Investment Highlights

• We maintain our NEUTRAL outlook on the technology sector for the next 12 months. This is due to near-term uncertainty in orders clouding the outlook of some semiconductor companies, arising from the long-standing technology and trade spat between the US and China. Moderate growth is expected in global semiconductor sales in 2020 and 2021, where the auto outlook remains soft for the next 2 years while smartphone sales are anticipated to grow in 2020 driven by demand for 5G phone models in spite of overall shaky markets amid trade war uncertainties.

• Moderate growth in semiconductor sales expected in 2020 & 2021: The World Semiconductor Trade Statistics (WSTS) projects that annual global semiconductor sales will decline 12.8% in 2019 to US$409bil sales and increase by 5.9% and 6.3% respectively in 2020 and 2021, signaling a rebound with moderate growth. This is supported by the Semiconductor Industry Association’s (SIA) data that following 5 consecutive months of sales decline (October 2018–March 2019), sales began to show a positive trend of recovery from April 2019 onwards, reaching US$36.6bil sales in October 2019 (Exhibit 1). On a YoY basis, global semiconductor sales were 13% lower vs. the same month in the preceding year.

• Huawei wins 90-day reprieve from US ban, but more affiliates added to blacklist: After the US Department of Commerce added Huawei to its entity blacklist in May 2019 that restricts sales of US-made goods to the company and limited items abroad containing US technology, Huawei was given a reprieve on 18 Nov 2019 in an extension of the licence that allows companies to export goods to the company by 90 days (extension set to end on 16 Feb 2020). However, another 46 Huawei affiliates were added to the blacklist, bringing to a total of more than a 100 companies being banned.

US-China phase 1 deal announced: The phase-one US-China trade deal was reached just prior to the 15 December 2019 deadline. Under the deal, (i) the US suspended 15% tariffs scheduled on US$156bil worth of Chinese goods, including major consumer categories such as smartphones, automotive and industrial products; (ii) China cancelled its retaliatory tariffs including 25% tariff on US-made autos; (iii) the US cut tariffs on US$120bil worth of Chinese goods from 15% to 7.5% (while a 25% tariff on some US$250bil imports remains unchanged); (iv) China was urged to improve intellectual property protections; and (v) China to buy more US agricultural, manufacturing, energy & services sector products by at least US$200bil in the next two years, among other details. The agreement is expected to be signed in January 2020. Despite a sigh of relief, we are still cautious on the impact of the US-China trade war as there may be more phased deals and as negotiations might hit a pause with the US bracing for its presidential election in November 2020.

Some players may benefit as Chinese companies look elsewhere: As a result of the trade war, Chinese companies have been forced to reconsider their supply chain and reduce their dependency on US suppliers by shifting to local sources. As an example, Malaysian Pacific Industries’ (BUY, RM2.02) Carsem Suzhou plant has seen stronger demand of orders from Chinese customers who have turned to locally-based OSAT players to reduce supply chain risk.

• Smartphone users hold back on 5G phone purchases until 2020: Gartner’s 26 September 2019 report forecasted that the global smartphone market is expected to recover and grow by 2.9% in 2020 as a result of 5G adoption, after a 3.2% global decline in shipment of devices i.e. PCs, tablets and mobile phones in 2019. Meanwhile, users are reportedly holding onto their phones longer given the limited attraction of new technology. We believe some users are also holding back purchases in anticipation of 5G adoption in upcoming models. According to Gartner, 5G phones are predicted to account for more than half of phone sales in 2023. With Inari Amertron’s (HOLD, FV RM1.76) exposure to the radio frequency (RF) market, the group will benefit from the transition to 5G due to increasing RF chip content per phone with every new 5G model produced, which will help to cushion any declines in overall smartphone sales.

