Cost-cutting has become the new norm across the technology (tech) industry and businesses that hoarded chips during the pandemic are now opting to cancel or postpone orders and tap on inventories. The semiconductor industry is also grappling with export restrictions from the US government, which is ratcheting up pressure on its allies to prevent shipment of cuttingedge chips to a growing list of Chinese companies. On a positive note, we see more inflows of investments into the ASEAN region with Malaysia standing to benefit significantly from the heightening US-China standoff. In view of the attractive risk-reward benefits, we think investors should relook at technology stocks with strong fundamentals in the long-term. Maintain Overweight on the technology sector.

• Cutting iPhone 14 Plus production. Sources have cited that Apple Inc is cutting production of iPhone 14 Plus, which is positioned as a cheaper alternative to its more expensive iPhone Pro models, within weeks of starting shipments as it re-evaluates demand for the mid-range model. One of the manufacturers in China had immediately halted production of iPhone 14 Plus components. Last month, Apple dropped its plan to increase production of the new iPhone models as an anticipated surge in demand failed to materialize.

• 2Q Smartphone shipments decline 8.7% YoY. Worldwide smartphone shipments declined 8.7% YoY in the 2Q 2022 (refer to Figure 3), according to preliminary data from the International Data Corporation. This marks the fourth consecutive quarter of decline for the smartphone market as shipments fell to 286m units in the quarter, about 3.5% lower than forecast.

• Chip delivery times shrinking. Chip delivery times shrank by four days in September, the steepest drop in years. Lead times, the gap between a chip is ordered and when it is delivered, averaged at 26.3 weeks in September compared to 27 weeks in the prior month. Wait times contracted for all key product categories, with power-management and analog chips seeing the biggest declines. The Philadelphia Stock Exchange Semiconductor Index, a key benchmark of chip stocks, has fallen 44% this year.

• TSMC cuts capex by about 10%. Chip giant TSMC has slashed its capital expenditure (capex) by 10% for this year to USD36bn as sluggish demand for smartphones and PC’s curtailed demand for its 6-nanometer and 7-nanometer chips and lowered capacity utilization going forward. Only data center and automotive-related applications remain steady. The sharp reduction in expenditure suggests that the Taiwanese firm is bracing for a prolonged downturn. The inventory correction is expected to carry through the first half of next year, leading to a reduction in TSMC’s factory utilization during the period. Management attributed this to most of its customers pushing back new product schedules, causing a slide in demand.

• Standoff between the US and China worsening. The Biden administration has recently come out with two main policies aiming at slowing the technological advancement of its geopolitical rival. It is also a roadblock on China’s bid to achieve technological self-sufficiency. The measures will not only cut the country’s access to advanced chips but also impede the arrival of researchers and engineers capable of designing such systems within its borders Firstly, US technology companies are no longer allowed to supply advanced computing chips, chip-making equipment and other products to China unless they receive a special license. The restrictions will limit exports of high-tech chips called graphic processing units, which are used to power artificial intelligence applications, and place broad limits on chips destined for supercomputers in China. It is believed that most of those licenses will be denied though certain shipments to facilities operated by US companies or allied countries will be evaluated cases by case basis.
  
  Secondly, new measures also prohibit US persons from supporting the development, production and use of integrated circuits at some chip plants located in China. The broad measures are likely to encompass holders of US green cards as well as US residents and American citizens. This new US restrictions on Chinese chip firms could put American executives at targeted companies in a precarious situation as there are dozens of executives in China’s chip industry with US citizenships. Most of these executives are naturalized citizens, who were born in China and studied at American universities or are workers in the US chip industry.
   
