) region. SIA also forecasts that annual global chip sales will decline from USD574.1bn to USD515.1bn in 2023 followed by record sales of USD576bn in 2024.

• SEMI projection shows moderate contraction in 2Q. SEMI, the industry association representing the global electronics design and manufacturing supply chain, expects the current global semiconductor manufacturing industry contraction to moderate in the second quarter of 2023, pointing to a gradual recovery starting in the third quarter. In the 2Q 2023, industry indicators including IC sales and silicon shipments showed a QoQ improvement, underpinned by seasonality. However, despite the gains, elevated inventories continue to dampen silicon shipments and fab utilization rates remains significantly lower than the levels seen last year. (refer to Figure 5) In addition, semiconductor equipment sales continue to decline in tandem with capex adjustment by major industry players. Its latest indicators point to a likely bottoming of the current downturn in the 2Q 2023 as the inventory correction will likely end by this month, with a mild recovery expected in the 2H driven by a pick-up in demand for inventory and the holiday season.
   
• Global AI server shipments expected to surge 40% this year. Amid all the hype over generative Artificial Intelligence (AI), which uses Graphic Processing Units (GPUs), Field Programmable Gate Arrays (FPGAs) and Application-specific integrated circuit (ASICs), TrendForce projects a surge in AI server shipments with an estimated 1.2m units for 2023, marking a robust YoY growth of 38.4%. The steep increase is in tandem with the mounting demand for AI servers and chips, resulting in AI servers poised to constitute nearly 9% of the total server ships, and projected to increase to 15% by 2026. The growth of chatbots and AI computations is expected to expand its footprint across various professional fields such as cloud and e-commerce services, intelligent manufacturing, financial insurance, smart healthcare and advanced driver-assistance systems.
   
• 1Q 2023 global smartphone sales contracted 15% YoY. IDC reported that global smartphone shipments fell 14.6% YoY to 268.6m units (refer to Figure 5) in the first quarter of this year, marking the market’s seventh straight quarter of fall as the market continues to struggle with i) lukewarm, ii) inflationary inflation and iii) macro uncertainties. Almost all the regions suffered double-digit decline in 1Q23 with China witnessing close to 12% drop as consumers prioritize travel and entertainment over smartphone purchases since the reopening of the market. Inventory levels have remained high throughout all regions, although they are much better than they were six months ago because of a reduction in capacity and intensive marketing initiatives. IDC anticipates the market enter positive territory following numerous channel checks with the OEMs and supply chain.

• Global foundry sales expected to extend slide in 2Q. TrendForce reported that the global top 10 foundries witnessed a significant 18.6% QoQ decline to USD27.3bn in revenue (refer to Figure 5) during the first quarter of 2023, hit by declining capacity utilization rates and shipment volume on weakened demand for mainstream applications such as laptops and smartphones. It expects continued declines in revenue for the global foundry sales in 2Q albeit at a slower rate than in the 1Q23. While supply chains are expected to gradually build inventory in response to peak season demand in the 2H, the accumulation of inventory and slow consumption have dampened customer sentiment towards stockpiling. Consequently, the overall production cycle of foundries in 2Q is expected to be more relaxed, with limited growth in capacity utilization rates.

• Top pick. Inari (Outperform, TP: RM3.53) is primed to ride on the stronger 5G adoption globally and set to benefit from the upcoming new smartphone cycle as well as the new footprint in China.

Source: PublicInvest Research - 22 Jun 2023