Turnaround signs glowing. We reiterate our OVERWEIGHT stance on the technology sector going into 1QCY20, supported by potential turnaround signs as the outlook for both 5G connectivity and automotive segments are improving. To capitalise on this potential recovery, our preferred picks are MPI (OP; TP: RM14.00) and KESM (OP; TP: RM10.80).

Downstream players seeing an uptick in activity. We understand that there is usually is a time lag of one quarter before upstream activities trickle down to downstream players. That explains why the tripling of TSMC’s production lead time did not immediately translate into meaningful growth for outsourced semiconductor assembly and test (OSAT) players. In the recent 3QCY19 earnings season, we notice that the global top 10 OSAT players recorded an aggregate revenue growth of 1% YoY. While the growth is marginal, it is nonetheless a commendable feat given the choppy semiconductor industry this year. That said, we interpret this as an early sign for a stronger rebound next year for OSAT players.

5G smartphones will see an increase in RF content. The upcoming flagship smartphone in September 2020 from a US company is expected to support 5G connectivity. While this may bring about more buying interest among consumers, we do not expect to see a huge jump in unit sales. Instead, we see a larger quantum of growth coming from the jump in semiconductor content per smartphone. As a result, we believe local OSAT players that are involved in radio frequency (RF) will likely benefit more compared with those that are solely focused on smartphone sensors. To a certain extent, the absence of Google Mobile Services (GMS) in Huawei devices may also sway less tech-savvy customers towards, inter alia, Apple or Samsung to avoid the inconvenience of having to root or flash their devices. This has positive implications for our local semiconductor players given that their business prospects tracks closely with the Korean and North American smartphones supply chain. Within our coverage, companies with meaningful smartphone exposure are MPI and UNISEM (33% and 26% of revenue in 3QCY19, respectively), but we are maintaining our UNDERPERFORM call on UNISEM on valuation grounds.

China will be crucial in driving the sector forward. Although the last wave of tariff was recently called off, we believe that it does not change the fact that China still intends to be technologically self-sufficient. This will be driven by China’s techcentric “Big Fund Phase II” (204bil yuan or $28.9bil) which will begin deployment end-2019, representing a 47% jump from the allocation in Phase I. In our recent meetings with local downstream equipment makers, companies such as ViTrox Corporation (Not Rated) and MI Technovation (Not Rated) also shared the same view as they are experiencing a surge in orders from Chinese customers with demanding deadlines.

Source: Kenanga Research - 2 Jan 2020