Investment Highlights

• We downgrade the technology sector to NEUTRAL from OVERWEIGHT following a slew of setbacks that dampened hopes for a recovery in 2H2019, mainly arising from the long-standing trade spat between US and China. Semiconductor Industry Association (SIA) reported a decline in global semiconductor sales for the sixth consecutive month (Exhibit 2), after registering its record sales in Oct 2018. For the year through April, sales have fallen 11% compared with the same period last year. Recognising the deteriorating outlook on the sector, World Semiconductor Trade Statistics (WSTS) had recently revised its 2019 forecast to a 12.1% YoY decline from an earlier 2.6% YoY growth, with memory, sensors and optoelectronics identified to be the cause of the drastic swing.

• Tech cold war rages on with no clear winner. Observing the supposedly “final trade talk” on May 10 taking a turn for the worse with further tariff hikes followed by the shocking ban on Huawei, we reckon that a recovery in 2H2019 is going to be a tall order. Although the G20 meeting between the US and China on June 28 has resulted in the lifting of the Huawei ban, the company is still not officially dropped from the US blacklist. The US indicated that the decision will be dependent on further trade talks with China. While the resumption of the trade talks is positive, optimism is partially negated by the absence of a timeline, still leaving many technology companies around the globe in limbo. Companies under our coverage had also in recent briefings indicated that their customers are taking a wait-and-see approach, holding back on orders in fear of further tariffs.

China has the size and money... To the US’s dismay, it hasn’t been able to replicate its success with Huawei as it did last year with Chinese telecom company ZTE. Huawei is showing no signs of backing down knowing that it controls the largest market share in global telecom infrastructure and 5G standards, overshadowing the fact that US was the first to pioneer the telephone. Having the largest presence in China with a population of 1.42bil (vs 329mil in US) further explains why being potentially shut off from US consumers does not dent Huawei easily. Even the total population of the Five Eyes (the intelligence alliance comprising AU, CA, NZ, the UK and US), who would likely side with the US, still trails behind China. China’s population is one of the main reasons that has made it the manufacturing muscle it is today. Apple and many US companies rely heavily on China for its manufacturing and assembly services. Foxconn Technology Group, known for manufacturing the iPhone, hired a million workers during its peak. China’s strength in numbers extends beyond population count as it narrows the gap with the US in terms of venture capital investment. According to a report by data provider Preqin, China recorded US$105bil in 2018 with the bulk of it related to technology, compared with US$111bil for the US. This is quite different from 2010 when China’s numbers were only US$5.6bil in contrast to US$30.8bil for the US.

…while US has the edge on intellectual property. China may have shown tremendous growth but it is still dependent on the US for certain technologies such as chip designing software and operating software from industry leading companies like Cadence Design Systems (Cadence), Synopsys and Google. HiSilicon (a subsidiary of Huawei), relies on Cadence and Synopsys to build its processors for Huawei smartphone and 5G base station. Not helping either is the fact that all these processors are built on chip blueprints licenced by a UK company Arm Holdings (ARM), which may be pressured to sever ties with Huawei due to claims that US technology is present in ARM’s designs.

• Languishing car sales in key markets like the EU and China may likely persist due to weak consumer sentiment, thus lowering demand for the automotive semiconductor. While the EU saw its first positive sales growth (May 2019: +0.1% YoY) in 9 months, it is likely to be short-lived due to tightening EU regulations on carbon dioxide (CO2) emission where the industry may face potential fines of up to €33bil if requirements are not met. EU carmakers have until end-2020 to reduce CO2 emission to 95g/km from the current level of 124.5g/km (Exhibit 3), which experts regard as the most ambitious emission target in the automotive industry.

Instead of increasing R&D cost to battle CO2 emission in combustion engines, carmakers could sell more electric vehicles (EV) to average down emission figures. However, carmakers at this juncture are faced with challenges like: (1) lower margins on EV compared with combustion engine vehicles; (2) higher selling prices of EV that may dampen sales during times of weak consumer spending; (3) higher demand for semiconductor content in EV which is facing the uncertainty of the US-China trade war; and (4) the looming tariff on EU cars sold to the US.

Source: AmInvest Research - 2 Jul 2019