We are reiterating our OVERWEIGHT rating on the semiconductor sector. Post-Thai flood in Oct 2011, the current ASP of hard disk drive (HDD) has been rising and the market expects this trend to be sustainable until 2014. Pricing of HDD will still remain stable with HDD's shipments expected to rise by another 10% in 3QCY12. Coupled with the consolidation of the five top players in the industry to just three now, this will also give more a stable pricing foundation for HDD. Our  recent study on the industry suggests that the YoY growth trend of the global semiconductor sales may also serve as an alternative indicator (apart from the well-adopted book-to-bill ratio indicator) to predict the semiconductor sales trend. Based on our observation, the industry cycle will likely reach a peak when GSS growth reached a +45% YoY (+2SD from its mean) while a bottom is suggested when it falls -28% YoY (-2SD  below its mean). Our study suggests that the inflection point of the semiconductor cycle will likely appear when the GSS and book-to-bill ratio are recorded at more than 40% YoY and 1.2x respectively. We reckon that this inflection point is likely to appear between Jan 2013 and Mar 2013 based on historical trends. However, it may only be reflected in the semiconductor companies' earnings results in three to six months  after the time of inflection since these companies are assembly manufacturers, who will only be affected in the later stage of the industry's turning point. Meanwhile, to align our forecasts to our latest inhouse change of the USD to RM forex rate forecast (new average rate of RM3.12 and RM3.06 for CY12 and CY13 respectively as compared to RM2.90 and RM2.80 previously), our FY12 earnings forecasts for MPI, Unisem, SAM Engineering (SAM) and Notion have been revised upwards by 9% for MPI and 5% each for the remaining three companies. Similarly, our FY13 earnings forecasts for the above-mentioned companies have risen by 20%, 16%, 5% and 16% accordingly. Note that SAM will not see much of an impact to its earnings given its substantial exposure to the aerospace's engine casing business, which is protected by back-to-back agreements on its raw materials. Our OUTPERFORM rating on the overall Semiconductor sector remain unchanged. Due to our revised higher earnings estimates above, we have raised our target prices for MPI, Unisem, SAM and Notion to RM3.50, RM1.87, RM3.60 and RM1.85 respectively (from RM3.45, RM1.86, RM3.50, RM1.60 previously). Note that we, however, are maintaining Kelington's earnings and target price (RM1.10) as forex rate changes have no major impact on its earnings.

1QCY12 results snapshot. While the results top lines were within ours as well as the street estimates, they underperformed in their bottom lines due mainly to higher material prices. Higher cost incurred led to margins compression in those companies under our coverage. That said, none of the companies did exceptionally well or very bad during the quarter. We also expect earnings growth rates to rebound to the region of 20%-30% in 2012/2013 due to rising consumer demand in electronics devices. 

Stable ASP but higher unit shipments in 2H. According to IHS iSuppli (IHS), a global leader in market research, the ASP for the HDD market rose by 28% to $66/unit from $52/unit in 4QCY11. It held steady at the same price in 1QCY12 and is expected to be sustained throughout 2HCY12 due to the completion of the industry's consolidation. Meanwhile, unit shipments are expected to recover completely by 3QCY12 after the 29% YoY dropped in 4QCY11. To recap, unit shipments rose by 23% QoQ in 1Q followed by another 10% to 159m in 2QCY12. For the coming quarter, IHS is expecting unit shipments to rise by another 10% QoQ in 3QCY12 to 176m mainly driven by  increasing storage capacity demand by consumers.

Consolidation of top players to keep pricing stable.  Following the acquisition of Samsung by Seagate, and Hitachi GST by WD, the top two suppliers now hold 85% of the HDD market share in 1QCY12 from just 62% in 3QCY11 (before the acquisitions). The acquisitions have resulted in the top players now being more able to control pricing and thus able to keep the ASPs at a relatively high level. In summary, we expect trends of rising volumes and stable ASPs to emerge and boost the HDD market in 2HFY12. 

Party continues but may end in 1QCY13.  Apart from using the book-to-bill ratio to measure the semiconductor industry cycle, the YoY growth of global semiconductor sales ('GSS') published by SIA may be another useful tool to measure the industry cycle (see Figure 5).  GSS is a three-month moving average of the semiconductor sales activity. Based on our observation, the industry cycle will likely to reach a peak when GSS growth rises +45% YoY (+2SD from its mean) and conversely, reaches bottom if it falls  -28% YoY (-2SD below its mean). The GSS YoY growth is currently at -2.7%, suggesting ample room for the up-cycle to continue before reaching its average (at 8.7%) and peak level.

Source: Kenanga