We came away with our POSITIVE conviction on the Technology and Rubber Glove sectors reaffirmed by the OPTIMISTIC guidance from several players in these sectors that attended the event. From the perspective of a Top- Down approach, Malaysia’s economic landscape is expected to face more challenges in light of the weaker Ringgit and falling oil prices. However, all these are double-edged swords, which are also benefiting export-oriented companies, especially the Technology/Semiconductor and Rubber gloves players under our coverage. Note that exporters are also expected to be LEAST AFFECTED by the GST (due to the zero rated status) in accordance with the draft general guideline issued by Royal Malaysian Customs.

On the Technology sector front, while we believe the industry will stay resilient with the global semiconductor sales continuing to show healthy momentum, the BOTTOM-FISHING approach is especially apt with current risk-reward ratio less favourable following rich valuations in some counters. Typically, 1QCY and 4QCY earnings for the semiconductor players are seasonally weaker (orders fluctuation amid inventory adjustment). That said we see any price weakness in these stocks as opportunities to accumulate as the earnings shortfall could be made up by the seasonally stronger second and third quarters on the back of the resilient industry prospects. We like all the corporates that attended our KIBB Corporate Day; all with investment merits being resilient earnings prospects and also being net beneficiaries of weaker Ringgit and GST (please refer to the overleaf for each company’s details). Screening through the semiconductor value chain, we see VITROX (NR, implied FV: RM3.54), being the leading solution providers of automated vision inspection systems to continue benefiting from the increasing complexity of semiconductor packages, which requires enormous inspection. Meanwhile moving over to back-end semiconductor players, we are SANGUINE over OSAT players such as UNISEM (OP, TP: RM2.20) and INARI (NR, implied FV: RM3.15) on top of our Top Pick, MPI (OP, TP: RM7.00), given their strategic product exposures to the Smartphone/Tablets (S/T) and Automotive sectors, which provide a balanced earnings play between cyclicality and defensiveness. Over to the Electronic Manufacturing Services players, we see K1, a design and development house which is positioned at the high value-end of the manufacturing chain and SKPRES, which recently acquired Tecnic Group, to register robust earnings growth between 77%-105%.

Meanwhile, among the rubber gloves players, we prefer HARTA (OP, TP: RM7.73) for its “highly automated production processes” model which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins, solid improvement in production capacity and reduction in costs and its position in a booming nitrile segment with a dominant market position.

Key highlights. Kenanga Research held its Corporate Day themed “Sectors of refuge in light of weaker Ringgit and GST- Safe Haven from the Storm” yesterday which attracted a crowd of c.40 analysts and fund managers. The event featured highlights, by the export players namely HARTA, UNISEM, INARI, VITROX, K1 and SKPRES, on business updates, key investment merits, earnings impact amid the weakening of RM vs. USD and the implications on the upcoming GST.

Exporters- Positive on strengthening USD/MYR and least affected by GST. While Malaysia’s economic landscape is facing more challenges in light of the weaker Ringgit and falling oil prices, all these, being double-edged swords, are also benefiting export-oriented companies, especially the Technology/Semiconductor and Rubber gloves players under our coverage. On the Tech/Semiconductor front, based on our sensitivity analysis, every 1% fluctuations in the USD will impact our CY14E-CY15E NP estimates in UNISEM, INARI, and K1 by 0.5% respectively. On the Rubber glove sector, ceteris paribus, a 1% weakening of RM against USD will lead to an average 1%-2% increase in the net profit of rubber glove players. Meanwhile, on the GST front, exporters are expected to be LEAST AFFECTED (based on the draft general guideline issued by Royal Malaysian Customs) due to the zero rated status.

Resilient momentum in global semiconductor sales to continue in 2015. Global semiconductor sales in November 2014 maintained its strong momentum, with a decent growth of 9.1% YoY which marked the 19th consecutive month of year-on-year increase. According to the president and CEO of Semiconductor Industry Association (SIA), Brian Toohey, the global semiconductor industry is well-positioned for a strong close in 2014 with nearly all regions and product categories exhibiting increases. All in, SIA expects nearly double-digit growth in 2014, followed by moderate growth in 2015 and 2016. Note that SIA’s forecasts are also in line with the sales forecasts by World Semiconductor Trade Statistics (WSTS), which has recently revised up its full-year global semiconductor sales growth target to 9% (from 6.5% previously) and expects the sales to grow 3.4% YoY (to USD344.5b) in CY15 followed by another 3.1% YoY a year later. In end markets, automotive and communications (especially wireless) are expected to grow stronger by high single digit, than the total market whereas growth for the consumer and computer segments are assumed to remain almost flat; a view also shared by us.

