We maintain our NEUTRAL call as we see limited re-rating catalyst for the sector. Although global semiconductor sales in July increased 2.6% sequentially, YoY sales continued to show weakness (- 2.8% YoY), marking the thirteenth consecutive YoY decline with YTD numbers still caught in negative territory of -5.7%. Additionally, the Smartphone segment which has been the key driver for the semiconductor industry over the past three years marked the second slowest YoY growth rate (of +4.3%) since 2008. Beyond this point, while the launching of flagship smartphones from top vendors might partly help to boost sales in the Smartphone segment of Malaysian OSAT players, we remain cautious on both UNISEM (UP; TP: RM2.42) and MPI (MP; TP: RM8.48) given their broad base exposures as we believe potential sales improvement derived from Smartphone segment might not be enough to offset the overall drop in the other segments (such as PC and Consumer). We prefer names which provide greater earnings visibility as well as less sensitivity to currency fluctuation. We like SKPRES given its resilient mid-term earnings prospect that is anchored by the two long-term contracts awarded by its UK customer which will eventually support its robust 2-year NP CAGR of 43%. We also like MYEG (TB; TP: RM2.80) which could benefit from the Budget 2017 as our channel checks suggest that the installation of GST electronic manufacturing system might be made mandatory to the categories C and D and eventually retail sectors. Besides its resilient midterm earnings prospects, a recent 1-for-2 bonus issuance to improve trading liquidity is also an additional sweetener.

Prevailing weakness from macro side. Although global semiconductor sales in July increased 2.6% sequentially, YoY sales continue to show weakness (- 2.8% YoY), marking the thirteenth consecutive YoY decline. Hence, on YTD basis, global semiconductor sales are still caught in the negative territory of - 5.7%, dragged mainly by the global economic uncertainty as well as sluggish demand. Outlook-wise, we observed that WSTS’s forecast for 2016 was once again lowered to -3.2% after its 2Q2016 forecast figures were updated with actual results. Integrated Circuits as well as Optoelectronics were forecasted to be the main drags for 2016. Meanwhile, no changes were made to its 2017 and 2018 forecasts which WSTS expects to see gradual improvement at low single-digit growth each year.

Still lacklustre smartphone sales in 2Q16. Worldwide sales of smartphones to end-users in 2Q16 hit 344.4m units (-1% QoQ and +4% YoY). While the quarterly decline reflected the seasonality weakness (where consumers typically hold back their purchases for new hardware launches in the second half of the year), the YoY mid-single-digit growth marked as the second slowest YoY growth rate (of +4.3%) since 2008. On a closer look, YoY, Samsung, Oppo and Huawei were the clear winners underpinned by the launching of their respective new series of smartphones. Meanwhile Apple, on the other hand, continued to see its downward trend (-7.7% YoY) in 2Q16 despite the launching of its new 4-inch iPhone SE. All in, large smartphone vendors continued to see growth saturation with market shares grabbed by Chinese smartphone vendors, which are dominating the low-cost smartphone markets.

Major smartphone launching might not be able to turn the tide. Beyond this point, while the launching of flagship smartphones from top vendors, i.e. iPhone 7, 7 Plus from Apple and Note 7 from Samsung might partly help to boost sales in the Smartphone segment of Malaysian OSAT players, we remain cautious on both UNISEM (UP; TP: RM2.42) and MPI (MP; TP: RM8.48) given their broad base exposures as we believe that 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). Moreover, we reckon that the abovementioned smartphones sales might not be overwhelming given maturing penetration as well as the hardware issues. Note that both these premium phones were hit by exploding device incidents recently.

Selective picks amid the general industry weakness. We are more risk averse on the OSAT players given their position as sub-con manufacturers in the back-end manufacturing process which are more vulnerable to sales weakness (thin margins; thus, with less tolerance for margin of errors). We prefer names which provide greater earnings visibility as well as less sensitive to currency fluctuation. In this case, we like SKPRES (OP; TP: RM1.48) given its resilient mid-term earnings prospect anchored by the two long-term contracts awarded by its UK customer (sales contributions from existing and new products, amounting to RM1.1b/year) which will eventually support the robust 2-year NP CAGR of 43%. The stock is trading at an undemanding 9.6x FY17E PER against its 2-year NP CAGR of 43%, higher than industry margins backed by its cost pass-through mechanism as well as decent dividend yields of c.5%.

On the non-semiconductor side, we like MYEG (TB; TP: RM2.80) which could benefit from Budget 2017 as our channel checks suggested that the installation of GST electronic manufacturing system might be made mandatory to the categories C and D (restaurants, pubs and massage parlours) with annual revenue of >RM500k and eventually retail sector. Meanwhile, its mid-term earnings prospect is still resilient, backed by its immigration-related services, which should continue to see encouraging uptake of its renewal of Foreign Worker Permit, insurance and the rehiring programme for illegal immigrants (PATI) amid the freeze lifted by the Cabinet. A recent 1-for-2 bonus issuance to improve trading liquidity is also an additional sweetener.

Source: Kenanga Research - 6 Oct 2016