We keep our OVERWEIGHT call on the technology sector moving into 4QCY20 as demand for semiconductor remains strong judging from the fact that 8-inch wafer foundry are experiencing orders at 20% beyond their supply capacity. We believe the increase in demand could be attributed to: (i) pent-up demand as companies recover from the Covid-19 lockdown, (ii) front loading ahead of worsening US-China tech war, and (iii) general increase in demand for consumer electronics driven by work-from-home practice. We remain excited for the upcoming iPhone 12 launch which is expected to be well received owing to: (i) 5G support, (ii) fresh UI experience, and (iii) long overdue replacement cycle among consumers. On the automotive side, China’s new vehicle sale recorded growth for the fifth consecutive month from April to August 2020. The momentum is expected to continue, thanks to subsidy extension until 2022. Market share of electric vehicles in Europe has reached a record high of 7.2% in 2QCY20 (vs. 2.4% in 2QCY19) thanks to continuous effort from regulators to push for electrification among car manufacturers. Our top picks are JHM (OP; RM2.00) and D&O (OP; RM1.20) for exposure in the automotive space. For a proxy to 5G adoption in smartphone, we favour INARI (OP; RM2.50) given its expertise in the radio frequency (RF) filter which is critical for optimal 5G transmission.

Demand for semiconductor remains strong. We maintain our OVERWEIGHT call on the technology sector moving into 4QCY20 as demand for semiconductor remains strong, judging from the fact that 8- inch wafer foundry are experiencing orders at 20% beyond their supply capacity. We believe the increase in demand could be attributed to: (i) pent-up demand as companies recover from the Covid-19 lockdown, (ii) front loading ahead of the worsening US-China tech war, and (iii) general increase in demand for consumer electronics driven by work-from-home practice which is likely to continue. DigiTimes also reported that urgent orders will see a 10% increase in pricing for 8-inch wafer foundry capacity.

This trend can be observed in the local scene as SilTerra Malaysia Sdn Bhd (SilTerra), a loss-making wafer foundry, has attracted bids from foreign parties for potential takeover. There is an ongoing bidding war among Germany’s X-FAB, Taiwan’s Foxconn, Beijing CGP Investment Co Ltd (via a 40:60 consortium with DNex Bhd) and Green Packet Bhd. There is no verdict yet but Foxconn was reportedly the highest bidder with US$150m offer. While SilTerra (capable of ~90nm process node) is far from the cutting-edge players like TSMC and Samsung who are already producing 5nm node, it still offers some competition in the 8-inch wafer segment with the current condition turning into a seller market. SilTerra is capable of monthly production capacity of about 46,000 wafers.

Consumer market bottoming out. We expect the consumer market to see improved demand especially in the smartphone category with the upcoming launch of the Apple iPhone 12 which will be 5G-ready out of the box. We opine that it will be well received thanks to the new iOS 14 which has debuted ahead of the iPhone launch and has received very positive responses from the general public. The three main features, namely: (i) app library, (ii) widgets, and (iii) picture-in-picture will bring about a fresh experience that iOS users have envied Android users for. Notwithstanding that, we believe the replacement cycle is also long overdue and the iPhone 12 will likely be the go-to choice for a future-proof upgrade. The top three iPhone models in circulation comprise 4-5 years old models like the iPhone 7 (2016), iPhone 6s (2015) and iPhone 8 (2017) which are starting to experience some slowdown in the user interface owing to aging hardware. The iPhone 12 is expected to launch mid-Oct, a month later than its usual annual release owing to the Covid-19 disruption. We favour INARI (OP; TP: RM2.50) as it is the closest proxy to 5G adoption in smartphones, given its expertise in radio frequency (RF) testing and assembly.

China logged V-shape recovery. Upon the reopening of showrooms and shopping centres as the coronavirus pandemic eases, car sales in China have shown very positive signs as registration of new vehicles recorded growth for the fifth consecutive month from April to August 2020. Sales came off a low of -82% YoY in Feb 2020 to +6% YoY in Aug 2020, thanks to the local government’s measures on easing access to credit and subsidies. This has successfully spurred consumer spending as the rebound in China car sales has been especially pronounced in the premium segments and SUVs.