• US export restrictions hamper chip equipment players. The announcement of new export regulations for US semiconductor technology sold in China, including wafer fabrication equipment essentially stops the sale in China of semiconductor equipment for making Nand and DRAM memory chips. Also weighing on semiconductor equipment are chipmakers cutting their spending plans for new chip gear. Following the latest trade restrictions, majority of the chip-equipment makers, namely, Lam Research, Applied Materials and KLA have guided for low-teen negative impacts. Only Dutch-based ASML Holdings expects to be spared the brunt of the restrictions as it still can continue to offer less sophisticated tools to Chinese customers.
• Memory chip makers the worst hit. Global memory chipmakers had been riding high during the pandemic, when the work-from-home trend fuelled demand for computers and other consumer technology. Inflationary pressures plus a return to the office have put a damper on purchases however. That has left memory-chip customers sitting on stockpiles of unused chips. Memory chips, which are used to store data and help process information in phones, PCs and servers, are unique in the semiconductor field in that they are built to industry standards, meaning products from rival companies are interchangeable. To restore the balance between supply and demand, a majority of the memory chip players, namely, Samsung Electronics, SK Hynix Inc, Micron and Kioxia are dialing back production.

• Global electrical vehicle (EV) sales continued their strong momentum. Despite global car sales showing a decline of 8.1% for the 1H 2022, the sales of electric vehicles (including fully electric and plug-in hybrids) surged 62% YoY to 4.3m units (refer to Figure 4). Against the backdrop of its real estate crisis and strict Covid-19 lockdowns, China’s EV sales surged 113% YoY to 2.4m, contributing more than 56% to global EV sales. In September, China’s EV sales soared by 83% YoY to 611k units, bringing the YTD EV sales to nearly 3.9m. Multiple Chinese automakers have been looking to move into chip manufacturing, having been hit by the ongoing chip shortage amid growing uncertainty caused by multiple supply challenges, including the US chip export ban on China. Globally, automakers have been forced to cut more than 3.4m vehicles from their production schedules so far this year. BYD is by far the country’s biggest maker of automotive microcontroller chips and has recently begun trial operations at a new chip plant in Changsha, China.

• Demand for automotive LED stays healthy. According to TrendForce’s latest report, although global car sales are projected to fall in 2022 due to the impact of the Russia-Ukraine war and China’s zero-Covid policy, the development of advanced technologies such as i) intelligent headlights, ii) logo lamps and iii) intelligent ambient lights will continue to push for higher penetration of automotive LEDs. It forecasts that the market size of the global automotive lighting will reach USD32.6bn in 2022, up 4% YoY (refer to Figure 5). Led by the increasing market share through improving product differentiation, the global penetration rate of LED headlights in conventional and electric vehicles is expected to increase from 60% and 90% to 72% and 92%, respectively in 2022. In the long-term, the trend of automotive lighting will develop towards i) Personalization, ii) Communication Display and iii) Driver Assistance. Another key segment to watch out is the Adaptive Driving Beam (ADB) headlight system, which can expand the field of drivers’ night-time vision, effectively shortening drivers’ reaction time to oncoming obstacles, achieve better roadway lighting and reduce discomfort caused by the lights of vehicles ahead of the driver, oncoming vehicles and pedestrians. As more countries start implementing regulations on ADB headlights, market penetration of ADB headlight is projected to jump from 3.2% this year to 13.2% in 2026.

• Malaysia stands out in the region. We believe there will be positive spillover effects in terms of the relocation of industries from China and the US to this region in order to minimize futures risks arising from increased US-China tensions. Malaysia is among the leading countries in terms of investments for the semiconductor, telecommunications and technology industries as it has a favourable eco-system, including i) talent, ii) infrastructure and iii) a business-friendly environment. Malaysia’s outsourced services assembly and test and automated test equipment players could benefit from trade diversion from US and China. In addition, the current weakness in Malaysian Ringgit is also attractive for foreign investors. Malaysia’s semiconductor industry, which takes up 13% of global chip assembly and testing market share, is set to benefit from the recently passed US CHIPS and Science Act (USD52.7bn in federal subsidies allocated to support chip manufacturing) in the long-term, as more assembly and testing jobs are needed to cater for the new state-ofthe-art chip fabrication plants with process technology 7 nanometres and below.

• Top picks. Inari (TP: RM4.13, Outperform) is primed to ride on the stronger 5G adoption globally and to benefit from US smartphone supercycle in the next release. Meanwhile, D&O (TP: RM5.16, Outperform) is expected to see strong multi-year growth on the back of increasing market share in the global automotive LED market given the increasing adoption of smart LEDs especially for ambient lighting and spillover orders from one of the global leading automotive LED makers, which has been scaling down its operations.

Source: PublicInvest Research - 25 Oct 2022