We maintain OVERWEIGHT on the TECHNOLOGY sector as we see: (i) healthy global industry outlook, (ii) strong USD vs MYR trend, and (iii) the export-oriented earnings profile of local semiconductor companies making them the least affected by GST, as investment merit for investors seeking refuge in the challenging local economic landscape. However, after two consecutive years of share price outperformance, risk-reward ratios of the local tech stocks have become less favourable. Hence, we see the BOTTOM-FISHING approach as especially apt for the sector. Putting things into perspective regionally, our findings suggest that while forward PER valuations of the local Outsourced Semiconductor Assembly and Test Services (OSAT) players appear to be stretched (trading at the industry average 1-year/2-year forward PER of 16.7x/13.5x which are at 33%/19% premiums on the regional OSAT players), the 1- year/2-year forward PEG-ratio of 0.4x/0.7x of local players are still at discounts compared to regional players’ 1- year/2-year forward PEG-ratio of 0.9x respectively, suggesting that some of the local tech stocks are undervalued against their robust earnings performance. Filtering through our universe of coverage; while we like both MPI and Unisem given their respective strategic portfolio exposures, as they give a balanced exposure of high growth Smartphone/Tablets (S/T) segments and the defensive Automotive segments (at 60% and 48% respectively), our Top Pick remains MPI (TP: RM8.90) which is best fitted to the themes above. In terms of valuation, MPI is currently trading at 11.8x FY16 PER which is at a 24% discount to the industry average 2-year forward PER, and against its 2- year CAGR of 28%. Meanwhile, screening through the semiconductor value chain, we also like VITROX (TB, TP: RM3.84), being the leading solution providers of automated vision inspection systems, which is positioned in the front-end of semiconductor value chain, to continue benefiting from the healthy outlook of equipment spending and semiconductor sales. In terms of valuation, VITROX is currently trading at 11.8x FY16E PER, which is at a 21% discount to the industry average and against its 2-year CAGR of 17%.

Global semiconductor industry’s outlook expected to remain steady until 2017. Global semiconductor sales in April 2015 maintained its strong momentum, (+4.8% YoY) which marked the 24th consecutive months of year-on-year increase. Outlook-wise, the Semiconductor Industry Association (SIA) expects continued growth in 2015, with World Semiconductor Trade Statistics (WSTS) sharing the same optimism, expecting the worldwide semiconductor market to grow steadily at a 2-year CAGR of 3.4% to USD359b in 2016 and further grow by 3.0% in 2017. Looking at another crucial indicator, which tracks equipment spending (indicates the industry capacity expansion), SEMI, SIA and WSTS concurrently expect a high-single to mid-teens digit growth for the worldwide equipment sales in 2015. At the front-end of the semiconductor value chain, inspection equipment supplier is expected to do well amid the high volume and increasing complexity of semiconductor packages. For the end-market, automotive and communications (especially wireless) are expected to grow stronger than the total market whereas consumer and computer segments are assumed to remain almost flat.

Smartphones/Tablets (S/T) and Automotive segments to drive tech companies’ earnings beyond 2015. Worldwide sales of smartphones to end-users were reported to reach 336m units (+19%) in first quarter driven mainly by Apple and other Chinese vendors. While Samsung dropped 5% with its market share being grabbed by the abovementioned, the drop rate is expected to be slower than that seen in recent quarters with sales of its new S6 smartphone starting in the 2QCY15. Moving forward, worldwide combined shipments of devices (PCs, Tablets, Premium ultramobiles and Mobile Phones) are projected by Gartner to reach 2.5bn units in 2015, at a higher growth of 2.8% YoY increase (vs 3.6% YoY growth in 2014) to be led by Tablets (+4.3%) and Mobile Phones (+3.7%) with PCs expected to decline by 8.7% in 2015. We see both of our core coverages, namely MPI and Unisem, to continue benefitting from the trend given that they have relatively high exposure of c.38% and c.32%, respectively, to the above-mentioned segments. Note that both MPI and Unisem are already in expansionary mode (with some in max-ramp volume production) for their Smartphones customers. Meanwhile, the automotive semiconductor outlook for 2015 is also forecasted to register a promising growth of 7.5% YoY by IHS, underpinned by growth from: (i) more sensor components being installed for safety measures, and (ii) higher electronics content with new models rollout. We understand that both MPI and Unisem’s Automotive segments (with exposure of c.22% and c.16%, respectively) are currently being driven by the continued strong orders for Tire-Pressure Monitoring System (TPMS).

Export-oriented semiconductor companies to benefit from the stronger USD. 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 players under our coverage. Our economics team is projecting an exchange rate of USD vs MYR at an average of RM3.57/USD in 2015. Based on our sensitivity analysis, every 1% fluctuations in the USD will impact our FY15E NPs for UNISEM, MPI and VITROX by 1%. Meanwhile, on the GST front, these players are expected to be least affected (based on the draft general guideline issued by Royal Malaysian Customs) due to their zero-rated status.

Risks. Touching base on the sustainability of the tech upcycle, data from SIA shown that the last round of industry upcycle (from November 2009 to July 2011) lasted 20 months before YoY growth tapered off which developed into an industry downturn. The key culprits then 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 fuelling industry growth. Note that our assumptions are premised on the continuation of gradual improvement in the global economy with the US leading on firmer expansion of its domestic economy. Should there be any unforeseen adverse macro factors such as global economy slowdown, adverse currency fluctuations or a financial crisis, it could alter/deviate our positive convictions on the sectors and stock picks. 

Source: Kenanga Research - 2 Jul 2015