Kenanga Research & Investment

Technology - 4QCY22 Results Review: A Mixed Bag

Publish date: Tue, 07 Mar 2023, 09:17 AM

We maintain our NEUTRAL rating on the technology sector. To be sure, the 4QCY22 results season was less disappointing QoQ, but this was mainly due to a slew of earnings cuts in the prior quarterly review. That said, MPI, SKP and D&O still reported earnings which came below expectations owing to unabsorbed overheads incurred to expand their capacity and workforce in anticipation of higher orders that never materialise. Most players under our coverage expect the inventory correction to continue over the near term as China’s reopening has not translated to any major surge in demand. We continue to like names such as: (i) KGB (OP; TP: RM1.92) for its strong earnings visibility backed by a RM1.7b orderbook, and (ii) LGMS (OP; TP: RM1.50) which operates in the high-growth cybersecurity space.

Little year-end boost in 4QCY22. For all the 12 companies under our coverage, the overall results improved sequentially; with 33%, 33%, and 33% coming in above, within and below our forecasts vs. 9%, 27%, and 64% for the preceding quarter, respectively (see Exhibit 1).

Earnings were evenly distributed for most of the companies under our coverage following a round of earnings cut during the previous quarterly results review. The lower comparative earnings base also helped GHLSYS and JHM to post 3QCY22 results that outperformed expectations. While GHLSYS (upgraded to OP; TP: RM1.05 from MP; TP: RM0.80) experienced better-than-expected transaction volume during the Christmas season, JHM’s (MP; TP: RM0.80) better performance was merely due to a low base effect rather than improved fundamentals. On the other hand, both KGB (OP; TP: RM1.92) and NATGATE (OP; TP: RM1.50) exceeded expectations; on better project recognition for KGB’s ultra-high-purity gas solution segment while NATGATE saw improved margins thanks to better optimisation of its floor space utilisation. Hence, we upgrade our target prices for both KGB and NATGATE by 7% and 76%, respectively.

On the flip side, D&O, MPI and SKP came in below expectations largely due to underutilised capacity. All three companies expanded their floor space and workforce in anticipation of higher demand which did not materialise due to reduced orders from customers to align with softening consumer demand. This led to unabsorbed overhead, higher depreciation and margin compression. As such, we downgrade our recommendation for all three companies to UNDERPERFORM.

Maintain NEUTRAL. All in, we reiterate our NEUTRAL stance on the technology sector owing to a prolonged inventory correction. Many players have also indicated that China’s reopening has yet to translate into meaningful recovery given the dampened sentiment surrounding the consumer electronics segment. Not helping either is the high interest rate and inflationary environment which had led to downbeat order forecasts from customers. To prevent further margin erosion, MPI has opted to delay the completion of its second plant in Suzhou by three months. Meanwhile, JHM also indicated that its Batu Kawan expansion will remain on hold until sentiment improves. That said, we still see value in selected names that possess resilient earnings visibility. We like KGB (OP; TP: RM1.92) for: (i) it being a direct proxy to the front-end wafer fab expansion, (ii) its strong earnings visibility underpinned by robust order book and tender book exceeding RM1b, and (iii) its strong foothold in multiple markets, i.e. Malaysia, Singapore and China. We also favour LGMS (OP; TP: RM1.50) for: (i) its involvement in the high-growth cybersecurity space, (ii) the deep moat around its business given the high entry barrier created by the tough qualification process as a vendor, and (iii) its new proprietary certification software which is expected to be the next earnings driver.

Source: Kenanga Research - 7 Mar 2023

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