We maintain our NEUTRAL call in view of: (i) the industry’s moderating growth, and (ii) the soft USD/MYR which will keep most of the net exporters’ profitability in check. Meanwhile, the US and China trade war does not augur well for the OSAT players if exacerbated, given their involvement in sub-assembly jobs and end-products delivery from both countries. Global semiconductor sales (GSS) extended its 19th YoY consecutive growth at +22.7% as of February 2018. While 2018 GSS growth is still forecasted to be positive at +9.5%, we noticed that the momentum is already moderating, which mimicked the movement of the last up-cycle which lasted for 26 months back then from May 2013 to Jun 2015. Back home, though prospects of most local tech players are still decent in 2018 (to be driven by rising adoption of automotive semiconductor and higher automation from industrial segment), we believe the positives have mostly been priced-in at this level. We continue to prefer the BOTTOM-FISHING approach which is especially apt for the sector; with our preference skewed towards undervalued laggards with good growth prospect and sound financial fundamentals. Our only preferred pick is SKPRES (OP, TP: RM2.05 @ 15.0x FY19E P/E).

Still growing; but at a moderate rate. According to the latest SIA data, February GSS extended its 19th consecutive YoY growth (at +22.7%), with WSTS revising up its 2018 growth forecasts to 9.5% from 7.0%, of which Optoelectronics and ICs are expected to lead growth. While 2018 GSS is still forecasted to be positive at +9.5%, this is a normalisation from the high base in 2017 (growth of 21.6%), where we also noticed that the growth momentum is already moderating, which mimicked the movement of last up-cycle which had lasted for 26 months back then from May 2013 to Jun 2015. On another observation, semiconductor equipment billings for North American headquartered equipment manufacturers marked the 17th consecutive YoY growth, with billings of 22% in Nov 2017, although at a slower pace after the strong surge in 1H17.

Smartphone losing steam, to be compensated by Automotive and Industrial segments. From our channel checks with the local semiconductor players, the main growth drivers for 2018 will be from a mixture of Smartphone (albeit at a slower pace), Automotive and Industrial segments. From the latest Gartner’s smartphone sales data, it was reported that the 4Q17 sales dropped 5.6% YoY, which marked the first YoY decline since data tracking in 2004. Main culprits were the slower replacement as well as the slower upgrades from feature phone to smartphones. In terms of vendors, both top market share leaders namely Samsung and Apple saw 3.6% and 5.0% decline, respectively, while Chinese vendors Huawei and Xiaomi gained higher popularity with growth of 7.6% and 79%, respectively. On the local front, we understand that capex for 2018 will be skewed more towards Automotive centric portfolio (i.e. Sensors packaging, advanced vehicle safety systems) as well as Industrial (i.e. higher automation, advanced manufacturing, test and inspection features) segments. In fact, MPI and UNISEM which are the OSAT players for different segments, have been realigning their portfolios since past few quarters by taking up more: (i) sensors-related packaging business on the Automotive side (ii) power management from Industrial segment, while reducing reliance from the Smartphone segments.

More headwinds down the road. Note that since our downgrade on the sector premised on: (i) the industry’s moderating growth, (ii) less favourable risk-to-reward ratio in most of the tech names following valuations expansion, and (iii) the weakening of USD/MYR, the Bursa Malaysia Technology Index has retraced by 22%, with most stocks’ valuations normalising back to average or +1SD above their forward average PER band, from +1SD to +2SD level. Additionally, the fear of US and China trade war further exacerbated the situation. From our takes, while we are unable to ascertain the quantum of impact arising from a trade war between US and China, the impact will not be positive to the stocks under our coverage, especially the OSAT players given their involvement of sub-assembly jobs and end-products delivery (both involving both US and China). On the other hand, USD/MYR is also expected to stay soft at RM3.90/USD level which does not favour the USD sales denominated players under our coverage namely NOTION, PIE, MPI and UNISEM. Note that we have imputed such assumption across our stock coverage. Based on our sensitivity analysis, every 1% fluctuations in the USD from our base case assumption of RM3.90/USD will impact our 1-year Fwd. and 2-year Fwd. NP for the tech companies under our coverage by 0-3%. All in, while we made no changes to our coverage’s earnings estimates, we review its latest 3-year mean forward valuation, which led to changes in TPs (ratings remained, please refer to overleaf).

Maintain NEUTRAL; stick to stocks with solid fundamentals. While the industry’s risk-and-reward ratio is still not compelling, we still see some bright spots following the industry-wide sell down. From our coverage, we see no appealing names in the OSAT as well as Precision Manufacturer spaces. While EMS players were also affected by the negative sentiment, we see an underappreciated gem with good growth prospect and sound financial fundamentals. From the perspective of less currency risk and sound fundamentals, we prefer SKPRES (OP, TP: RM2.05) with investment merits anchored by: (i) its sustainable growth prospect and stable earnings visibility (2-year NP CAGR of 27%) (ii) potential margins enhancement and new contracts in the pipeline post PCBA-line commencement, (iii) decent dividend yield of 4.1%, and (iv) cost pass-through mechanism, which are the stabilizing and appealing factors to investors in the tech space.

Source: Kenanga Research - 6 Apr 2018