We reiterate our OVERWEIGHT call for the sector premised on the resilient industry prospect alongside better earnings momentum amid the launching of new flagship smartphones as well as the rising adoption of Automotive semiconductor. Global semiconductor sales in April 2017 extended its growth momentum with a ninth consecutive growth recorded at +21.1%, which is also the highest YoY growth since October 2010. With improving numbers being recorded recently, drastic revisions have been made to WSTS’s 2017/2018 growth forecasts from 6.5%/2.3% to 11.5%/2.7%; with higher growth forecasts mainly from Sensors and ICs. Smartphone segment which has been the key driver for the semiconductor industry over the past three years is expected to see better growth in conjunction with the launching of flagship models by world’s largest vendors second half of the year. On top of that, Automotive semiconductor market continues to see resilient growth from the increasing semiconductor content per vehicle as well as growing demand for advanced vehicle safety and comfort systems. While the overall industry prospect is still resilient, risk/reward ratios of most of the local tech stocks have become less favourable following share prices’ outperformance YTD. We see the BOTTOM-FISHING approach as especially apt for the sector; with our preference skewed towards stocks with undemanding valuation alongside good growth prospect and sound financial fundamentals. Of all, our top picks are PIE (OP, TP: RM2.87@ 15.0x FY18 P/E) and NOTION (OP, TP: RM1.66 @ 15.5x FY18 P/E).

Strong momentum continued. According to the latest SIA data, April sales recorded the highest YoY growth of +21.1% since October 2010, marking the ninth consecutive YoY growth. With the latest strong numbers, WSTS had again revised its 2017/2018 growth forecasts up from 6.5%/2.3% to 11.5%/2.7%; with higher growth forecasts mainly from Sensors and ICs. On another observation from SEMI, the semiconductor equipment billings for North American headquartered equipment manufacturers recorded the eighth consecutive YoY growth, with billings of 42% recorded in May driven by Memory and Foundry manufacturers as the industry invests in 3D NAND and other leading-edge technologies.

Smartphone and Automotive to still drive growth. The data from Gartner suggests that the end-user spending to mobile phones is on track to reach nearly USD400b in 2017, which is an increase of 4.3% YoY. Besides the increasing ASP trend, the launching of flagship smartphone models by world’s largest vendors is expected to lend strength to the end demand, hence contributing to better shipment this year (+1% in 2017 vis-à-vis -1% in 2016). We continue to expect positive spill-over flowing into our local semiconductor players; with higher volume ramp-up for MLP and wlCSP (in MPI and UNISEM case) alongside the resolution of the inventory overstock issue, which we have already accounted in our earnings assumptions.

Meanwhile for Automotive, our channel checks with the OSAT players in Malaysia revealed that their respective Automotive segments are still seeing resilient demand thanks to the increasing semiconductor content per vehicle as well as growing demand for advanced vehicle safety and comfort systems. In this segment, we continue to see MPI as a better proxy in Automotive exposure as we gather that the group’s leading Automotive technologies that are used for safety features (such as advanced package for pressures, magnetic, acceleration sensors), have already passed the stringent qualification stage and will see more meaningful earnings fruition in the next few quarters. Meanwhile, we also like NOTION for its near-term earning driver, being the stack-up orders of Automotive EBS components, which could see a 2-year revenue CAGR of 30%. Note also that we had recently initiated coverage on small-cap tech player KESM with an OUTPERFORM call under the Bursa MidS Research Scheme. To capitalise on the uptrend of the Automotive semiconductor, the group has a massive CAPEX plan over the next two years, developing technologies such as the test-during-burn-in (TDBI) to take on more complex/ higher margin products, which we believe will anchor its growth.

Maintain OVERWEIGHT but with selective picks. While we maintain OVERWEIGHT on the sector given the industry’s resilient prospects as well as the outweighing of OUTPERFORM ratings in the total market capitalization of our stocks coverage universe, we see the BOTTOM-FISHING approach as especially apt for the sector given the less favourable riskreward ratio coupled with the stretched valuations in most of the tech names. Note that the Bursa Malaysia Technology Index has advanced by 58%, which significantly outperformed the FBMKLCI Index which only increased by 8%; with forward PER of the tech players also appearing stretched (OSAT/Equipment manufacturers/EMS industry average 2-year forward PER of 14x-18x / 15x-20x / 12x-16x).

From both quantitative and qualitative perspectives, PIE is our top pick for the sector anchored by: (i) its earnings recovery story with sustainable growth prospects (2-year NP CAGR of 38%) alongside generous dividend pay-out ratio (DPR) of at least 40% of PATAMI (translating into decent dividend yield of c.4%), (ii) its state-of-the-art manufacturing capabilities underpinned by constant vertical integration, which provides higher value-added services (thus higher margins) and higher chances of winning other contracts in the near to medium term, and (iii) strong parentage support from the world’s largest EMS group, Hon Hai/Foxconn Technology Group, which allows PIE to tap on its parent’s first class engineering and manufacturing capabilities.

We also like NOTION for its superior earnings prospect (2-year NP CAGR of >100% from low base) underpinned by the stack-up orders of Automotive EBS components, which could see a 2-year revenue CAGR of 30% as well as the new orders from its Engineered products, which could be the main driver for the next two years. Meanwhile for the recent 10% placement exercise as well as the warrants conversion, the group has since raised a total of RM61.3m cash to facilitate the expansion of its operations. Beyond that, management has also committed to reward its investors by forming dividend policy of minimum 30% of PATAMI, to be paid out quarterly (at dividend yield of 3% assuming minimum pay-out of 30%).

Source: Kenanga Research - 5 Jul 2017