More importantly, electric vehicles sales are regaining momentum after losing steam in mid-2019 due to the withdrawal of certain government subsidies and worsened by coronavirus. As seen in the most recent numbers by the China Association of Automobile Manufacturers (CAAM), electric vehicle sales saw back-to-back gains for July 2020 (+15.6% YoY) and August 2020 (+19.3% YoY) after bottoming out in June 2020 (-25% YoY). CAAM expects the momentum to continue towards the end of the year owing to favourable policies rolled out to support the development of new energy vehicles. This includes extended subsidies for new energy vehicles until 2022 as buyers will be exempted from purchase taxes.

Europe’s new-car registrations recorded a 3-month recovery streak, coming off a low of -76.3% YoY in April 2020 to -5.7% YoY in July 2020. While August numbers were less great at -18.9% YoY due to the expiry of France’s subsidies on new-car purchase in July which offered 5,000 euros rebate, we believe that the recovery will continue but at a gradual pace, leaning towards a “W-shaped” recovery instead of a “V-shaped” recovery.

Market share of electric vehicles in Europe has reached a record 7.2% in 2QCY20, an improvement from 6.8% in 1QCY20. Comparing to a year ago, the market share of electric vehicle was merely 2.4% and 2.5% in 2Q19 and 1Q19, respectively. Tax incentives from regulators aimed towards pushing car manufacturers to adopt electrification coupled with increased fines on carbon emission have shown very positive results and is expected to continue as electric vehicles are gaining traction among consumers. Hence, we favour local player such as JHM (OP; TP: RM2.00) and D&O (OP; TP: RM1.20) as they will continue to benefit from the overall recovery in the automotive market as well as the increasing popularity of electric vehicles. JHM and D&O’s revenue exposure to automotive are approximately 60% and 95%, respectively.

Maintain OVERWEIGHT stance on the technology sector. Our top picks are:

(i) JHM (OUTPERFORM, TP: RM2.00). With the largely expected weak 1HCY20 behind them, we are looking forward to a sharp recovery in 2HFY20 with stellar 3Q and 4Q. The company is ramping up automotive LED orders by 4x of normal capacity on customers’ request, backed by strong rebound in car sales. Furthermore, the group has also secured several new customers including one which is the biggest auto LED player worldwide with ~30% market share. In the industrial division, we also expect doubling of revenue from a US customer (specialising in signal test and measurement equipment) for FY20, thanks to aggressive 5G rollout. The transfer to Bursa Main Board which is expected to happen end of the year will attract greater interest from institutional funds.

(ii) D&O (OUTPERFORM, TP: RM1.20). We anticipate YoY growth for 2HCY20 with expectation of record high numbers in the subsequent quarters to make up for losses during the movement control order (MCO) period. After resuming to full capacity since June, the group is experiencing orders beyond its usual volume on the back of pentup demand from China and Europe. Seasonally, 2H is usually the better half for the company as customers ramp up orders to prepare for the festive and year-end promotional season. With the order visibility at hand, we expect the positive momentum to continue towards FY21, thanks to the group’s continuous effort in R&D which consistently translates into design-wins.

(iii) INARI (OUTPERFORM, TP: RM2.00). Inari is ramping up its plant in preparation for the upcoming launch of the US flagship smartphone which will be supporting 5G connectivity. The group’s radio frequency (RF) space is poised for a massive up-cycle with the adoption of 5G in handsets. With the need for c.75% more RF filters per handset, Inari has added 8 more systems-in-package (SiP) assembly lines for RF in its P34 plant, in addition to the existing 8 lines in its P13 plant. In an effort to move up the value chain and diversify revenue stream, the group is also venturing into developing OSAT equipment in partnership with Singapore-based MIT Semiconductor. Inari also plans to pursue intellectual property (IP) protection upon getting qualified by potential customers. This will allow the group to sell equipment to external OSATs which could lead to margin expansion.

Source: Kenanga Research - 5 Oct 2020