Investment Highlights

• We maintain our OVERWEIGHT stance on the technology sector. We expect growth to stem from the automotive and cloud computing division which is anticipated to grow ahead of other categories. However, the growth will likely be moderated, owing to a slowdown in the heavily weighted communication segment. One of the main reasons for the slowdown is the lack of breakthrough features in recent smartphone launches, which has lengthened the replacement cycle among consumers. With commercial rollouts of 5G connectivity to be seen only in 2020, we believe FY19 to be a year of research & development (R&D), with companies allocating more resources towards the innovation and adoption of the Internet of Things (IoT).

• Automotive industry to drive semiconductor demand. With electric vehicles (EV) and autonomous driving gaining traction, there will be opportunities for a potential pick-up in demand for automotive semiconductor components. IC Insights anticipates automotive electronics systems to grow 6.4% YoY in 2019 (see Exhibit 3), topping all other categories including communication. The growth is premised on the rapid adoption of advance driver-assistance system (ADAS) and active safety features, which increases the need for more automotive electrical systems such as sensor fusion, camera, radar and lidar (light detection and ranging). This augurs well for Malaysia Pacific Industries (MPI) (BUY: RM13.79) which is ahead of its peers in positioning itself for more automotive-related jobs. Infineon Technologies, a prominent player in the automotive semiconductor space, projects that a Level 2 (see Exhibit 4) vehicle will likely incur an additional US$150 worth of semiconductor content per car. At Level 3, the number increases to US$580 while Level 4 and 5 require an additional US$860 per car. Similar to the transition to autonomous driving, the transition to EV does not need to be instantaneous. Vehicles with hybrid powertrains will bridge the gap, and IHS Markit estimates a simple hybrid vehicle to have an increase of US$428 worth of semiconductor content. All in, a full EV with full autonomous driving capability should have approximately six times the value of the average semiconductor components in a typical internal combustion engine (ICE) vehicles.

• Cloud computing is gradually emerging as a prominent segment on its own, with data centre and enterprise software recording the highest growth in terms of spending in 2017 (see Exhibit 5). This trend is expected to continue in 2018F and 2019F with the emphasis on enterprise software, as companies are moving towards cloud-based software as a service (SaaS) such as customer relationship management (CRM), supply chain management (SCM) and enterprise resource planning (ERP). This has sparked a trend of aggressive acquisitions among SaaS players in 2018 itself, notably SAPQualtrics, Adobe-Marketo and IBM-RedHat. Riding on the move towards cloud computing, back-end data centres facilitating cloud-based software will eventually see a need for expansion or upgrades in order to accommodate higher number of users and increasing data size. Local players like Dufu Technology Corp (UNRATED) and MPI (BUY: RM13.79), who are involved in server hardware such as storage drives and power management chips, are poised to benefit.

• 5G connectivity to be a game-changer reaching a theoretical speed that is 20x faster than 4G LTE, pushing the frontier of IoT innovations with the higher bandwidth and lower latency that comes with 5G connection. However, we believe commercial adoption may only take place in 2020 owing to: (1) bottlenecks from current network architecture which requires optimisation; and (2) higher cost of incorporating 5G modem into smartphones due to the need for multi-mode legacy network support (e.g. 2G, 3G, 3.5G, 4G) until we achieve widespread 5G coverage. We do not discount the possibility of several smartphones being launched in the next 6-12 months and marketed as “5G capable”, as these devices will probably serve as a reference device for 5G adoption rather than a commercial deployment. Meanwhile, we expect smartphone manufactures to be focusing more on R&D in 2019 to incorporate 5G connectivity and breakthrough features like foldable display into future devices, replacing the stale trend of annual marginal upgrades that consumers have been desensitised to. While this may not immediately translate into higher demand for smartphone semiconductor component, we believe Inari Amertron (BUY: RM1.90), with its expertise as an outsourced semiconductor assembly and test (OSAT) player in radio frequency (RF) chips and optoelectronics, is well positioned to gain from the transition to 5G in the longer term.

• Key risks: 1) Lukewarm demand for end products owing to weak economic conditions; 2) monotonous content growth in underlying products in the absence of innovation; 3) margin erosion in the face of a weakening USD; and 4) trade war between the US and China, specifically relating to technology and intellectual property. If such risks materialise, we may downgrade our stance on the sector from OVERWEIGHT to NEUTRAL.

• Our top picks for the sector are:

Malaysia Pacific Industries (BUY: RM13.79)

We believe MPI to be a good proxy to the growing semiconductor content in vehicles. Ahead of its peers, MPI has rationalised its customer portfolio and refocused its resources for higher margin businesses, specifically in the automotive segment. In line with its 5-year goal, the company aims to achieve 50% of its revenue from automotive jobs from a current level of 30%. With enterprises moving aggressively towards cloud-computing, MPI expects to deliver more flip-chip packaging for power management chips that are used in server farms running 24/7 to facilitate cloud storage database. With power consumption being the crucial cost component in these server farms, MPI’s power management chip edged ahead of its competitors given its power efficiency. Also, its strong net cash position of RM644mil allows the company to look into meaningful M&A as valuations of certain technology companies may have come down.

Inari Amertron (BUY: RM1.90)

We understand that Inari may see choppy earnings in the near term due to weakening smartphone sales. In the longer term, we believe its expertise as a reputable OSAT player in RF and optoelectronics will place the company in a strong position to gain from the adoption of 5G connectivity. Currently, Inari is diversifying its customer portfolio by expanding into laser devices, which are boosted by increasing biometric and augmented reality (AR) applications in smartphones; and LED, which rides on rising demand for high-resolution billboards in shopping malls.

Source: AmInvest Research - 3 Jan 2019