Weak global smartphone demand in 3QCY19: Global smartphone sales slid 0.4% YoY in 3QCY19. Customers’ preference for mid-tier phones has led to brands strengthening entry-level and mid-tier offerings which helped Huawei, Samsung and Oppo sales grow and increase market share in 3QCY19, while Apple and Xiaomi’s market share declined (Exhibit 2). Despite the trade war, Huawei was the only global smartphone vendor to achieve double-digit growth in 3QCY19, with sales climbing 26% YoY mainly due to its performance in China where 62% of its phones were sold and its market share grew by 15ppt. Meanwhile, Samsung maintained its #1 market position while Apple sales dropped 11%, due to a double-digit decline in the beginning of the year despite improving sales in Greater China (Exhibit 3). Apple’s numbers may be more positive in upcoming quarters due to positive response to its iPhone 11 line-up.

• Global auto outlook remains tepid for 2020 and 2021: Fitch Ratings cited that declining new car sales in China is the biggest reason global auto sales are expected to shrink 4% in 2019 with “little reason to anticipate a rebound in global car sales in 2020”. S&P Global Ratings concurred, saying no revenue growth will be seen in 2020 and expectations of this to extend in 2021 with all regions anticipated to face volume weakness except for China which might see a modest rebound after 2021. Due to the subdued global auto outlook, demand for the automotive semiconductor industry might also be muted.

Car sales in key markets were up except for China: The European Automobile Manufacturers Association (ACEA) reported that new car registrations in the EU grew 8.7% YoY in October 2019, reaching a 1.18mil vehicles, its highest total on record since 2009. A lower base was set in nearly all EU countries due to the introduction of stricter emissions-testing rules in October 2018 (Exhibit 4). Meanwhile, TradingEconomics.com reported that China’s vehicle sales declined 4% YoY in October 2019 while sales of new energy vehicles (NEVs) fell for the 4th consecutive month, plunging 45% YoY in October 2019 after the government reduced incentives for NEV car purchases in March 2019 to encourage local manufacturers to focus on innovation rather than relying on government assistance. According to Bloomberg, US auto sales stood at a high 17.5mil units in November 2019 (up slightly vs. 17.4mil in the previous year), mainly boosted by Black Friday deals on old model-year vehicles and higher average sale prices driven by demand of popular new car models.

In the face of stricter pollution laws in the EU & China and clouded outlook due to the US-China trade war, electro mobility is likely to underpin new growth and global auto sales moving ahead. In 2018, McKinsey’s analysis of its EV Index found that China’s EV market was 51% of global EV sales; about 3x the size of the EU and US markets each (US at 1mil, EU at 320K while US at 361K units of light EVs). Therefore, any recovery in the auto industry would likely come from China’s market.

• Potential changes in sector rating:

• We may upgrade our sector outlook to OVERWEIGHT if: (i) semiconductor companies under our coverage i.e Malaysian Pacific Industries, Inari Amertron and QES Group secure significant jobs, (ii) strengthening USD outlook, (iii) faster-thanexpected adoption of 5G globally, spurring higher demand for end products, and (iv) positive progress in the US-China trade war which will reduce uncertainty in markets.

• On the other hand, we may downgrade our stance on the sector to UNDERWEIGHT if: (i) weak economic conditions cause a lukewarm demand for end-products, (ii) monotonous content growth in underlying products in the absence of innovation, (iii) margin erosion in the face of a weakening USD, and (iv) worsening trade war between the US and China, specifically relating to technology and intellectual property.

• Our top pick for the sector is Malaysian Pacific Industries (BUY, FV RM12.45) due to its: (i) new product portfolio that focuses on the higher-margin specialized market, (ii) leading market position in the ultra-thin micro leadframe package (MLP) and increased R&D in micro-electromechanical systems (MEMS) sensors riding on the Internet of Things (IoT) wave particularly in the automotive and industrial segments, and (iii) strong net cash position of RM761mil as at 30 September that allows for the group to look for meaningful M&A opportunities. Despite global uncertainties, the group’s automotive segment which contributes 32% of group revenue, is strengthening and its Carsem pipeline remains intact with around US$55mil (around RM229mil) capex earmarked for machinery in its Suzhou plant due to higher demand from Chinese customers, while the remainder of its capex will be utilized to enhance its Ipoh plant’s capabilities.

Source: AmInvest Research - 2 Jan 2020