We reiterate our OVERWEIGHT call on the technology sector for 3QCY21. While there is a possibility of double booking amidst the current chip shortage situation, we are not overly concerned as the bargaining power has shifted to the vendors. With capacity expansion expected to lag behind by 6 to 12 months, certain vendors have imposed a non-cancellation clause up to one year for customers wanting to lock in a steady flow of supplies as demand for end-devices remains elevated. INARI (OP; TP: RM4.00) continues to see strong orders as smartphone shipment in 1QCY21 rose 26% YoY while laptop shipment in 1QCY21 jumped 55% YoY as the work-from-home trend continued. This has sparked capex spending even among smaller fabs like GlobalFoundries which recently allocated US$4b for its new expansion in Singapore, potentially benefiting KGB (OP; TP: RM2.60) given its strong presence in Singapore and China. Automotive sales continued to soar in China (with 13 months consecutive growth) and Europe, driving D&O (OP; TP: RM5.50) towards another year of record earnings after starting off with a 577% YoY net profit growth in 1QFY21. With inflationary pressure rising as a result of heightened money supply owing to aggressive stimulus programs in the past year, we believe e-payment processor such as GHL (OP; TP: RM2.30) and Revenue Group (unrated) will stand to benefit from rising prices of goods and services as they earn a fee from each payment processed. Furthermore, the push towards a cashless society and opening of cross-border travel in the near future will serve as additional catalysts for e-payment processors.

Double booking? We reiterate our OVERWEIGHT call on the technology sector going into 3QCY21. While there is a possibility of double booking amidst the current chip shortage situation, we are not overly concerned as the bargaining power has shifted to the vendors. The on-going pent up demand for end-devices has now resulted in tight supply while capacity expansion is expected to lag behind by 6 to 12 months or even longer as construction of new plants has been delayed owing to lockdowns that are still being enforced in certain countries around the world. This has allowed vendors to impose a non-cancellation clause up to one year for customers wanting to lock in a steady flow of supplies. Based on our channel checks, some vendors are even requesting cash payment upfront instead of credit terms for certain critical components. Front-end (i.e. TSMC) and back-end (i.e. ASE Global) vendors are also mulling over the possibility of further upward revision in prices as they continue to see orders potentially outpacing capacity in 2022 as well. Hence, we remain positive on INARI (OP; TP: RM4.00) being the largest local OSAT player and the closest proxy to benefit from the multi-year growth of 5G adoption in smartphones.

Expansion is inevitable as demand continues to surge. While bigger players like TSMC and SMIC have begun their expansion earlier this year, there are companies which adopted the wait-and-see approach to avoid the risk of demand cooling off. However, demand is showing no signs of abating as smartphone shipment in 1QCY21 saw 26% YoY growth while laptop shipment in 1QCY21 jumped 55% YoY. This was due to unfulfilled orders carried forward into 2021 coupled with additional orders brought on by further lockdown implementations as many firms continued to scramble for end-devices to enable employees to work from home. As a result, smaller players like GlobalFroundries recently allocated US$6b to expand its capacity in Singapore (US$4b), Germany (US$1b) and United States (US$1b) and the management anticipates the group to be chasing supply instead of demand in the next five years. This has thrust Kelington Group (OP; TP: RM2.60) into the limelight as it stands to benefit from these fab expansions given its strong presence in China and Singapore. The group is in the midst of tendering for GlobalFroundries ultra-high purity (UHP) gas delivery project and is expecting memory maker Micron Technologies to announce its new Singapore fab expansion in 3Q or 4Q this year as supply of memory chips is tightening.

Soaring automotive sales. Despite media headlines that chip shortages are impacting the automotive market, car sales have continued to rise with China recording 13 months of consecutive growth from May 2020 to May 2021. Europe region lagged behind for a while but has recently picked up speed as their car sales turned positive in Mar 2021 with 87% YoY growth, followed by 219% YoY in April 2021 and 53% YoY in May 2021. The growth is largely attributable to: (i) incentives provided by dealerships, (ii) government rebates to encourage the adoption of electric vehicles, and (iii) change in consumer’s preference to use private vehicles instead of public transport during the pandemic. This has benefited the likes of D&O (OP; TP: RM5.50) which is experiencing overwhelming orders from customers both in China and Europe. From our recent engagement with the management, we learnt that the group has secured orders up till the third quarter this year and is already in discussion for fourth quarter’s orders. With the expectation of automotive sales remaining positive throughout 2021, we believe D&O is poised for another year of record sales and earnings.

