We maintain our NEUTRAL call on the technology sector. Although (i) the robust sales growth in the global semiconductor market as well as (ii) the current trend of strengthening of USD against MYR will continue to lend strength to the earnings of local semiconductor companies given their export-oriented earnings profile, we do not expect general improvement to be reflected in all the companies under our coverage given their respective different product mix profile. Our preference picks are still companies with high exposure in the high growth area such as S&T segment and Automotive segment. Meanwhile on the HDD front, we believe the industry growth will likely remain flat in 2014 in light of the overall slower consumer spending in Desktop HDD and Mobile HDD, which mimicked the weaker PC demand (commanding c.76% of the total market share for total HDD shipments) despite the increasing demand of cloud computing, which drives Enterprise HDD (with its total market share of c.12% of total HDD shipments). MPI (OP, TP: RM5.23) remains as the only OUTPERFORM stock in our core coverage given its resilient earnings outlook as well as its attractive potential net dividend yield of c.4% in FY15.

1QCY14 results round-up. Industry players generally reported mixed set of results with SAM being the sole outperformer for the quarter thanks to its better-than-expected EBIT margin on the back of better operational efficiency as well as lower-than-expected effective tax rate. Meanwhile, our Top Pick of the sector, MPI, posted a reasonable 3Q14 results underpinned by healthy sales and profitability as expected. On the other hand, taking a closer look at the underperformers, both UNISEM and NOTION suffered pallid sales with lower operational efficiency seen while CENSOF was dragged down mainly by the higherthan-expected operation costs. Post results, while we maintain the ratings for all the stocks under our coverage, we have switched CENSOF from our core coverage to retail coverage given the lack of institutional interest in the stock.

Global industry indicators still remained healthy. According to data from the Semiconductor Industry Association (SIA), global semiconductor sales in April 2014 maintained its strong momentum in April, with a decent growth of 11.5% YoY with overall improvement seen in all countries and continuous uptick of 0.7% MoM. Looking at the other noticeable indicator, namely the SEMI book-to-bill, the ratio came in at 1.03x which pointed to stronger demand. Notably, this also marked the seven consecutive months of the ratio above the 1.0x parity. With improvements seen in bookings and billings over the same period, this suggests continual industry capital spending.

But magnitude varies among segments. While the indicators mentioned above are pointing towards positive trend, we do not expect general improvement to be reflected in all the companies under our coverage given the difference product mix profile of each company. We concurred with Gartner’s view that the high growth areas such as Smartphones and Tablets (S&T) as well as Automotive segments will remain resilient while PC shipments will remain in the doldrums which should see the HDD outlook being shadowed given its high PC exposure (by Desktop HDD and Mobile HDD, which in total commanding c.76% of the total market share for total HDD shipments). Thus, we see no immediate catalysts for earnings upgrade to the HDD segment of the companies under our coverage such as Notion VTec (c.35% exposure) and Sam Engineering (c.25% exposure).

Selective plays with high exposure in S&T and Automotive segments. As two of our core coverage semiconductor companies namely MPI and Unisem fall into the range of OSAT (outsourced assembly and test) players which generally operates at the tail-end of the semiconductor value chain, selective picks are especially important given its vulnerability to the industry volatility. In this case, although both MPI and Unisem have relative high exposure of c.55% and c.40%, respectively, to the Smartphones, Tablets (S&T) and Automotive segments, we prefer MPI (OP, TP: RM5.23) over UNISEM (UP, TP: RM0.86) given its (i) production ramp in high margin products (namely HD leaded, MLP and turnkey test), (ii) foray into new segments such as LGA & FBGA market for the low-cost smart phones from China and MEMS-based sensors for Automotive, and (iii) higher operational efficiency after the line consolidation and product rationalisation. Valuation-wise, MPI is trading at 1.3x FY15 PBV which is at +1SD above three-year forward PBV and 14.1x FY15 PER which we deem it to be still undemanding given its resilient earnings outlook as well as its attractive potential net dividend yield of c.4% in FY15.

