Investment Highlights

• 4QCY23 results largely within expectations. Out of 7 companies under our active coverage, 5 reported earnings which were within estimates with the remaining 2 below expectations. ViTrox Corp’s (VITROX) (BUY; FV: RM9.00) earnings were below expectation, primarily attributed to lower demand in machine vision system (MVS) and automated board inspection (ABI) segments amid softer global economic growth and slower recovery in the semiconductor industry. Infomina (HOLD; FV:RM1.70) results also disappointed due to slower recognition of orderbook for the renewal segment. Meanwhile, the results of the remaining 5 companies - Globetronics (HOLD, FV: RM1.36), Inari Amertron (Inari) (BUY, FV: RM3.86), Pentamaster Corporation (Pentamaster) (BUY, FV: RM5.50), CTOS Digital (CTOS) (BUY; FV:RM1.80) and Malaysian Pacific Industries’ (MPI) (HOLD, FV: RM23.40) - met our expectations and consensus’.

• The sector’s 4QCY23 earnings improved by 15% QoQ, mainly contributed by the outsourced semiconductor assembly and test (OSAT) segment (+33%). 4QCY23 saw an improvement in demand for consumer electronics with new smart phone launches. Earnings of IT support and services segment increased by 10% QoQ, contributed by Infomina’s recognition of higher revenue from turnkey projects servicing government agencies in Malaysia, partially offset by the decline in CTOS’ net profit due to higher operating expenses such as staff cost and increased finance cost from new borrowings for acquisitions.

• Turning positive on the outlook on OSAT players. OSAT players’ revenue improved marginally by 1% QoQ as higher revenue of Inari and MPI were largely offset by Globetronics’s decline in revenue by 6% due to lower volume loadings from a customer impacted by year-end maintenance shutdown. Earnings for OSAT players grew 33% QoQ, thanks to MPI and Inari, which recorded improvement in production yields on consumer electronics and power packaging for data servers.

• Consumer electronics segment picking up momentum albeit still at a slow pace supported by new smartphone launches and PC refresh cycles. According to Canalys’ data, global smartphone shipments have improved by 8% QoQ, mainly attributed to the spillover effects of the launch of new smartphone models in 4QCY23 . We expect demand in 1HCY24 to be soft as buyers are expected to be cautious on consumer spending while waiting for the next generation models to be launched in 2HCY24. We understand that the volume of smartphone shipments has improved due to: (i) new on-device AI for high-end smartphone models, and (ii) capturing of mass market needs with the availability of mid-to-low end smartphone models amid soft consumer sentiments. Meanwhile, global PC (desktop and notebook) shipment has bottomed out with a slight growth of 3% YoY to 65mil units in 4QCY23 . We anticipate a modest revenue growth for PC shipments going forward, with AI-capable PCs set and ongoing refresh cycles due to depleting inventory coupled with the end of Windows 10 support.

• OSAT players eyeing the China market. Channel checks revealed withdrawals from foreign MNCs in chip packaging and testing business in China due to geopolitical tensions. However, our OSAT players are seeing this as an opportunity to enter the market given their strong capabilities. According to SEMI World Fab Forecast, China is set to boost its global semiconductor production capacity share with government support. Chinese chip manufacturers are expected to launch 18 new wafer fabs in 2024, with an increase in annual production capacity to 13% in 2024 from 12% in 2023, raising production from 7.6mil pieces to 8.6mil pieces.
  
  MPI is setting up a new factory at Suxiang, China to tap on the strong growth in the automotive sector with the plant expected to be fully operational by 2025. Meanwhile, Inari has joint-ventured with China Fortune-Tech Capital Co (CFTC) to take up a 54.5% interest in a JV company, YiWu Semiconductor International Corporation (YSIC), to carry out OSAT services in China. While Inari has recently completed machine and equipment installations, this is expected to generate insignificant earnings to the group in the near term. It will gradually ramp up the plant when production yield and margins are more stable as the cost of production is costly in China.

