Strong momentum extended. According to the latest SIA data, July sales recorded the highest YoY growth of +24.0% since October 2010, marking the twelveth consecutive YoY growth. With the latest strong numbers, WSTS again revised its 2017/2018 growth forecasts up from +11.5%/+2.7% to +17.0%/4.3%; with higher growth forecasts, mainly from Discrete semiconductors and ICs. On another observation from SEMI, the semiconductor equipment billings for North American headquartered equipment manufacturers marked its eleventh consecutive YoY growth, with billings of 28% recorded in August, although at a slower pace following the strong surge in 1H17.

Still have legs; from Smartphone Automotive segments. Data from Gartner suggests that the overall smartphone shipments will reach 1.6b units, which is an increase of 5% YoY; with user spending continuing to shift from low-cost phones to higher priced basic and premium smartphones. Thus far, 2Q17 sales of smartphones grew by 7% to 366m units YoY underpinned by growing demand in emerging markets for 4G smartphones. With the launching of new flagship smartphones throughout 3Q/4Q17, we continue to expect positive spill-over for our local semiconductor players; with higher volume rampup for IC packaging (MLP, wlCSP, foCSP later) which we have already accounted in our earnings assumptions. This is accompanied by consistently high Capex after 2016. Meanwhile for Automotive, our discussion 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 for 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 from July 2017 onwards. We also like small cap Burn-in and Testing player KESM, which derives c.70%-80% of its business from the automotive semiconductors. KESM recently posted its 4Q17 results, which showed a 10th sequential quarterly increase in revenue and had also achieved a record year on capital investment spend. Going forward, we expect the Capex trajectory to continue into the immediate quarters ahead, catering to the increased demand and complexity for testing services.

Maintain OVERWEIGHT; stick with fundamental stocks. Given the current capex ramp-up among the technology players as well as the strong equipment orders activities, we maintain OVERWEIGHT on the sector. However, we see the BOTTOM-FISHING approach as especially apt for the sector given the less favourable risk-reward ratio coupled with the stretched valuations in most of the tech names. Note that the Bursa Malaysia Technology Index has advanced by 70% (also its highest level since 2005), 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 13x-18x / 17x-21x / 12x-13x).

From both quantitative and qualitative perspectives, PIE remains as our top pick for the sector anchored by: (i) its earnings recovery story with sustainable growth prospects (2-year NP CAGR of 38%), which is only trading at 0.3x 2-year PEG vs peers’ 0.4x-0.5x 2-year PEG, (ii) its state-of-the-art manufacturing capabilities underpinned by constant vertical integration (more capabilities than the other EMS players), which provides higher value-added services (thus higher margins of 8%-9% vs. other EMS’s players 5-6%), hence better chances of winning more 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 provides PIE access to first class engineering and manufacturing capabilities.

We also like MPI for: (i) its undemanding valuation, which is trading at 2-year forward PER of 12.5x vs its peers’ PER of 14.0x-18.0x, which we think is unjustified given the similar market cap as well as NP margins enjoyed by its competitors, alongside improving market liquidity of +c.60% YTD vs. CY16 volume, (ii) its strategic positioning in different segments (well balanced between high growth-Smartphone and Defensive- Automotive); with higher share contribution from Automotive in three years‘ time (from current 25% to as high as 50%), which we believe could smoothen the earnings volatility given the earnings stickiness from the Automotive segment and (iii) imminent earnings contribution from its Automotive segment (of high single-digit growth) which will anchor its top-line USD sales growth of 6% vis-a-vis the industry growth of 3%.

Source: Kenanga Research - 4 Oct 2017