Global industry indicators still remained healthy

Global semiconductor sales in April marked the 12th consecutive month that YoY sales have increased. According to the data from Semiconductor Industry Association (SIA), global semiconductor sales in April 2014 maintained its strong momentum in April, with a decent growth of 11.5% YoY with overall improvement seen in all countries. Meanwhile, MoM sales continue to see a moderate uptick of 0.7% as the growth in Asia Pacific (+1.7%) and Japan (+1.1%) was offset by Europe (-0.6%) and Americas (-1.6%). According to the president and CEO of SIA, Brian Toohey, the market currently remains well ahead of the pace set in 2013, which was a record year for semiconductor revenues. With April decent growth of 11.5% YoY, this marked the twelfth consecutive month that the YoY sales have increased and SIA also expects the trend to continue during the remainder of 2014 and into 2015. Additionally, SIA also endorsed the World Semiconductor Trade Statistics (WSTS) Spring 2014 global semiconductor sales forecast, which projects the industry's worldwide sales to reach USD325.4bn in 2014, implying a 6.5% increase from the 2013 total sales. This number also reflects a revision up from the WSTS Fall 2013 forecast, which projected only 4.1% growth in 2014. At a closer look, this growth of 6.5% in 2014 is underpinned by Asia Pacific (9.3%), Europe (7.9%) and the Americas (2.1%), with a slight decline projected for Japan (-1.3%). SEMI’s book-to-bill ratio in April remained above the 1.03x parity for the seventh consecutive months, also with improvements seen in bookings and billings over the same period. According to Semiconductor Equipment and Materials International (SEMI), the book-to-bill ratio for North America-based semiconductor equipment manufacturers in April remained above 1.0x, at 1.03x. A ratio of 1.03x means that USD103 worth of orders was received for every USD100 of products billed for the month. On a closer look MoM, April billings increased by 14% while bookings numbers also booked in a double-digit growth of 10%. Meanwhile, on YoY basis, both billings and bookings continue to register a double-digit growth at 29% and 23% respectively, complementing the ratio of 1.03x. All these indicators point to stronger demand and continuous industry capital spending.

PC shipments in 1Q2014 marked the eight consecutive quarter of shipment decline, although the severity of the decline has eased compared to the past seven quarters according to Gartner. While the PC market still remains weak, the declining trend has slow down compared to last year in conjunction with the fading impact of tablets. Volume-wise, preliminary worldwide PC vendor unit shipment for 1Q14 came in at 76.6m (-2% YoY; -7% QoQ) of which the seasonality weakness on a QoQ basis was reflective of the normalisation of high base in 4Q14 (holiday seasons).

Declining PC trend might moderate in 2014, but still far from over. According to Gartner, worldwide combined shipments of devices (PCs, Tablets, Ultramobiles and mobile phones) are projected to reach 2.5bn units in 2014, a 6.9% increase from 2013. Of noteworthy, worldwide shipments of traditional PCs are forecasted to register a smaller decline of 6.6% YoY (compared to c.10% in 2013) to total 276.7m units in 2014 with the right usage pattern aligning to the right device. Of which, only about two-thirds of notebook and desktop replacements remaining within the traditional PCs with the remaining one-third to move into tablets and other ultramobiles. While we see no major impact to our stocks coverage with exposure of PC segments namely MPI and Unisem as their revenue exposure to the PC segment are only about 15% respectively, we are cautious with the HDD outlook as the Desktop HDD and Mobile HDD (commanding c.76% of the total market share for total HDD shipments) are heavily dependent on the PC demand. We believe that the growth of HDD shipment will likely remain flat in 2014 given the lion share contribution from the Desktop HDD and Mobile HDD segments. Thus, we see no immediate catalysts for earnings upgrade to the HDD segment of the companies under our coverage such as Notion VTec (c.35% exposure) and Sam Engineering (c.25% exposure).

Tablets and Mobile Phones segments to remain resilient. As mentioned, with the majority of the remaining one-third PC segment to move into tablets, this segment is forecasted to grow 38.6% as overall adoption continues to grow faster in markets outside North America with the uptake of lower cost, smaller, non-branded tablets, becomes more apparent. Similarly, for mobile phones, the largest segment of the overall device market (at c.76%), are also expected to grow positively by 4.9% YoY to 1.9b units in 2014, with growth derived from the lower end of the premium phone market and the higher end basic phone market.

Automotive to be the upcoming segment with higher applications of electronics content. Our channel checks with the leading technology and semiconductor companies suggested that the semiconductor application in Automotive segment will continue to grow stronger over the next few years. With the general theme of “Greener, Safer and Better connected”, this should see (i) more energy efficient vehicles (EEV) being introduced which requires more electronic components and equipments, (ii) more sensor components being installed for safety measurement, (iii) and higher electronics content with new models rollout.

In summary, our preference picks are still with companies with high exposure in the high growth area such as S&T segment and Automotive segment. As two of our core coverage semiconductor companies namely MPI and Unisem fall into the range of OSAT (outsourced assembly and test) players which generally operates at the tail-end of the semiconductor value chain, selective picks are especially important given its vulnerability to the industry volatility. In this case, although both MPI and Unisem have relative high exposure of c.55% and c.40% respectively to the Smartphones, Tablets (S&T) and Automotive segments, we prefer MPI (OP, TP: RM5.23) over UNISEM (UP, TP: RM0.86) given its (i) production ramp in high margin products (namely HD leaded, MLP and turnkey test), (ii) foray into new segments such as LGA & FBGA market for the low cost smart phones from China and MEMS-based sensors for Automotive, and (iii) higher operational efficiency after the line consolidation and product rationalisation. Valuation-wise, MPI is trading at 1.3x FY15 PBV which is at +1SD above threeyear forward PBV and 14.1x FY15 PER which we deem to be still undemanding given its resilient earnings outlook as well as its attractive potential net dividend yield of c.4% in FY15.

Source: Kenanga