AmInvest Research Reports

TECHNOLOGY - Positive in the Long Run Amidst Near-term Challenges

AmInvest
Publish date: Thu, 23 May 2024, 11:17 AM
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  • Slow and gradual recovery in semiconductor industry. Global semiconductor sales grew 15% YoY in March 2024 compared to March 2023 according to Semiconductor Industry Association. This was supported by higher sales in America (+26% YoY), China (+27% YoY) and Asia Pacific (+11% YoY) with a recovery in sentiments for the semiconductor sector. However, on a month-on-month (MoM) basis, sales declined marginally by 0.6% in March 2024, largely dragged by lower sales in Japan.
  • According to SEMI, CAPEX and fab utilisation rates are likely to see a mild recovery starting in 1Q24. In 1Q24, fab utilisation rate saw a modest improvement from 66% in 4Q23 to 70% in 1Q24. Fab capacity grew 1.3% in 4Q23 while total integrated circuit (IC) inventory fell below US$60bil . With that, we expect a continued gradual recovery in sentiments for the semiconductor sector from a seasonally weaker 1Q24.
  • Small incremental pickup in orders on the back of a gradual improvement in sentiments. We gather that companies’ orderbook are still flattish QoQ in 1QCY24 compared to 4QCY23, with a slow replenishment in orders. Nevertheless, companies are optimistic that orders will gradually increase, albeit in small increments, due to buyers’ ongoing inventory adjustments despite ongoing geopolitical tensions and persistent inflationary pressures. We visited some companies in Penang recently and observed similar sentiments:

    1. UWC (UNRATED) reported a relatively stable orderbook QoQ in 1QCY24. Small orders were seen from existing front- end semiconductor customers while modules delivered to back-end semiconductor customers improved marginally.

    2. TT Vision (UNRATED) also showed a stable trend of orderbook QoQ in 1QFY24. TT Vision is experiencing increased orders and requests for quotation (RFQ) from the semiconductor industry, benefiting from a gradual recovery in global semiconductor demand.
  • We anticipate a flattish or marginal improvement in revenue contribution in 2QCY24 compared to 1QCY24 across the sector as business activities remain slow. Recovery in the semiconductor cycle is still gradual with revenue impacted from shipments deferred to 2HCY24. We also expect to see a similar revenue trend for companies under our coverage.
  • Shipment deferrals and new orders from launches of new products/models/innovations will flow into 2HFY24 and beyond. We understand that the sector is still recovering at a slow pace and shipments have been requested to be deferred to a later period. Hence, more deliveries are expected to be seen in 2HCY24. With the gradual uptick in semiconductor sentiments and sales, we anticipate newer products/models/introductions to be launched in 2HCY24. This bodes well for an improvement in semiconductor sales in 2HCY24 with higher revenue anticipated to be recognised by companies in the sector.

    1. UWC alluded that some orders were deferred to a later period. However, the company anticipates a more significant improvement in earnings in 4QCY24 driven by contribution from the back-end semiconductor segment.

    2. Inari Amertron (BUY: FV:RM3.86) continued to remain positive on the volume loading of products dedicated for the next generation smartphone.
  • Riding on the trend in the communication market. As demand for services in data centres continue to surge, the need for AI-related products, particularly optical transceivers, has risen. These devices are essential for AI connectivity and extensively used by web-scale IT and other cloud companies. Optical transceivers have been a staple in the market for a considerable time, traditionally offering signal transmission rates of 100G, 200G and 400G. These rates have been sufficient for moderate data rate applications, providing an optimal balance of performance and cost.

    The industry is experiencing growing demand for even higher-speed optical transceivers, specifically those capable of 800G or even 1.6T. These advancements are crucial for supporting the high-speed optical communications necessary for modern data centres. As data transmission technology continues to evolve, this presents significant opportunities for local players to produce more advanced optical transceivers, thus underpinning increasing chip demand.

    1. NationGate, recently appointed as an original equipment manufacturer (OEM) for an AI server customer, is expected to recognise higher revenue in 2025, riding on the AI boom. We foresee better earnings recovery in FY24 on the back of improvement in orders from their main customers with stronger demand for higher bandwidth of transceivers as well as inventory depletion of lower transmission rate transceivers.

    2. Inari is also involved in the test and assembly for optical transceivers. To recap, its revenue contribution for datacom segment grew 24% QoQ in 2QFY24 due to AI-related orders.
  • Seeing more significant trade diversion (China+ strategy) to Malaysia which will benefit local players in securing new customers and orders. Our channel checks revealed multinational corporations (MNCs) in China are withdrawing due to the US-China trade war and geopolitical ramifications. We observed more Chinese players looking to relocate to Southeast Asian countries such as Malaysia, Vietnam, Indonesia and Philippines to serve their foreign customers. These companies are employing strategies like mergers and acquisitions, joint ventures or establishing new plants. Conversely, MNCs/customers are reducing or redirecting their orders from China to other countries to minimise exposure to China-based production. This shift continues to be seen as benefiting our local players, in bringing in new streams of income and enhancement to the E&E ecosystem.
  • Foreign direct investment continues to flow into Malaysia. Over the years, foreign direct investment (FDI) has continued to grew by CAGR of 40% to RM83.4mil in 2023 as more foreign MNCs continue to invest in Malaysia such as Infineon, Intel and Texas Instruments. FDI in Malaysia’s electrical and electronics industry serves as a catalyst for economic growth, technological advancement and overall national development. It enhances the country’s industrial capabilities, integrates local firms into global value chains and fosters a skilled workforce, thereby positioning Malaysia as a competitive player in the global E&E market .

