Investment Highlights

• 2018 earnings to be driven by sensors, radio frequency chips and operational efficiencies. We have a NEUTRAL stance on the technology sector over the next 12 months. The key theme of the sector in 2018 should revolve around connected cars, smart homes and automation. This paints a positive outlook for sensor and radio frequency (RF) chip manufacturers, automated equipment manufacturers and companies looking to improve operational efficiencies through automation. On the other hand, we believe the smartphone segment is on the verge of entering a single-digit growth trajectory as it moves towards saturation point in major markets. Overall, earnings prospects are looking positive for local semiconductor companies, but valuations are unattractive.
• Key beneficiaries. In 2018, companies in the limelight are Inari Amertron (HOLD, FV: RM3.00), Malaysian Pacific Industries (HOLD, FV: RM13.11), Unisem (HOLD, FV: RM3.32) and Globetronics (UNRATED) given sensors and RF are imperatives in a connected world, while prospects of ViTrox Corporation (UNRATED) and Pentamaster Corporation (UNRATED) are also exciting amid the rising adoption of automation.
• Valuations dampen the excitement. From our projections, Inari Amertron (Inari), Malaysian Pacific Industries (MPI) and Unisem are expected to register net earnings growth of 27%, 7% and 7% YoY in CY18F respectively. At current valuations, we believe positive prospects of the companies are already priced in. To put it in context, Inari/Unisem/MPI are trading at a CY18F PE of 17x/14x/14x, which are 1.5SD/1SD/4SD above historical average respectively and higher than the regional average of 13x (see Exhibit 1).

• USD/MYR no longer a plus. Our USD/MYR assumptions are 4.30 for 2017 and 4.12 for 2018, a projected depreciation of circa 4%. Based on our sensitivity analysis, every 1% depreciation (appreciation) in USD/MYR will decrease (increase) Inari, MPI and Unisem's net profits by 3-5%. Note that the expected USD depreciation has already been accounted for in our earnings forecasts.

• Investing in automation to boost efficiencies. In Budget 2018, the government has announced that it will provide matching grants and capital allowances to support automation initiatives. Among the beneficiaries are Inari and MPI, which have expressed intentions to adopt automation next year. Inari has indicated that it intends to invest in automated optical inspection machines, which would cost circa US$1mil per unit. Meanwhile, MPI has said the group is exploring areas within its manufacturing processes it could replace with automation and robotic equipment. While the impact is unquantifiable at this juncture, we are confident that the initiatives would underpin margin expansion on the back of improved operational efficiencies and lower effective tax rates.

• Upside to our call. We may upgrade our stance on the sector from NEUTRAL to OVERWEIGHT if: 1) there is a change in the USD outlook for the better; 2) the semiconductor companies under our coverage (Inari, MPI and Unisem) secure new jobs of significance; and/or 3) share prices correct by 15-20%.

• Key risks. 1) Lukewarm demand for end products owing to weak economic conditions; 2) monotonous content growth in underlying products in the absence of innovation; and 3) margin erosion in the face of a weakening USD. If such risks materialise, we may downgrade our stance on the sector from NEUTRAL to UNDERWEIGHT.

• Our top picks for the sector are:

Inari Amertron (HOLD, FV RM3.00). A good proxy to the rapid adoption of LTE-A and the growing thirst for high-speed data should keep it busy until the next wave, i.e. the commercial introduction of 5th generation (5G) network. The company is well prepared to welcome the mega optical cycle, which calls for a large-scale network infrastructural upgrade to increase the penetration of high-speed internet and enlarge the storage of cloud data centres.

Malaysian Pacific Industries (HOLD, FV RM13.11). A relatively diversified player given its exposure in various industries. Notably, we like the company's exposure in the communications, automotive and industrial segments which have higher projected growth. The company is well-positioned to ride the wave of surging number of connected devices, given that its MLPs are ideal in the area of RF applications. MPI's larger exposure in the automotive segment relative to its peers offers bright prospects due to increasing functionalities and semiconductor content in vehicles.

Source: AmInvest Research - 21 Dec 2017