We maintain our NEUTRAL call in view of: (i) industry’s moderating growth, and (ii) lingering risk from the escalating US-China trade war. Global semiconductor sales (GSS) extended its YoY growth for 24th consecutive time at 17.4% (driven by ICs and Discreet Semiconductor). That said, normalisation trend from high base is getting more apparent, which mimicked the movement of last up-cycle (which lasted for 26 months back then from May 2013 to June 2015). On one side, while the USD strengthening continues to be a boon to the industry, the escalating trade war between US and China poses more uncertainties to the mid-long-term prospect of technology space. Though it appears to benefit Malaysian OSATs and EMSs players thus far with short-term earnings boost from the relocation of orders from China, our concern is more on the repercussions from lower demand of components and end-products (following higher prices) alongside the ripple effect from the re-orientation of the supply chain. Segmental-wise, unexciting growth prospect in Smartphone sales should be counter-balanced by Automotive and Industrials; areas which are seeing heavy ploughing of capex. We prefer semiconductor players with Automotivecentric portfolio with ample rooms for growth as well as earnings resiliency. Our preferred pick is D&O (OP, TP: RM1.00 @ 24.0x FY19E P/E) with investment merits being: (i) continuous business-win from Tier-1 customers, (ii) strong order visibility on products stickiness, as well as (iii) margin uplift on new products commercialisation, altogether that will anchor 2-year CNP CAGR of 64%.

Growth tapering off. According to the latest SIA data, July GSS extended its YoY growth for the 24th consecutive time (at +17.4%), with WSTS revising up its 2018 growth forecasts to 15.7% from 12.4%. ICs and Discreet Semiconductors are expected to lead growth. While 2018 GSS is still forecasted to be positive, the normalisation trend from the high base in 2017 (growth of 21.6%) is becoming more apparent, mimicking the movement of last up-cycle which had lasted for 26 months back then from May 2013 to June 2015. In fact, July GSS growth of 17.4% is marked as the first dropout from the c.20% growth region that have lasted over the past 15 consecutive months. On another observation, though semiconductor equipment billings for North American headquartered equipment manufacturers marked the 23rd consecutive YoY growth, billings grew by only 3%, closing to the tail-end of YoY growth.

Smartphone, not as striking. Our channel checks with local semiconductor companies suggested that the growth for 2018- 2019 will be supported by a mixture of Smartphone (though at a slower pace), Automotive, and Industrial segments. Smartphone-wise, worldwide sales recorded an unimpressive growth of 2% YoY/-2% QoQ in 2Q18. Key notables are: (i) Huawei surpassing Apple to be the Top-2 vendor for the first-time ever, and (ii) slowing sales of Apple (+1% YoY) and Samsung (-13% YoY) globally amid growing competition from the Chinese manufacturers. On the Apple’s new flagship models, though there is a notable change in terms of display technology; however, there is not much features upgrades. Meanwhile, uninspiring results from the preliminary Purchase-Intent survey as well as the relatively shorter queues on the first-day of launching by media presses suggested lacklustre take-up relative to previous models thus far. Taking cues from the above-mentioned, we are unimpressed with the smartphone-related growth stories and neutral on the smartphone component suppliers, i.e. MPI and UNISEM (with meaningful smartphone portfolio exposure of 35%/26% as of 2Q18) for now.

Silver lining still the Automotive and Industrial segments. Market research firm IC Insights forecasts automotive semiconductor market to be the strongest end market for chips through 2021, with 5-year CAGR of +5.4%. Catalysts are: (i) rising demand for electronic systems in cars, with increasing attention focused on autonomous vehicles, vehicle-to-vehicle and vehicle-to-infrastructure communications, as well as (ii) on-board safety, convenience and environmental features. Back home, typical OSATs are already 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. MPI is already seeing a gradual pick-up in Automotive sensor-related packaging products, expecting contribution of 50% (from current 29%) in two to three years while UNISEM’s new 12-inch bumping capacity should see completion in 4Q18 with new products in the pipeline. Additionally, the

latter’s recent collaboration with Chinese’s Tianshui Huatian Technology, which allows it to tap into small form-factor package and more I/Os (FOWLP), is also a boon to support its prospect. For other players with Automotive-centric portfolio namely KESM and D&O (at nearly 100%/95% of total revenue), earnings prospects are more resilient relatively (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 in initial phase is not as robust, the product cycle is relatively longer (orders remained sticky) due to low penetration as well as stringent qualification process.

Catalysts balancing out. On one hand, while the USD strengthening continues to be a boon to the tech players under our coverage (ex-SKPRES; with every 1% strengthening in the USD from our base case of RM4.05/USD to boost forward earnings for the tech companies under our coverage by 1-3%), the escalating trade war between US and China is posing more uncertainties to the mid-long term prospect of technology space. Though it appears to benefit Malaysian OSATs and EMSs players thus far with short-term earnings boost from relocation of orders/production from China, our concern is more on the repercussions from lower demand of components and end-products (following higher prices) as well as the ripple effect from the reorientation of the supply chain.

Maintain NEUTRAL. We made no changes to our coverage’s earnings estimates. While industry’s risk-and-reward ratio is not compelling given the decent share price run-up across the sector, we still see some bright spots on stocks with decent earnings prospects. We still like D&O (OP, TP: RM1.00) for the sector exposure, with investment merits being: (i) continuous contract wins from Tier-1 customers, (ii) strong order visibility on products stickiness, as well as (iii) margin uplift on new products commercialisation; altogether that will anchor 2-year CNP CAGR of 64%. Note that we raised our TP to RM1.00 from RM0.850 (still an unchanged 24.0x FY19E PER); on the reversion from fully-diluted ICPS share base assumption (total share base enlargement of 38.7%) to a 5-year staggered conversion (7.7% share base enlargement/year). As the majority of the ICPS shareholders are also the existing shareholders’ of D&O with holdings of >2/3 of shares, we believe the ICPS shareholders will only convert in a gradual manner for now (if any) in lieu of the compliance of Public Spread Requirement (of at least 25% of total listed shares to be in the hands of public shareholders). Note that. YTD, since the effective date of ICPS exercise (of 7 months, from Mar 2018), only 6.7% ICPS (or 3% of D&O share base enlargement) were exercised, which is in line with our new assumption thus far.

Source: Kenanga Research - 3 Oct 2018