We maintain our NEUTRAL call as we see limited re-rating catalyst for the sector coupled with the less favourable risk and reward ratios given the rich valuations in most of the stocks. Global semiconductor sales kicked start the year with a sluggish sales growth of -2.7% sequentially and -5.8% YoY in January, marking the seventh consecutive months of YoY weakness since July (after posting 26 consecutive months of YoY growth). This latest sales number reaffirmed our view that the industry slowdown was already in the making; with growth tipping off from the high base alongside softening demand of end-products from major economies. Recall that the last two rounds of industry downcycle [from October 2008 to October 2009] and [from July 2011 to October 2012] shared similar patterns where trends of YoY growth were seen tapering off at the initial phase, followed by the first YoY decline setting in before further developing into an industry downturn. Additionally, the Smartphone segment which has been the key driver for the semiconductor industry since the past three years is tipping off amidst weaker consumer demand. Meanwhile, higher currency volatility is also fencing off investment interest in the sector. We have imputed a weaker USD/MYR assumption of RM4.10/USD from RM4.21/USD, which led to downward earnings revision of 3-9% across the OSAT players under our coverage to align with our team of economists’ forecasts (please refer to the overleaf for earnings revisions and changes in TPs). All in, with less compelling risk and reward ratios coupled with growing uncertainties in the sector, we prefer to stick with name that provides greater earnings visibility as well as less sensitive to currency fluctuation. SKPRES bests fit the theme, with investment merits being its: (i) resilient earnings prospect (at a 2-year NP CAGR of 93%) backed by its on-hand long-term contracts from the top-notch home appliance maker, Dyson as well as (ii) strong Balance Sheet and healthy Operating Cash Flow, which will support its generous Dividend Payout Policy of no less than 50% of PATAMI (translating into decent dividend yield of 2.6%-4.9%). Valuation-wise, it is also trading at an undemanding 10.2x FY17E PER, which is at an unjustified 15% discount from the industry average PER of 12x; all against its superb 2-year NP CAGR of 93% as well as the higher-than-industry (yet sustainable) margins backed by its cost pass through mechanism.

A sluggish start in 2016. Global semiconductor sales kicked off the year with a weaker sales of -2.7% sequentially and -5.8% YoY in January. This marked the seventh consecutive YoY declines. According to the president and CEO of SIA, John Neuffer, the sales weakness seen across most regional markets and product categories were owing to softening demand and lingering macroeconomic headwinds. Outlook-wise, while WSTS and Gartner are still forecasting YoY growth for both 2016 and 2017, we observed that the growth quantum forecasts from these industry experts were again lowered down further to almost flat to low single-digit growth. We understand that the downgrades are to account for the lower forecasts of the major applications (PCs, smartphones, and tablets) that drive the semiconductor markets as well as the currency devaluation of other major economies against USD.

Smartphones is losing steam while Automotive is inching up steadily. Worldwide sales of smartphones to end-users in 4Q15 recorded 403.1m units (+14% QoQ; and +10% YoY), bringing 2015’s sales to 1423.9m units which imply a growth of 14.4% YoY. However, this is the slowest growth rate since 2008 which we believe is due to high base effect as well as the slowing demand from the major economies. On a closer look at 4Q15 sales, Samsung and Huawei were the only two top-five smartphone vendors with positive sales growths. Apple meanwhile suffered its first decline in sales of smartphones with its signature iPhone sales down by 4.4%. Taking a closer look at Apple, according to Japan’s Nikkei Asian Review report, the group is expected to reduce output of iPhone 6s and 6s Plus by 30% in 1QCY16 as excess inventories of the new models were seen in major markets ranging from China and Japan to Europe and the U.S. as a result of Dollar appreciations as well as weaker consumer sentiment. Production is expected to normalise in the April-June quarter, once inventory adjustment is complete. Taking cues from this news, we believe the Outsourced Semiconductor Assembly and Test players (OSAT) in Malaysia with their respective sales in the Smartphone segment derived from the components suppliers of this name could experience temporary earnings blips in 1Q16. While rumors have it that the new generation of iPhone will be launched as early as September; which might help to boost sales in the Smartphone segment of Malaysia’s OSAT players, we remain cautious on both Unisem and MPI given their broad base exposure as we believe that the potential sales improvement derived from Smartphone segment might not be enough to offset the overall sales drop in the other segments (such as PC and Consumer). On the Automotive side, we understand from the OSAT players that semiconductor sales in this segment are still growing although momentum is modest. Note that both MPI and UNISEM’s Automotive segments (with latest exposure of c.23% and c.15%, respectively) are currently driven by the solid orders for different pressure and impact sensors. Going forward, we believe this slow-and-steady growing trend will continue given the rising trend of vehicle electrification and growing demand for advanced safety, convenience, and comfort systems. Our view is also echoed by the report of Research and Markets that the value of automotive semiconductor market is expected to grow by a 7-year CAGR of 5.8%.

Currency fluctuation, another swing factor to watch out for. Recall that when USD/MYR exchange rate strengthened (+6% QoQ) from average RM4.05/USD in 3Q15 to average RM4.28/USD in 4Q15, the share prices of Malaysian OSAT players were re-rated by 5%-24% QoQ. Similarly with the YTD strengthening of MYR vs USD by +7%, the share prices of Malaysian OSAT players have also retraced by 7- 21%; sharing the similar percentiles quantum which is also suggesting that the current investment dynamics are tied to the currency fluctuations. On the fundamental side, based on our sensitivity analysis, every 1% fluctuations in the USD will impact our FY16E NPs for both UNISEM and MPI by c.2-3%. Following the latest revision of our in-house USD/MYR assumption, we have imputed an average of RM4.10/USD for 2016 for our Tech companies from RM4.21/USD under our coverage which led to 3%-9% downward revisions.

Within our coverage universe, we are more risk averse on the OSAT players given their position as sub-con manufacturers in the backend manufacturing process which are more vulnerable to the sales weakness (thin margins, thus with lesser tolerance for margin of errors). We prefer names which provide greater earnings visibility as well as less sensitive to currency fluctuation. SKPRES bests fit our theme, premised on its resilient earnings prospect as well as decent dividend yields of 2.6%-4.9%. Valuation-wise, it is also trading at an undemanding 10x FY17E PER, which is at an unjustified 15% discount from the industry average PER of 12x; all against its superb 2-year NP CAGR of 93% as well as the higher-than-industry (yet sustainable) margins backed by its cost pass-through mechanism.

Source: Kenanga Research - 6 Apr 2016