Kenanga Research & Investment

Technology - Chip Sales Decline, Cautious Outlook Persists

Publish date: Wed, 12 Jul 2023, 09:45 AM

We maintain a NEUTRAL stance on the technology sector following the World Semiconductor Trade Statistic (WSTS) downward revision in global semiconductor sales to -10.3% for 2023 (previously -4.1%), coupled with persisting operating challenges faced by players due to underwhelming order recovery. Not helping, companies across our coverage have expanded their capacity and workforce which are now underutilised, contributing to further margin pressure. Smartphone shipments continue to decline while renewed orders for automotive semiconductors remain weak as car manufacturers are still paring down existing inventories. However, certain EMS companies in the industrial products space, such as PIE (OP: TP: RM4.05) and NATGATE (OP; TP: RM1.40) are benefiting from healthy order pipelines. We also like the resilient earnings visibility in KGB (OP; TP: RM1.92) and the growing cybersecurity awareness which benefit the likes of LGMS (OP; TP: RM1.32).

We maintain our NEUTRAL call on the technology sector following the underwhelming outlook indicated by players under our coverage. In response to escalating inflation and weakening demand in end-products, particularly those dependent on consumer spending, WSTS has further revised its projections of global semiconductor demand downwards in May 2023 to a -10.3% contraction in 2023 (vs. a previous forecast of -4.1%). While the discrete semiconductor and optoelectronics categories are expected to maintain single-digit YoY growth in 2023, with an estimate of 5.6% and 4.6%, respectively, this will likely be entirely offset by other categories which are expected to dip into negative growth territory. This includes memory, which is forecasted to experience a significant decline of 35% YoY.

Looking specifically at regional trends for 2023, growth is anticipated in the European and Japanese markets, with projected increases of 6.3% and 1.2%, respectively. On the other hand, a downturn is expected in the remaining regions, with the Americas forecasted to decline by 9.1% and the Asia Pacific region by 15.1%. According to actual global chip sales tracked by the Semiconductor Industry Association (SIA), the demand in 2023 thus far has remained subdued. Despite a modest MoM increase of 0.3% in chip sales in March 2023 (marking the first MoM gain in 10 months since May 2022), it was still a steep decline of 21.3% YoY, resulting in an overall 8.7% YoY decline for 1QCY23. Unfortunately, the latest data indicates that the lacklustre trend has continued in April with chip sales experiencing a substantial 21.3% YoY decrease (see Exhibit 4) across all regions, with China and the Asia Pacific region weighing heavily.

Actual orders continued to diverge from forecasts. Focusing on players under our coverage, we learnt that the 1QCY23 brought a wave of challenges that will likely continue into the subsequent quarters. In addition to the seasonal dip in earnings due to shorter working days during Chinese New Year, companies were faced with disappointing order recovery on an expanded workforce which led to margin pressure. The situation was exacerbated by the recent surge in electricity costs for commercial usage, as well as the lingering effects of the wage hike for foreign workers. In light of these challenges, players are navigating a landscape of elevated operating costs, prompting a cautious approach to rationalise operating cost. This caution stems from the glaring disparity between the optimistic forecasts verbally indicated by customers and the actual orders committed.

Focused on alleviating margin pressure. To combat further erosion of margins, players will prioritise implementing measures aimed at mitigating those challenges. For instance, MPI (UP; TP: RM15.26) is bracing itself for yet another quarter of net loss (albeit reduced) and has made the decision to delay the completion of its new plant in China for the second time. The revised timeline now extends the completion date to January 2025, incurring a fine of USD900k. D&O (UP; TP: RM2.68), with a substantial 50% of revenue generated from China, has cautioned about the slower-than-expected recovery in the country, which continues to exert downward pressure on their earnings. Consequently, efforts to streamline their workforce and align it with the prevailing soft outlook will persist. Similarly, SKPRES (UP; TP: RM0.95) is nearing the completion of its new c.650k sq ft plant (representing a significant c.50% increase in total floor space) next month but has yet to secure any anchor customer. If unsuccessful, the company may have to implement cost cutting measures by not renewing permits for a portion of its foreign workers which are now underutilised due to order cuts by existing customers. As a result, earnings in the upcoming quarters are expected to remain subdued, with only marginal improvements.

Prospects for smart phone remains dim following the 14.6% YoY decline in 1QCY23 global shipment as published by the International Data Corporation (IDC), which came in worse that the forecasted decline of 12.7% YoY. This marks the seventh consecutive quarter of YoY decline, owing to the underwhelming consumer demand in light of rising inflation and growing macro uncertainties. IDC noted that smartphone manufacturers globally have continued to exercise caution, adopting a prudent strategy instead of flooding the channel with excess stock in pursuit of short-term gains. We also maintain our neutral view on INARI (MP; TP: RM2.46) given its large exposure (c.60% of group revenue) to the smartphone radio frequency (RF) business. While the company continues to explore new product lines and work on its expansion in China, these efforts may not yield immediate relief to offset the existing weakness.

Source: Kenanga Research - 12 Jul 2023

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