We maintain our NEUTRAL call as we see no clear re-rating catalyst for the sector. While global semiconductor sales in November increased 5.1% YoY which has prompted higher forecasts in 2017 and 2018, the revisions are marginal from +2.0% and +2.2% to +3.3%/2.3%, respectively; still with marginal improvement expected in the next two years. Additionally, the Smartphone segment which has been the key driver for the semiconductor industry over the past three years is still seeing slow growth despite the launching of flagship models by two global largest vendors. We remain cautious on the OSAT players under our coverage given their broad-base exposures. All said, favourable currency translations are expected to partly cushion the slowdown. We have imputed an average RM4.35/USD, a 2-year forward MYR/USD assumption (from RM4.10/USD) for the Tech companies under our coverage to be in-line with our team of economists’ forecasts. While most of the ratings of our stocks remained status quo (but with revision in earnings thus TPs), UNISEM has been upgraded to MARKET PERFORM. Among all, we still 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 support its robust 2-year NP CAGR of 30%. Meanwhile, our recently upgraded stockNOTION could continue to surprise on the POSITIVE side following its improving earnings prospect. Hence, we place NOTION’s TP and rating to UNDER-REVIEW (with upside bias) pending meeting with management next week.

Modest improvement from low base. Global semiconductor sales in November 2016 increased 5.1% YoY, marking the third consecutive YoY growth. Note that sales in August marked the first YoY growth since June 2015 driven by the Asia Pacific and Japan regions. That said, YTD global semiconductor sales are still caught in negative territory of -2.9%. With its latest reported positive numbers, WSTS’s conservative forecast for 2016 has been tuned up from -3.2% to -0.1%; with Integrated Circuits and Optoelectronics forecasted to drop by narrower quantum. Meanwhile, 2017/2018 forecasts were marginally tuned upwards (from +2.0%/+2.2% to +3.3%/2.3%) as WSTS expects to see gradual improvement at low single-digit growth each year.

Lack of impetus in the short term. Worldwide sales of smartphones to endusers in 3Q16 hit 373.3m units (+8% QoQ and +5% YoY). While the growth was mainly reflective of seasonality strength (where consumers resume their purchases for new hardware launches in the second half of the year), the world’s two largest vendors namely Samsung and Apple continued to see downward trends QoQ; with respective flagship models struggling to stimulate replacement sales. On the other hand, Chinese smartphone vendors maintained their sales momentum with expansion into the Western markets. Looking beyond smartphones, PC and portable devices markets continued to slow down with replacement trend still sluggish. Outlook-wise, we observed that growth forecasts for 2017 and 2018 by Gartner were again lowered, to 1% from 2% with slower growth expected from both PC and portable devices market. Back home, given the slow sales momentum in the key drivers for Malaysian OSAT players, we remain cautious on both UNISEM (MP; TP: RM2.52) and MPI (MP; TP: RM8.88). While there is a glimpse of hope with completely new flagship smartphone models launching in 2H17, 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) given their broad base exposures.

Moderate sales compensated by favourable currency translation. All said with moderate USD sales growth for majority of the export-oriented semiconductor companies under our coverage, favourable currency translations to MYR terms are augmenting earnings. Note that USD/MYR exchange rate improved further (+6% QoQ; +1% YoY) to average RM4.31/USD in 4Q16. Based on our sensitivity analysis, every 1% fluctuations in the USD will impact our 1-year/2-year forward NPs estimates for USD sales oriented companies by 1%/2%. Recall that nearly 100% of their revenue are denoted in USD, with natural hedge from raw materials purchases (mainly in USD) which constitute about c.40% of total costs as well as the 50% hedging on the net receivables (in some companies). We have imputed an average of RM4.35/USD, a 2-year forward MYR/USD assumption (from RM4.10/USD) for the Tech companies under our coverage to be in-line with our team of economists’ forecasts (please refer to the overleaf for the earnings/TPs impact and revision).

Earnings/TPs/Ratings revision. Rating from UNISEM is upgraded with higher TP of RM2.52 (from RM2.38) and to MARKET PERFORM. Meanwhile, ratings in all other stocks remained status quo (but with higher TPs). On the other hand, our recently upgraded stock- NOTION could continue to surprise on the POSITIVE side following its improving earnings prospect. Hence, we place NOTION’s TP and rating to UNDER-REVIEW (with upside bias) pending meeting with management next week. Note that we have also revised the valuation of PIE from 15.0x FY17E PER to 12.0x FY17E PER to realign with the industry average, thus leading to a lower TP of RM2.05 (from RM2.40).

Cherry-picking amid the general softness. All in, we are still 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. We continue to like SKPRES (OP; TP: RM1.48) given its resilient mid-term earnings prospect anchored by the long-term contracts awarded by its UK customer (which will support the robust 2-year NP CAGR of 43%). The stock is trading at an undemanding 11.7x FY18E PER against its 2-year NP CAGR of 30%, higher than industry margins backed by its cost pass-through mechanism as well as decent dividend yields of c.4%. Meanwhile, we also favour NOTION (UNDER REVIEW; previous rating is OUTPERFORM with TP of RM0.44) for its improving earnings prospect.

Source: Kenanga Research - 6 Jan 2017