We maintain our NEUTRAL call in view of: (i) industry’s moderating growth, and (ii) impending minimum wage hike, which will compress manufacturers’ profitability in the short term. Meanwhile, the US and China trade war will 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 21st YoY consecutive growth at +20.2% as of April 2018. While 2018 GSS growth is still forecasted to be positive at +12.4% (driven by ICs and Discreet Semiconductor), 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 June 2015. Segmental-wise, though Smartphone sales have reached a saturation point, Automotive and Industrials are still gaining traction from the rising adoption of automotive semiconductor and increasing automation. We prefer semiconductor players with Automotive-centric portfolio with ample rooms for growth as well as earnings resiliency. Our preferred pick is D&O (OP, TP: RM0.810 @ 24.0x FY19E P/E) with investment merits being: (i) better products portfolio (thus higher margins), (ii) production capacity expansion, and (iii) higher stake in Dominant to anchor a 2-year CNP CAGR of 60%.

Still riding high, though at a more modest pace. According to the latest SIA data, April GSS extended its 21st consecutive YoY growth (at +20.2%), with WSTS revising up its 2018 growth forecasts to 12.4% from 9.5%, of which ICs and Discreet Semiconductors are expected to lead growth. While 2018 GSS is still forecasted to be positive at +12.4%, 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, mimicking the movement of last up-cycle, which had lasted for 26 months back then from May 2013 to June 2015. On another observation, semiconductor equipment billings for North American headquartered equipment manufacturers marked the 19th consecutive YoY growth, with billings of 26% in Nov 2017, although at a more modest pace after the strong surge in 1H17.

Smartphone losing steam. Our channel checks with the local semiconductor companies suggested that the main growth drivers for 2018 will be from a mixture of Smartphone (at a slower pace), Automotive, and Industrial segments. Nikkei reported, citing industry sources, that Apple has asked its supply chain to prepare c.20% fewer components for new iPhones that are slated for launching in Sep 2018. Nikkei also noted that Apple currently only expects a total shipment of c.80m units for the new models, a more conservative volume than the 100m units orders placed last year. If this materialises, stocks under our coverage with meaningful smartphone portfolio exposure namely MPI and UNISEM (35%/26% as of its latest quarterly revenue) could be negatively impacted though they also have exposures to other Vendors as a cushion. In the meantime, neither had the latest Gartner’s 1Q18 smartphone sales showed impressive growth (-6.0% QoQ; 1.3%% YoY).

Automotive and Industrial segments are still gaining traction. That said, not all is gloom and doom for MPI and UNISEM as they have been realigning their portfolios since the past few quarters with capex skewing 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, compensating the potential shortfall from Smartphone segment. In particular, MPI is already seeing a gradual pick-up in Automotive sensor-related packaging products with ideal contribution of 50% (from current 29%) in two to three years while UNISEM’s new 12-inch bumping capacity should see completion in 3Q/4Q18 with new products in the pipeline. For other semiconductor players with Automotive-centric portfolio namely KESM and D&O (at nearly 100%/95% of total revenue), earnings prospects are more resilient (2-year revenue CAGR 10-23%, vs. MPI and UNISEM’s single digit growth), with more aggressive expansionary moves (i.e. more testing machines and factory acquisition) in the medium-term pipeline. Typically, though Automotive growth as compared to Smartphone is not as robust, the product cycle is relatively longer (orders remained sticky) due to low penetration as well as stringent qualification process.

Mix catalysts. On one hand, while the weakening of MYR is a boon to the tech players under our coverage (ex-SKPRES) given their net exporter profile (with every 1% strengthening in the USD from our base case of RM3.90/USD to impact 1-to-2 year Fwd. NP for the tech companies under our coverage by 1-3%), the impending minimum wage hike is a bane to all as labour accounts for 10-30% of their respective total cost. Ceteris paribus, assuming the worst-case scenario (without cost passing-through with higher ASP), a minimum hike to RM1,500/month would impact their bottom-lines by 10-15% if being implemented all at once. We have yet to account in any impact from the minimum wage hike. On the US and China trade war, while we are unable to ascertain the quantum of impact, it will negatively disrupt the ecosystem, especially to the OSAT players given their involvement of sub-assembly jobs and end-products delivery (involving both US and China).

Maintain NEUTRAL. All in, while we made no changes to our coverage earnings estimates, we reviewed its latest 3-year mean forward valuation and rolled over its respective valuation base year for standardisation, which led to changes in TPs and ratings (please refer to overleaf). While the industry’s risk-and-reward ratio is not compelling given the decent share price run-up across the sector alongside cost pressure from minimum wage hikes, we still see some bright spots with decent earnings prospects. In the Semiconductor space, we prefer D&O (OP, TP: RM0.810) from the perspective of: (i) better products portfolio (leading to higher margins), (ii) production capacity expansion, and (iii) higher stake in Dominant to anchor a 2-year CNP CAGR of 60%. Meanwhile in the EMS space, we also like SKPRES (OP, TP: RM1.70) with investment merits anchored by: (i) its sustainable growth prospect and stable earnings visibility (2-year NP CAGR of 13%), (ii) potential margins enhancement and new contracts in the pipeline post PCBA-line commencement, (iii) decent dividend yield of 4.8%, and (iv) cost pass-through mechanism, which are the stabilizing and appealing factors to investors in the tech space.

Source: Kenanga Research - 6 Jul 2018