Resilient demand in the Automotive and S/T segments to drive tech companies earnings. For the corporates that attended the Corporate day, UNISEM and INARI are the direct beneficiaries from the semiconductor upcycle given their strategic exposure in Automotive (UNISEM: 17% of total sales) and Communications (UNISEM: 30% and INARI: 45%). For Unisem, the group is looking to expand through bottleneck capacity (please refer to overleaf for further details) that will translate into 30% growth for its high margins 8" and 12" WLCSP and Flipchip services with a huge reversal core NP from –RM15.5m in FY13A to RM60.7m in FY14E and RM96.5m in FY15E. Meanwhile, for INARI, management is expecting a 30% YoY volume loadings in its RF products due to resilient demand for S/T which could see a 2-year NP CAGR of 31% assuming an Utilisation Rate of 85%. VITROX is also the direct proxy to these two strategic segments given the wide usage of its inspection systems in these segments. With the increasing complexity of semiconductor packages which requires enormous inspection amid the semiconductor upcycle, the group is expecting NP growths of “double-digit” in FY14E and FY15E on the back of higher demand in its inspection machines as well as better operation effectiveness, all of which could translate into a 2-year NP CAGR of 51%. On the other hand, K1 has an indirect exposure to the S/T with 30% of its revenue generating from the Mobile phone accessories, has recently seen new orders worth of RM20m to manufacture high-end communication accessories for a world-renowned multinational corporation. Earnings-wise, this order and healthy demand across the other products could translate into a robust 2-year CAGR of 361% to the group. Additionally, this order could also open doors of opportunity to win potentially 4-5x bigger size orders from another global brand customer. Separately, SKPRES, more like a proxy to the general consumer electronic goods in the space of Electronic Manufacturing Services, is looking to register a 2-year NP CAGR of 105% by realising the synergistic benefits from the acquisition of Tecnic and the additional capacity expansion in its new factory.

Meanwhile touching base on the sustainability of the tech upcycle, data from SIA shown that the last round of upcycle (from November 2009 to July 2011) lasted for 20 months before the consecutive month of YoY growth tapered off. The key culprits were the weaker consumer demand amidst: (i) fears of contagion of the European sovereign debt crisis in Spain and Italy, and (ii) concerns over the slow economic growth of the United States with its credit rating being downgraded. On our take on this current cycle, we see favourable macro factors fueling the growth on the industry. These are all on the back of: (i) the continuation of gradual improvement in the global economy with the US leading on firmer expansion of its domestic economy, and (ii) Europe putting more emphasis on growth rather than austerity, and (iii) whilst Japan is expected to retain its upwards trend. On the upcoming 4QCY14 results that will be released in two weeks time, we are expecting a seasonally weaker earnings to be reported across all the tech players due to orders fluctuation amid inventory adjustment. However, strengthening of USD vs MYR could be the buffer for the earnings softness.

Rubber Gloves- Time to bounce back. The positive outlook is driven by commercial production of new capacity, which has come onstream gradually by end 4QCY15, which will drive earnings growth. We believe persistent concerns over falling demand, fears of oversupply and price wars are overplayed as addressed in our past quarterly strategy reports. As an indication, selected stock prices of rubber gloves stocks under our coverage are currently trading close to their previous highs. Our investment case is based on: (i) earnings growth to resume in subsequent quarters, underpinned by new capacity expansion fuelled by sustained demand for rubber gloves, led by nitrile gloves, (ii) our analysis that the new capacity expansion is slower-than-expected, which should help maintain the supply-demand equilibrium, (iii) favourable USD/MYR exchange rate, and (iv) the sustained low raw material prices.

Reiterate our OVERWEIGHT ratings on Technology and Rubber glove sectors. Post-conference, we generally think that these sectors in Malaysia are favoured by the investment community, especially under the headwinds of weaker MYR and GST implementation. Within the technology/semiconductor attendee companies, we like all the corporates that attended our KIBB Corporate Day; all with investment merits being resilient earnings prospects and also being net beneficiaries of weaker Ringgit and GST (please refer to the overleaf for each company’s details). Screening through the semiconductor value chain, we see VITROX (NR, implied FV: RM3.54), being the leading solution providers of automated vision inspection systems to continue benefiting from the increasing complexity of semiconductor packages, which requires enormous inspection. Meanwhile moving over to back-end semiconductor players, we are SANGUINE over OSAT players such as UNISEM (OP, TP: RM2.20) and INARI (NR, implied FV: RM3.15) on top of our Top Pick, MPI (OP, TP: RM7.00), given their strategic product exposures to the Smartphone/Tablets (S/T) and Automotive sectors, which give a balanced cyclicality and defensiveness play. Over the space of Electronic Manufacturing Services players, we see K1, a design and development house which is positioned at the high value-end of the manufacturing chain and SKPRES, which recently acquired Tecnic Group, to register a robust earnings growth between 77%-105%. Meanwhile, among the rubber gloves players, we prefer HARTA (OP, TP: RM7.73) for its “highly automated production processes” model which is moving from ‘good’ to ‘great’ as they are head and shoulders above its peers in terms of better margins, solid improvement in production capacity and reduction in costs and its position in a booming nitrile segment with a dominant market position. 

Source: Kenanga