• Weaker QoQ revenue and earnings for ATE players. ATE players under our coverage showed a decline in revenue by 6% QoQ due to softer demand from automotive sector and global semiconductor slowdown in 4QCY23. To recap, automotive segment made up 23% of Vitrox’s FY23 revenue and 43% of Pentamaster’s. Earnings of ATE players declined by 6% QoQ largely due to higher composition of sales of lower-margin machines and automotive slowdown. However, Pentamaster’s earnings grew 22% QoQ thanks to its factory automation solution segment which serves the medical industry. This segment provided a higher margin to offset the weaker earnings of the automotive segment.

• Automotive segment experiencing a short-term slowdown. Nevertheless, long-term prospects remain bright. Pentamaster and Vitrox alluded to a near-term slowdown in the automotive industry which faces challenges from lower demand, price wars among car manufacturers and high borrowing costs, especially in US. However, China's automotive market appears to be thriving on price advantages, launch of new EV models and the receipt of governmental support.
  
  Despite short-term hurdles, optimism remains on the automotive sector, particularly in electric vehicles (EVs). Long-term prospects remain strong, driven by increasing adoption of vehicle electrification and autonomous driving. Although we expect a moderated growth in 2024F due to slower plant expansions by multinational corporations, the long-term sales growth trajectory of EVs remains intact.

• ATE players continued to strengthen market presence in China and Europe by increasing their sales/distribution partners and setting up regional sales offices/plants as well as participating in exhibitions to increase exposure to local Chinese customers. These companies are benefiting from the growth in China’s automotive segment by supplying more equipment as many manufacturers have exited consumer electronics to venture into the automotive industry. FDIs/MNCs are seen moving out from China to reinvest in Southeast Asia due to the ongoing trade war and geopolitical tensions.

• Orderbooks remained soft for ATE in the near term with limited longer-term visibility. Channel checks on companies’ order book indicated that order replenishments remained soft, with clouded longer term order visibility amid a slow recovery in the industry. We understand that this was due to the slower-than-anticipated recovery in semiconductor industry with orders staying cautious against a backdrop of uncertain market conditions. Nevertheless, we expect a clearer order visibility in 2QCY24 and more substantial recovery in 2HCY24 premised on recovery of the global semiconductor sector and tail-end of chip inventory corrections.

• We maintain OVERWEIGHT on the sector based on a positive revenue recovery prospects of semiconductor players in 2024 backed by the following:
  (i) The semiconductor sector has bottomed out from the technology downcycle with a slow pace of demand recovery.
  (ii) The adoption of advanced technologies for the automotive and consumer electronics segments with leading-edge chips and new features for equipment machines lead to expected improvement in demand of semiconductor sector, and
  (iii) Trade diversion with the “China/Taiwan plus one” strategy to leverage on the strength/production of multiple hubs and more cost-effective supply chains will benefit local players as MNCs divert their production hub to Malaysia and Vietnam.

• Top picks are Inari (BUY; FV: RM3.86) as increased content requirements for RF filters drive its radio frequency (RF) earnings and margin resiliency, and Vitrox (BUY; FV: RM9.00) for its well-diversified revenue base and exposure to high- growth industries such as computing, telecommunication and automotive segment on prospects of recovery in the global semiconductor space.
  
  We also like Pentamaster (BUY; FV: RM5.50). Pentamaster’s recent share price weakness is likely due to slower replenishment in orderbooks impacted by the short-term automotive slowdown. Nevertheless, we see the company’s sales growth to remain resilient, riding on sectors such as automotive and medical segments that have growth prospects on the uptrend over the longer term.

• Key risks:
  (i) escalation of US-China technology war and geopolitical conflicts, which may impose sanctions on advanced semiconductor chips and equipment, and
  (ii) concentration risk stemming from high reliance on key business segments.

Source: AmInvest Research - 15 Mar 2024