After a series of trade war between US and China, we found light in some Malaysian companies that may benefit from this conflict. The impose d tariff has heavily slapped the E&E sector, causing electronic goods that ship out of China turn uncompetitive in terms of pricing. We think there will be a spill over effect to Malaysia because domestic EMS/CMs have the capability/expertise and capacity to absorb new orders. We filtered out some CMs and we favour PIE and FPI. These two companies have (i) unique associations; (ii) no China exposure; (ii) strong balance sheets; (iv) undemanding valuations; and (v) good dividend yields.

Introduction. The trade war between US and China has built up tensions among manufacturers in China as uncertainties and the continuous negative news flow persist, multinational companies may make plans to reroute their production arm to South East Asia. The 25% tariffs on approximately USD34bn (with additional USD16bn in near term) and the potential 25% tariffs on another USD200bn of Chinese goods would impact negatively on many electrical and electronics (E&E) products.

Labour cost is another hurdle in China. Wages in China have increased dramatically from RMB840 in 2008 to RMB2,420 (+188%) in 2018. After evaluation, we opine that it will be 31-44% cheaper in terms of wages to manufacture in Philippines, Thailand, and Malaysia as compared to China.

How will the trade war affect Malaysia? Giant contract manufacturers (CM) like Foxconn, Pegatron, Flextronics, Wistron, USI and Venture have most of their productions concentrated in Asia (mainly China). As US retches up tariffs on Chinese goods including electronic gadgets (TV, camera, touch screens) and home appliances (vacuum cleaner, microwaves, electronic lighting), we believe it would benefit Malaysian EMS (electrical manufacturing services) players, because our domestic CMs have the expertise and capacity to absorb new orders.

Malaysia has upper hand to benefit more. Malaysian exporters are to benefit from the weaker RM against the USD. The RM has depreciated against the USD by 0.9% YTD. Our house forecast is for MYR to remain weak at RM4.10/USD in 2H18.

Which firm will benefit most? After analysing, we favour PIE and FPI, as these two companies fully meet our selection criteria. Our selection criteria involves having (i) a unique association with top CM; (ii) no presence in China; (iii) a strong balance sheet; (iv) an undemanding valuation; and (v) a good dividend yield.

PIE Industry. PIE offers a complete integrated 'one-stop' contract electronic manufacturing service to major multinational companies (i.e. Philips, Jabra, etc.) for various electronics products. We see potential in PIE to receive more OEM orders, mainly leveraging on Foxconn as its largest shareholder. It has net cash per share position of 22.8 sen as end of FY17 and trades at an average trailing PE of 13.5x. Conservatively assuming that it will distribute 6 sen per share (same as FY17), dividend yield is decent at 3.9%.

Formosa Prosonic Industry (FPI). The group is one of the leading manufacturers of high quality sound system. They specialise in woodworking, plastic injection, driver units, PCB assembly and finished-products assembly as well as ODM services. FPI has Wistron as its largest shareholders. FPI has a bulletproof balance sheet with net cash position of 60.4 sen per share as end of FY17 trading at an average trailing PE of 9.3x. Conservatively assuming that it will distribute 8 sen per share (same as FY17), dividend yield is decent at 5.3%.

Source: Hong Leong Investment Bank Research - 16 Aug 2018