The US-China trade war that has been ongoing since 2018 sees no sign of abating. Following our previous report on 16 Aug 2018 titled “China’s pain may be Malaysia’s gain”, we have seen events unfolded that proved our previous thesis. We analyse three themes (1) deeper decoupling as situation deteriorated further; (2) travel curtailment to boost consumer electronics spending; and (3) strong global semiconductor sales as additional catalysts for our local EMS players. In tandem with the positive outlook for VSI coupled with the abovementioned catalysts, we raised our FY21-22 earning assumptions by 9-16% respectively. Pegged to unchanged PE of 17x, TP is raised from RM1.99 to RM2.30 and we reiterate our BUY call.

Thesis panning out. Following our previous report titled “China’s pain may be Malaysia’s gain” dated on 16 Aug 2018, we have seen events unfolded that validated our previous thesis. After US-China trade war erupted on 6 July 2018, we viewed Malaysian CM / EMS providers to benefit from order diversion premise on the facts that (1) trade tension makes it less appealing to outsource / manufacture in China; (2) the increasing labor cost; and (3) the enticing Malaysian government incentives and favorable forex (strong USD) would encourage more global EMS to setup in Malaysia. However, we believe that it is still early days of this tectonic shift and the 3 themes below will continue to flourish our EMS sector.

Theme 1: Deeper decoupling as situation deteriorated further. Despite having inked the Phase 1 trade deal earlier this year, geopolitical relations subsequently resoured. The growing divide between China and US is expected to accelerate with (1) US blaming China on Covid-19; (2) implementation of Hong Kong national security law; (3) Huawei sanction and SMIC blacklisting threat and; (4) postponement of trade review. Given the trade war uncertainties exacerbated by other deteriorated factors , many companies including Foxconn, Samsung and Wistron, have taken an intuitive effort to move their production away from China.

Theme 2: Travel curtailment to boost consumer electronics spending. With the travel curtailments imposed due to Covid-19, we opine this could imply a diversion that could potentially benefit consumer electronics to fulfill self-satisfaction. According to World Bank’s data, global international tourism expenditure hit a total of USD1.6trn in 2018 while Statistica gathered that global consumer electronics spending was USD1trn for the same period. Assuming that 25% of international travel spending is diverted, we could potentially see a whooping USD400bn or 40% boost to the global consumer electronics market. Additionally, consumer electronic companies including Apple, Nintendo and Sony are seen ramping up production output in order to take advantage of this opportunity.

Theme 3: Riding on strong global semiconductor sales. Despite the confluence of negative events, 7M20 global semiconductor sales gained 5.7% YoY to USD242bn. Semiconductors or integrated circuits are usually not useful on the standalone basis instead almost all are eventually assembled into end user products. We estimate that circa 82% of ICs produced will involve CM / EMS supply chain before desired end products are produced. On the back of this strong correlation, EMS market is expected to remain robust, taking cue from the strong YTD semiconductor market growth registered and expect even more upbeat prospect in 2021.

Conclusion. We gather that VSI (BUY, TP RM2.30) is still in active negotiations with the 5 prospective customers. Should another partnership materialize, VSI is looking to buy another 400k sqft plant to support this growth. As the biggest EMS player in Malaysia with solid track record, we opine that VSI is on growth trajectory amid the intensifying trade diversion. Additionally, we opine FPI to benefit from spill over effect from Wistron’s USD45m capex into Malaysian operation. ATA IMS is seen to benefit further from homebound population with strong demand in consumer electronics.

Source: Hong Leong Investment Bank Research - 24 Sept 2020