We are maintaining our rating on the Technology sector at NEUTRAL. All the tech companies under our coverage reported recent 3Q12 results that came in below the street and our expectations. The industry players are also still wary about the outlook for 4QCY12 due to the global economic uncertainty and the slowdown in the consumer demand for electronic devices. In addition, we believe that the highly possible strengthening of Ringgit Malaysia against US Dollar over the next couple of months will have a further negative impact on the technology companies' earnings. In conclusion, our top-down analysis points toward a negative outlook for the sector in 4Q12. Post-3QCY12 results, we had revised down most of our earnings for the tech companies and downgraded their TPs (target prices) as well. Tech  stocks are now already trading at their bear level valuations but the bad news is that we do not think that they have hit rock-bottom yet (except MPI and Notion). At this juncture, we have only MARKET PERFORM calls on MPI (TP: RM2.78), JCY (TP: RM0.85), Unisem (TP: RM0.99), Notion (TP: RM1.07) and Kelington (TP: RM0.53).

Results summary: The aggregated 3Q12 profits of the tech companies in our coverage declined substantially by 70.5% QoQ. From the five major Malaysian tech companies, their 3Q results also showed that the aggregated revenue dropped 3.4% QoQ due to the slowdown in the ASP and volume. Meanwhile, the aggregated earnings fell a significantly 70.5% due to lower sales and the  strengthening of RM against USD. However, the individual numbers indicate a relatively mix set of 3Q results for each company. In general, the HDD companies' results were within our expectations while the semiconductor companies came in below. 

The aggregated 9M12 revenue meanwhile fared better, increasing by 9.5% YoY due to better sales from the HDD companies (JCY and Notion) as compared to the semiconductor companies (MPI and Unisem). Aggregated PBT also rose 35.3% YoY on the back of a better cost management at the semiconductor companies. The semiconductor companies recorded better earnings as compared to HDD companies as they were affected more by the Thai flood in Sep 2011 and hence, saw a higher rebound from a lower base. Margin-wise, the semiconductor companies also saw a slightly better profit margin due to the shift to the production of higher margin products (which is smaller physically in size) and the switch from gold wire bonding to copper wire bonding (lower cost of the latter).

Potential risks going forward. Tech companies will continue to be affected going forward by the uncertainties in the global economic growth and the slowdown of the consumer demand in electronic devices. Besides that, the minimum wage requirement implemented by the government this year could hurt the earnings of tech companies due to their high labour cost structure. 

Meanwhile, currency risk is another potential risk that could weigh on the revenue as well as erode the profitability of tech companies ahead. An appreciation of RM against USD beyond our assumption could further hit the earnings of tech companies. Together with potentially higher commodity prices, these factors remain a threat to the earnings visibility of the sector in the short term.

Valuation at bear levels. Due to the unpredictable earnings trend and uncertainties in the global economy, we are using a PB (Price to Book) measurement for our valuation model. For MPI, its PB is trading below the -1SD from its 3-year average. This is at its historical low range and suggests the share price could be near to a bottom. 

Meanwhile, Unisem is also trading at a -1SD level from its 3-year average. From its historical PB band, we believe that the valuation has not hit rock-bottom yet as the company traded at a -2SD level in Mar 2009. For JCY, its PB is trading at -1SD currently and could see further downsides as the stock traded at -1.5SD before the Thai flood. Note that Notion is also trading at a -1SD currently from the mean, which is at its lowest PB band, while Kelington is trading at the mean of its PB band with its historical low at -1SD from the mean.

In summary,  the sector has still to contend with tougher times  ahead. Europe and US are still problem spots for IT demand and the broader economic activity. As a result, we think that the economic uncertainty is likely to keep most tech stocks trading sideways to down in the near term before they reach their very bottoms. As such, we prefer to maintain a Neutral rating on the sector for now despite its low valuations.

Source: Kenanga