KLTEC underperformed the broader index in 1H22 (KLTEC -35% vs KLCI -8%). The latest industry average growth is projected to be 12% for 2022. As for 2023, the sector is expected to expand further by 4%. Capital spending is forecasted to rise 15% YoY to reach a record USD118bn in 2022. Stronger greenback YoY may boost the sector’s prospect. We are not overly concern on the rising input prices as tech players are believed to be able pass through the additional costs. Sector growth is expected to be driven by auto and HPC while partly offset by the weaknesses in PC and smartphone. We maintain OVERWEIGHT stance and tactically in favour of frontend players. Our top picks are Frontken (BUY; TP: RM3.20) and UWC (BUY, TP: RM4.21).

Underperformed in 1H22. Reversing 2021’s momentum, KLTEC lost 35% vs KLCI’s 8% drop (see Figure #1) as it has undergone a sector wide major de-rating on the back of hawkish US Fed to tame its runaway inflation. Our overweight stance on the sector since the beginning of the year is regrettable. However, we remain bullish on the sector in 2H22 supported by its fundamental strength and now more palatable valuations.

Global semiconductor sales. 5M22’s 20% YoY gain to USD253bn (see Figure #2) is on track to record another all-time high revenue. The latest industry average growth is projected to be 12% (see Figure #3) for 2022. As for 2023, the sector is expected to expand further by 4% (see Figure #4). According to WSTS, all product categories are expected to gain (see Figure #5) in 2022: logic (+21%) leads the pack, followed by analog (+19%), memory (+19%), sensors (+16%), micro (+11%), discrete (+10%) and optoelectronics (flat).

Equipment spending is forecasted to rise 15% YoY to reach a record USD118bn (see Figure #6) in 2022 and further increase to USD121bn in 2023. Driven by demand for both leading-edge and mature process nodes, the foundry and logic segments are expected to increase 21% YoY to USD55bn in 2022 and another 8% to USD60bn in 2023. The assembly and packaging segment is expected to grow 8% to USD8bn in 2022. The test equipment market is forecasted to grow 12% to USD9bn in 2022 on demand for high-performance computing applications.

Stronger greenback. HLIB expects USD to be firmer in 2022 averaging RM4.30/USD compared to 2021’s average of RM4.14/USD (see Figure #7). As such, we expect tech firms to be marginally boosted as their sales are majority denominated in USD terms while partly offset by the USD cost items.

Higher input costs. Gold, aluminium, copper and steel prices are still at elevated levels despite recent weaknesses (see Figure #8) and may spell bad news for tech players. Pricier commodities will exert pressures on margins for packagers and equipment makers. However, we are not overly concerned as industry wide capacity constraint positions tech players with stronger bargaining power to pass on higher material costs.

Segmental view. Demand from automotive is expected to be solid as EV/AV require significantly higher semiconductor content. According to Gartner, this segment is estimated to record a CAGR of 17% through 2026, while electronic components spending for EV, self-driving cars, ADAS and other in-vehicle products is expected to increase 50% by 2030. Next, high-performance computing (HPC) will be supported by the robust investments in cloud, crypto and metaverse. However, orders for consumer-centric PC and smartphone segments are expected to ease as demand was pulled forward during pandemic and impacted by inflationary pressures.

Reiterate OVERWEIGHT. We expect tech sector to experience multiyear earnings growths supported by fundamental exponential demand and further enticed by government incentives (see Figure #9). We maintain our tactical position in favour of frontend players as many countries have rushed to develop their semiconductor capabilities, especially in leading edge (≤7nm) frontend fabrication (foundry) to be self-sufficient on the back of national strategic and security interests. Our top picks  are Frontken and UWC who have exposures to frontend. 

Frontken. Reiterate BUY with TP of RM3.20, pegged to 30x of FY23 EPS. We like Frontken for its multi-year growth ahead on the back of: (1) sustainable global semiconductor market outlook, (2) robust fab investment, (3) leading edge technology (7nm and below), and (4) strong balance sheet (net cash of RM332m or 21 sen per share) to supports its Taiwan expansion.

UWC. Reiterate BUY with an unchanged TP of RM4.21, pegged to 34x of FY23 EPS. The ongoing trade intensity may eventually benefit UWC which provides a one -stop solution as more companies shift productions out of China to avoid import tariffs.

Source: Hong Leong Investment Bank Research - 18 Jul 2022