While leading indicators continue to point north, we observe downside risks in macro environment coupled with waning data trends. Boost from stronger USD may be neutralized by higher commodity prices. Growth is expected to be driven by automotive and IoT while smartphone takes a back seat. Trade war should benefit local players. Reiterate NEUTRAL with Frontken as out top pick.

Not living up to expectations. Despite the spectacular double-digit growth of global semiconductor sales and equipment spending, KLTEC plunged 30% vs KLCI’s 6% decline (see Figure #1). Our conservatism “a year ago” paid off.

Expansionary but slow pace. Global semiconductor sales were outstanding after gaining 16% in 11M18 thanks to memory’s explosive growth followed by discrete and optoelectronics (see Figure #2-3). Consensus is projecting a pedestrian growth of 3% for 2019 (see Figure #4). However, we see further downside to this projection considering the US-China trade conflict, stagnant smartphone demand, industry-wide inventory adjustment and weaker memory prices (se Figure #5).

Reaching the inflection point? Equipment industry remained solid with 3MA billings increasing 11% in 11M18 (11M17: +40%) supported by heavy investments in all regions except Taiwan. However, the monthly billings YoY growth has been on a snail’s pace (<+5%) for the past 5 months, a significant deceleration from past 20 consecutive months’ double-digit growth rates. According to SEMI, this reflected the near-term weakening demand for PC, mobile phones and servers as well as pulled back investments in response to recent softening of memory prices. This is in line with our expectation as expansion in capital spending should not outpace sales growth on the long run and may lead to industry-wide overcapacity.

Stronger greenback. HLIB expects RM to be weaker in FY19 with at full year average of RM4.20/USD (FY18: RM4.10/USD) (see Figure #7). As such, we expect tech firms to be marginally boosted thanks to their USD-denominated sales while partly offset by the USD cost items.

High input cost. Major raw material prices including gold, aluminium and copper remain elevated (see Figure #8). Compounded by stronger USD projection, pricier commodities will exert pressures on margins for traditional packaging.

Segmental view. Automotive is expected to be the major growth driver for global tech industry supported by its development towards full autonomy. Smartphone demand has plateaued due to longer replacement cycle and innovation stalemate. PC market has exhibited some revival signs on the back of robust cloud investments. IoT / M2M market looks promising. Although M2M device generally has lower IC content, the sheer forecasted volume suggests that this market is too big to ignore.

Trade spat. China sources substantial fabrication equipment from US players for its expansionary semiconductor industry towards Make in China 2025 vision. Vice versa, US fabless semiconductor players outsource their product fabrication and some are produced in China. Should the procurement levy and technology transfer restriction from US take effect, we opine that local semiconductor players may experience strong demand to support the disrupted global supply chain.

Maintain NEUTRAL. While global sales and capital spending are expected to grow moderately, we reiterate our cautious stance in the absence of near term catalyst.

Frontken (BUY, TP: RM1.05) remains our top pick on the back of (1) bullish global semiconductor market outlook; (2) robust fab investment (3) leading edge technology; (4) O&G recovery; and (5) strong balance sheet.

Source: Hong Leong Investment Bank Research - 22 Jan 2019