In 3Q19, despite trade-war-induced uncertainties, we reckon that the outlook for the technology sector is turning slightly more encouraging. We are seeing possible signs of recovery in major automotive markets like China and the Europe in 2H19. And, the long-term prospects of automotive-centric technology players are also promising due to rising semiconductor content in vehicles. To capitalise on the automotive market recovery and its exciting long-term prospects, we recommend taking positions in D&O and KESM given their automotive-focused portfolio (>90% and >80% of revenue, respectively). Meanwhile, the outlook for the smartphone industry appears fairly stable as we expect a decent functionality upgrade in the upcoming Apple iPhone models (to be launched in 3Q19). In the EMS space, prospects for SKPRES remain promising as it continues to see contracts driven by its major customers’ shift to newer models, while PIE is expected to benefit from the relocation of manufacturing facilities from China. All-in, with a potential turn of the tide in the technology sector (especially in the automotive segment), while valuations have also become more palatable, we upgrade the technology sector from NEUTRAL to OVERWEIGHT. We select (i) D&O (OP, TP: RM0.675) and (ii) KESM (OP, TP: RM8.70) as our top picks, both prime proxies for the automotive market recovery.

Showing positive signs. In 3Q19, though some uncertainty remains amidst the trade war, we reckon that the outlook for the technology sector is turning slightly more encouraging, while valuations have also become more palatable. As such, we are upgrading the technology sector from NEUTRAL to OVERWEIGHT, mainly premised on a possible recovery in major automotive markets, while the smartphone industry outlook appears fairly stable.

Worst could be over for the automotive market. We are seeing possible signs of recovery in major automotive markets like China and the Europe in 2H19. In China, passenger vehicle sales have been declining for 11 straight months since tariffs were imposed on American automobiles in April 2018. Additionally, consumers have likely been deferring car purchases in anticipation of new VI emission standards (to be implemented in July 2019). Going into 2H19, with a series of policies like tax-cut for rural consumers, fees reduction and lifting of licence plates quota in Guangzhou and Shenzen, passenger vehicle sales are likely to return to the growth trajectory. Meanwhile, in the Europe, passenger car registrations have already turned slightly positive (+0.1% YoY) after 8 consecutive months of YoY declines, as the adverse effect of the Worldwide Light Vehicles Test Procedure (WLTP; introduced in September 2018) subsides. For the long term, prospects of the automotive-centric semiconductor players are also promising. Market research firm IC Insights forecasts automotive semiconductor market to be the strongest end-market for electronic chips through 2021, with 5-year CAGR of 5.4%, underpinned by: (i) rising demand for electronic systems in vehicles to power autonomous driving, vehicle-to-vehicle and vehicle-to-infrastructure communications; as well as (ii) on-board safety, convenience and environmental features.

D&O and KESM are prime proxies for the automotive market recovery. To capitalise on the automotive market recovery and its exciting long-term prospects, we recommend taking positions in D&O (OP; TP: RM0.675) and KESM (OP; TP: RM8.70) given their automotive-centric portfolio (>90% and >80% of revenue, respectively). Apart from the duo, our outsourced semiconductor assembly and test (OSAT) players (MPI and Unisem) have also been realigning their portfolios in the past 1-2 years with capex skewing towards the automotive segment (e.g. sensors packaging, advanced vehicle safety systems). MPI (OP; TP: RM12.10) has shown increased contribution from automotive sensor-related packaging products with 32% share in 1QCY19 vs. 24-25% in FY17, and it targets to grow this to 50% in 2-3 years. For UNISEM (UP; TP: RM2.15), its contribution from the automotive segment has been stable at 15-18% in the past few years, but is set to grow larger going forward given its ties with one of the key players in tyre pressure monitoring system (TPMS). TPMS should see increasing market penetration over the next few years as China has made it compulsory for all new M1 vehicles to carry TPMS by 2019. However, we are maintaining our UNDERPERFORM call on UNISEM on valuation grounds.

Source: Kenanga Research - 3 Jul 2019