We reiterate our OVERWEIGHT stance on the technology sector as the environment appears conducive for a recovery in 4Q19, with outlook for both smartphone and automotive segments turning more encouraging, while valuations remain undemanding. Trading interests could return to the smartphone space as early signs show that demand for Apple’s trio of iPhone 11 models are stronger than expected. In the automotive segment, we are seeing possible signs of recovery in major markets such as (i) China, backed by friendly initiatives such as tax cuts for rural consumers and lifting of licence plate quota in Guangzhou and Shenzhen, and (ii) Europe, which has already seen positive growth in July 2019. 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. Overall, with a potential turn in the tide for the technology sector, while valuations remain undemanding, we reckon it is opportune to revisit the technology sector. Our top picks are MPI (OP, TP: RM12.10) and KESM (OP, TP: RM8.70)

Time to revisit. We reiterate our OVERWEIGHT stance on the technology sector as the environment appears conducive for a recovery in 4Q19, with outlook for both smartphone and automotive segments turning more encouraging, while valuations remain undemanding. To capitalise on this potential recovery, our preferred picks are MPI (OP, TP: RM12.10) and KESM (OP, TP: RM8.70).

Smartphone segment regaining limelight. We see trading interests potentially returning to the smartphone space within the semiconductor industry in 4Q19 as outlook turns positive. Apple has just launched a trio of its flagship smartphone models – iPhone 11, iPhone 11 Pro and iPhone 11 Pro Max – featuring camera upgrade (triple-camera system for the Pro versions), better battery life and cheaper pricing for entry-level iPhone 11 (US$50 cheaper than its predecessor iPhone XR). Thus far, early reports suggest that the phones are receiving stronger-than-expected response, even in China, which in our view is not a total surprise as most consumers anecdotally pay more attention to camera quality rather than connectivity. Besides, the launch also coincides with the smartphone replacement cycle of 2-3 years (Note: 2016 and 2017 iPhone generations did remarkably well). According to Reuters, JD.com said that pre-orders for the iPhone 11 series skyrocketed 480% compared to last year, while Alibaba’s Tmall saw 335% jump in the pre-sales of iPhone 11 on the first day vs. that of the iPhone XR. News of TSMC seeing strong demand for its 7nm technology (adopted in the iPhone 11 series’ A13 Bionic processor), as reported by Digitimes, also serves as corroboration for the sturdy iPhone presales. We also see serendipity from the Huawei Android ban, as less tech-savvy and conservative customers may gravitate towards, inter alia, Apple or Samsung to avoid the inconvenience of not being able to use Google services (such as YouTube and Gmail). This has positive implications for our local semiconductor players as their prospects are more closely tied to the Korean and North American smartphone players. Last but not least, there is a possibility that fabless companies would hoard inventory ahead of another round of 15% tariff imposition in December on an item list that includes cell phones, possibly resulting in pent-up demand for smartphone-related semiconductor in 4Q19. Even in the event that a trade war resolution is reached between the US and China before that, sentiment for the sector would likely be resuscitated. In other words, either way, we see limited risks in taking positions in smartphone-exposed OSAT players in 4Q19. Within our coverage, companies with meaningful smartphone exposure are MPI and UNISEM (33% and 25% of revenue in 2QCY19, respectively), but we are maintaining our MARKET PERFORM call on UNISEM on valuation grounds.

Source: Kenanga Research - 2 Oct 2019