Hedging against inflation… Aggressive stimulus programs implemented by governments around the world to support local economies during the pandemic have resulted in a significant rise in money supply. For instance, the United States’ M2 money supply has been on the rise for the past 10 consecutive months, resulting in increased spending as inflation in May 2021 rose 3.9% YoY. Similar trend is observed in Malaysia as the latest consumer price index rose 4.4% YoY in May 2021. This has caused some challenges for automated test equipment (ATE) manufacturers as they are unable to pass on the higher commodity cost to existing customers due to the nature of business where orders received will only be delivered 3-6 months later. Outsourced semiconductor assembly and test (OSAT) players on the other hand are less impacted due to shorter time to market, resulting in shorter repricing lag.

…via e-payment. We view increased inflation as a sign that consumers are eager to spend after being locked down for more than a year with excessed liquidity at hand. Hence, we believe e-payment processors would be the best candidate to ride through this inflationary environment as it has close to zero repricing lag. E-payment processors earn a fee known as merchant discount rate (MRD) for every payment processed. With prices of goods and services on a rise while MDR remains constant, this implies higher revenue for the likes of GHL Systems (OP; RM2.30) and Revenue Group (unrated). Furthermore, with improved vaccination roll-outs, governments are discussing the possibility of cross-border travels in the near future. As part of the ASEAN Payment Connectivity initiative, Bank Negara Malaysia has recently announced a crossborder QR payment linkage between Malaysia and Thailand, allowing citizens in both countries to make and receive crossborder QR-based payments which will go live in 4Q 2021. A continuous push for cross-border digital payment will be a boon for GHL which has already established a strong presence in the ASEAN region with more than 383k touchpoints. Hence, we expect GHL to enjoy accelerated growth upon the re-opening of borders.

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

(i) INARI (OUTPERFORM, TP: RM4.00). Inari recorded an all-time high third quarter earnings for 3QFY21. We expect subsequent quarterly earnings in 4QFY21 to remain satisfactory, on track to achieve our FY21E CNP of RM280.5m. The smartphone market continues to enjoy tailwinds, lifted by the overall demand surge in end-point devices among consumers amid the prolonged work-from-home trend. As the chip shortage continues to send MNCs scrambling for floor space, Inari is constantly receiving enquiries as the group still has 480k sq. ft. of unutilised space in its P34 plant to welcome potential customers. Inari is currently in discussion with three potential MNC customers where two of them are exhibiting high probability of success.

(ii) D&O (OUTPERFORM, TP: RM5.50). Despite 1QFY21 being its weakest quarter, D&O recorded an impressive growth of 577% YoY thanks to strong orders from the China market. We expect upcoming 2QFY21 to chalk up QoQ earnings growth trend, in line with our anticipation of a solid growth throughout FY21 as the order pipeline remains robust. Despite persistent chip shortage, D&O has continued to deliver customer’s orders without hiccups due to proper inventory planning. This is one of the many reasons that help D&O to be a prominent name in the automotive LED space given its niche expertise to not just compete on the global stage but also to continuously generate business wins as it gains more traction among Tier-1 automotive customers.

(iii) GHL (OUTPERFORM, TP: RM2.30). Due to the pandemic which has plagued many cash-based businesses, merchants are seeing an urgent need to digitalise their business and embrace digital payments as consumers are expected to continue using these platforms even as the pandemic eases. This is expected to benefit GHL which has taken the initiative to act as a third-party acquirer to cater to the underserved small to micro companies which in turn accelerates rollout and expands its addressable market beyond top-tier companies. With the ASEAN Payment Connectivity initiative in place, GHL stands to benefit greatly when borders reopen as it has more than 383,600 touchpoints across ASEAN in place to facilitate cross-border transactions.

Source: Kenanga Research - 1 Jul 2021