We are reiterating our NEUTRAL view on the technology sector. To recap, the technology companies under our coverage had generally reported subdued 1QCY13 results with four out of the six stocks’ results coming in below our expectations. The main culprit was the sluggish recovery momentum amid the frail global economic condition. While we are cautiously optimistic on the sector recovery taking cues from the modest yet steady improvements seen in the global semiconductor sales and the SEMI’s book-to-bill ratio, we believe the quantum of local semiconductor companies’ bottom line improvements in the 2H2013 YoY will not be as great as 2H2012 due to the high base effect (post the Thai flood in 2012). Coupled with the impact of the minimum wage policy (which we have already incorporated into the companies’ earnings estimates), we are reaffirming our conservative stance and also keeping the valuations of the stocks in our coverage at the conservative band (mostly at -0.5 SD below the mean valuation). We are also maintaining our NEUTRAL rating on the sector with unchanged calls on Unisem (MP, TP: RM0.97), MPI (MP, TP: RM2.59), Notion VTec (MP, TP: RM0.77), JCY (UP, TP: RM0.54) and Sam Engineering (MP, TP: RM2.28).

1QCY13 results round-up. Generally, most of the technology companies under our coverage posted marginally better QoQ net profit growth rates on the back of operational efficiencies on higher revenue growths. Four out of the six companies’ results were nonetheless still below expectations owing to the sluggish recovery momentum in 1Q2013 amid the frail global economic condition. Major earnings downgrades by us were on Notion and JCY where their HDD segment continued to put a drag on their earnings prospects. Post the 1QCY13 results, although we maintained our MARKET PERFORM calls on Unisem (TP: RM0.97), MPI (TP: RM2.59), Sam Engineering (TP: RM2.28), and also UNDERPERFORM call on JCY (TP: RM0.58), we had upgraded Notion (TP: RM0.77) to a MARKET PERFORM as we believe that the group’s efforts in venturing into the more lucrative market segments i.e. smart-phones and consumer electronics could cushion off the impact from its sluggish HDD segment.

Industry recovery on the mend. According to the Semiconductor Industry Association (SIA), the global semiconductor sales in May 2013 extended its gains by 4.6% MoM, marking the third consecutive months of improvement with the overall improvement seen in all segments. On a YoY basis, the global semiconductor sales improved by 1.2% despite the sharp decline in Japan’s sales. The positive offset was on the back of stronger sales in Americas and Asia Pacific segments. With the recent YoY improvement (except for April) in the SIA data and continuous improvements shown in the SEMI bookto-bill ratio (with five consecutive months of being above the 1.0x parity with also improvements seen in bookings and billings over the same period), we believe all these could translate into better sales prospects for Malaysian players in the next 3 to 6 months. This should be reflected onwards from their 3Q2013 revenue numbers, which we have already factored into our estimates. 

The bottom line growth could, however, be suppressed by the impact of the minimum wage policy. While we are cautiously optimistic on the recovery, we believe that the ongoing minimum wage policy could continue to put a drag to the group’s bottom line growth. Note that we have incorporated the potential earnings impact into our stocks coverage since March 2013. Meanwhile, we reckon that adverse currency translations could  be another potential risk to hinder the revenue momentum as well as erode the profitability of tech companies ahead. Notably, an appreciation of RM against USD beyond our assumption of RM3.00 could further hit the earnings of tech companies while this situation seems remote in the near term. Altogether, these factors remain as the major risks to our more bullish expectations.

In summary, while the empirical evidence by the Semiconductor Industry Association and SEMI’s book-to-bill ratio and the optimistic views of most managements point to a firmer recovery for the industry, we believe that the quantum of local semiconductor companies’ bottom line improvements in 2H2013 would not be as great as 2H2012 on a YoY basis due to the high base effect (post Thai-flood in 2012). For now, we are keeping the valuations of stocks in our coverage at the conservative band (mostly at -0.5 SD below the mean valuation) but we will re-look to upgrade our valuations should the quantum of improvements reflected in 3Q2013 outperformed ours and the consensus expectations. Maintaining NEUTRAL on the sector with unchanged calls on Unisem (MP, TP: RM0.97), MPI (MP, TP: RM2.59), Notion VTec (MP, TP: RM0.77), JCY (UP, TP: RM0.54) and Sam Engineering (MP, TP: RM2.28).

Source: Kenanga