Investment Highlights

• We upgrade our outlook on the technology sector to OVERWEIGHT from NEUTRAL for the 2H20 as the sector’s outlook remains resilient despite the Covid-19 pandemic impact on operations from the implementation of partial and/or complete lockdowns and travel restrictions worldwide to curb the spread of the virus. As the automotive and industrial segments have been hit harder by Covid-19, we expect the focus to be on: (i) the telecommunications segment with the 5G growth upswing; (ii) growth in smart sensors with applications in telecommunications and automotive segments; and (iii) the adoption of Industry 4.0 technologies such as artificial intelligence, internet of things (IoT) and automation to rapidly increase production when economies recover.

• Our OVERWEIGHT stance is based on the valuations of our stock coverage: (i) Inari Amertron (BUY, FV RM2.01) pegged to its 5-year historical average PE of 23.5x; (ii) Malaysian Pacific Industries (BUY, FV RM13.19) pegged to a rolledforward CY21F PE of 16x, which is +1SD above its 3-year historical forward average PE (previously RM12.06, FY21F PE of 15x); and (iii) Pentamaster Corp (HOLD, FV 4.95) downgraded from a BUY recommendation following the run-up of its share price.

• Covid-19 impact on earnings already factored in 1H20: The enforcement of lockdowns and travel restrictions had caused delays in revenue recognition and lower production shipments such as in the case of Pentamaster and Inari while causing reduced order visibility in light of uncertainties in demand for MPI. However, we note that the majority of orders impacted saw deferments and not cancellations, with expectations of recovery in orders in 2H20.

• Limited production under lockdowns has normalized following easing of restrictions: Companies under our coverage that have most of their operations in Malaysia had been impacted by the implementation of the movement control order (MCO) effective 18 March 2020, as they were only allowed to resume production at a limited capacity of 50% workforce (being under the Ministry of International Trade and Industry’s (MITI) list of approved critical sectors i.e. semiconductor production). Higher expenses were experienced during the MCO due to supply chain constraints, stringent standard operating procedures (SOPs) and higher staff expenses in relation to lower revenue. Since the gradual easing of the MCO, production has normalized. Overseas operations such as MPI’s Suzhou and Inari’s Kunshan plants in China and Inari’s Philippine plants were similarly impacted by lockdowns and have also resumed normal production.

• Global semiconductor market growth of 3–6% in next two years: The World Semiconductor Trade Statistics (WSTS) has released its updated forecast in May 2020, projecting a growth of 3.3% to US$46bil mainly from the Americas and Asia Pacific, with expectations of 5% growth in integrated circuits (ICs) where all categories memory, logic and micro are expected to recover, except analog ICs. Meanwhile, discrete semiconductors, optoelectronics and sensors are predicted to see declines of 6.6%, 5.1% and 2.1% respectively. For 2021, WSTS projects a 6.2% growth across all geographical regions and product categories. The Semiconductor Industry Association (SIA) recorded US$34.4bil sales in April 2020, down 1% MoM but 6% up YoY, showing resilience in light of Covid-19 although uncertainty remains in months ahead (Exhibit 3). Sales rose 25%, 4% and 3% YoY in the Americas, China and Asia Pacific/All Other but declined by 0.1% and 7% in Japan and Europe respectively.

• Smartphone shipments to shrink 13.7% in 2020: On 26 May 2020, Gartner reported that smartphone sales are expected to decline to 1.3bil units, expecting less customers to upgrade their phones due to lower disposable income causing phone lifetimes to extend to 2.7 years in 2020 (vs 2.5 years in 2018). Meanwhile, affordable 5G smartphones that were previously thought to account for most replacements in 2020 will no longer be the case. These are forecasted to only contribute 11% of total shipments with the anticipation that most regions, apart from China, will see reduced spending on 5G phones due to lack of infrastructure. Despite expectations of lower sales of 5G phones overall than initially expected, we gather that Inari’s radio frequency (RF) orders are still expected to ramp up from June 2020 onwards with expectations that 3Q20 will coincide with the new 5G phones cycle, with both its P34 and P13 plants being prepped to maximize utilization from higher RF demand. 
  
  In 1QCY20, global smartphone sales contracted 20% overall due to the Covid-19 impact as manufacturers were affected by factory closures and reduced consumer spending (Exhibit 4). All vendors recorded sales declines except for Xiaomi due to its strong sales of Redmi devices (entry-level and mid-range devices) and aggressive online channel focus while Samsung maintained its #1 market position

Source: AmInvest Research - 3 Jul 2020