    1. UWC’s 51%-owned WEPLUS Greentech (WEPLUS) strategically partnered with a Chinese company to produce cables and connectors for electric vehicle (EV) testers, responding to the US-China trade war. This move adds a new income stream for WEPLUS, which designs, manufactures and engineers green technology components. Meanwhile, UWC aims to leverage the cable and connectors business to add value for its customers to bid for next generation modules.

    2. TT Vision entered into a joint venture (JV) agreement with Autowell (Singapore) Pte Ltd (ATW), a wholly-owned subsidiary of Wuxi Autowell Technology Co.Ltd that specialises in the manufacturing and distribution of automation equipment for the solar, lithium battery and semiconductor industries. We understand that TT Vision can leverage on the capabilities of Autowell to introduce more new innovative products, expecting a more significant earnings contribution from this JV in FY25.
  • OSAT players eyeing China market – “In China, for China” strategy. Foreign MNCs are leaving the chip packaging and testing business businesses in China, creating an opening for our domestic OSAT players to penetrate the country’s market given their strong capabilities. Inari’s 54.5%-owned YiWu Semiconductor International Corp (YSIC) will serve the Chinese market by targeting the smartphone and internet of things (IoT) sectors. YSIC completed its machine and equipment installations in Fab 1 and has recently delivered sample products to customers. Though earnings are still insignificant to the group in the near term, as we expect YSIC to continue to ramp up production yield and expand its clientele base in China.
  • China market cannot be ignored amid intensified competition. Our players, including Vitrox and Pentamaster, are expected to benefit from trade diversions. These companies are tapping into the Chinese market to serve China’s domestic players by: (i) offering cost-efficient models, (ii) adjusting selling prices, and (iii) introducing new models for growth sectors like automotive. This is envisaged to compete with local players and gain more traction, resulting in potential new orders as customers relocate from China. Competitive advantages, such as in customisation and brand recognition on quality assurance provide competitive advantages for our local players to compete with Chinese players.
  • US imposed higher tariff on China imports. Recently, United States imposed a higher rate of tariff on a range of China imports with the aim to protect American workers and businesses from unfair trade practices. These tariff rates will take effect from 2024 to 2026 as follows:

    (i) Semiconductors increase from 25% to 50% by 2025,

    (ii) Electric vehicles increase from 25% to 100% in 2024,

    (iii) Lithium-ion EV increase from 7.5% to 25% in 2024,

    (iv) Lithium-ion non-EV increase from 7.5% to 25% in 2026,

    (v) Battery parts increase from 7.5% to 25% in 2024,

    (vi) Solar cells (whether or not assembled into modules) increase from 25% to 50% in 2024, and

    (vii) Syringes and needles increase from 0% to 50% in 2024.

    This development will benefit local technology players by driving more trade diversions to Malaysia, particularly from Chinese companies serving US customers. This shift is also expected to attach more foreign direct investments to Malaysia, spurred by companies seeking relocation and supply chain diversification.

    Companies such as Vitrox, Greatech, Pentamaster and TT Vision are poised to be beneficiaries as they are involved in EV, solar, medical and semiconductor sectors. These companies are well-positioned to capitalise on growth opportunities by leveraging on Malaysia’s strategic position, well-developed infrastructure/utilities and improving supply-chain ecosystem.
     
  • We maintain OVERWEIGHT on the sector based on positive revenue recovery prospects of semiconductor players this year backed by:

    (i) The semiconductor sector has bottomed out from the recent downcycle with a slow pace of demand recovery on more ongoing business activities in the front-end semiconductor space amid inventory corrections.

    (ii) The adoption of advanced technologies for the automotive and consumer electronics segments with leading-edge chips and new features for equipment/machines are expected to drive sales in the semiconductor sector,

    (iii) Increase in demand for AI-related products to support the boom in AI sector, and

    (iv) Trade diversion with “China/Taiwan plus one” strategy to leverage on the strength/production of multiple hubs and more cost-effective supply chains, benefiting local players as MNCs divert their production to Malaysia.


    Top picks for semiconductor sector:

    1. Inari (BUY; FV:RM3.86) as increased content requirements for RF filters are expected to drive its radio frequency (RF) earnings and margin resiliency, benefiting from the impending launch of next generation smartphones.

    2. MPI (BUY; FV:RM49.43) for new technology exposure into silicon carbide (SiC) and gallium nitride packaging solutions for automotive segment and diversification into renewable energy sector coupled with exposure in power management modules for data centres.

    3. Vitrox (BUY; FV: RM9.00) for a well-diversified revenue base and exposure to high-growth industries such as computing, telecommunication and automotive segments, underpinned by prospects of recovery in the global semiconductor space. We also expect a boost from recognition of 2HCY24 revenue from deferment of delivery orders.

    Top picks for EV and medical sectors:

    4. Greatech (BUY; FV: RM5.67) for exposure to growing sectors like automotive and life science sectors, diversifying out from single-sector concentration risk which could improve sales composition as well as gradual improvement in product mix skewed towards higher margin projects from solar and life science segments.

    5. 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 slowdown in the automative sector. Nevertheless, we see the company’s sales trajectory being resilient, riding on sectors such as automotive and medical segments that have positive growth prospects in the longer term. Orderbook skewed towards higher margin projects from the medical segment will continue to support the overall growth trend despite the automotive slowdown.
     
  • Key risks:

    (i) escalation of US-China technology war and geopolitical conflicts, which may impose sanctions on advanced semiconductor chips and equipment,

    (ii) concentration risk stemming from high reliance on key business segments, and

    (iii) oversupply of end-products such as legacy chips, EV and solar panels due to higher US tariffs on China imports.
     

Source: AmInvest Research - 23 May 2024

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