We reiterate our OVERWEIGHT call on the sector as we move into 2016. We expect share prices of the export-oriented technology manufacturers to be supported by the continued weakness in the MYR against the USD. Inari Amertron and Globetronics remain our Top Buys.

Focus on earnings growth. The MYR’s continued weakness against the USD is likely to help propel earnings growth for the export-oriented technology players’ 4Q15 results releases in Jan-Feb 2016. To recap, the USD/MYR averaged MYR4.29 for Oct-Nov 2015 vis-à-vis 3Q15’s MYR4.05 (+5.9% QoQ) and 4Q14’s MYR3.37 (+20.2% YoY). We expect the current downtrend to persist over the immediate term, as the US Federal Reserve is widely anticipated to raise rates this month. Our in-house USD/MYR forecast is at an average of MYR4.34 for 2016. We estimate that every 1% depreciation in the MYR against the USD could translate into earnings upgrades of 3-5% for the technology manufacturers under our coverage, ceteris paribus.

Internet-of-Things (IoT) to help propel long term demand. Overall, industry experts are cautiously optimistic on 2016 semiconductor sales forecasts, with growth estimates ranging from 1.9-6.0%. We believe that the gradually-increasing semiconductor content per device under the migration towards IoT would help to sustain demand for semiconductor components. We expect the earnings growth momentum of the local technology exporters to outpace the global industry as a whole over the medium term. This is because of: i) Malaysia’s relatively small base – the combined revenue share of the semiconductor players under our coverage makes up less than 0.6% of 2015 global semiconductor sales, and ii) local players’ attempts to penetrate into new products or sub-segments of their existing customers’ portfolios.

Top Picks are Inari Amertron (Inari) (INRI MK, BUY, TP: MYR4.55) and Globetronics (GTB MK, BUY, TP: MYR7.10). Inari is set to further expand its radio frequency integrated circuits (RFIC) division by riding on escalating demand for Avago Technologies’ (Avago) (AVGO US, NR) film bulk acoustic resonator filters. On top of hat, the group is working closely with Avago to grow its fibre-optics products division by offering value-added services for the latter’s existing fibre-optics connector offerings. Subsequently, it would market these products to Tier-2 and Tier-3 customers that Avago currently does not serve. Globetronics, on the other hand, will soon commence commercial production of its new 3D imaging sensors for its existing major Swiss customer, with full volume loadings of 30m-40m units per month by 2Q16. Key risks to our bullish stance on the sector include a potential recovery of MYR against USD and potential decline in worldwide demand for semiconductor components should global economic recovery falter.

3Q15 a mixed quarter

3Q15 was a mixed quarter for the technology stocks under our coverage as exporters continue to outshine the local-centric players. In particular, two/three/two companies reported earnings that were below/within/above our expectations respectively. Export-oriented manufacturing companies including Malaysian Pacific Industries (MPI) (MPI MK, BUY, TP: MYR11.46) and Unisem (UNI MK, NEUTRAL, TP: MYR2.67) reported positive earnings surprises driven by a favourable forex environment, as the USD averaged at MYR4.05 during the quarter (vs MYR3.66 in 2Q15 and MYR3.19 in 3Q14). Inari’s 1QFY16 (Jun) numbers came in within expectations while Globetronics reported a slight miss in its 9M15 performance due to start-up expenses incurred for its 3D imaging sensors. On the other hand, non-export players such as Prestariang (PRES MK, NEUTRAL, TP: MYR2.48) and Datasonic (DSON MK, NEUTRAL, TP: MYR1.51) reported decent results for the quarter, while GHL Systems (GHLS MK, NEUTRAL, TP: MYR1.08) reported disappointing earnings as the introduction of the goods and services tax (GST) continued to exert pressure on consumer spending in Malaysia.

4Q15 earnings momentum to further leverage on MYR weakness

Looking ahead, the continued weakness of the MYR against the USD is likely to help propel earnings growth for export-oriented technology players – which may be seen in their 4Q15 results releases, ie by Jan-Feb 2016. To recap, the USD/MYR averaged MYR4.29 for Oct-Nov 2015 vis-à-vis 3Q15’s MYR4.05 (+5.9% QoQ) and 4Q14’s MYR3.37 (+20.2% YoY). We expect the MYR’s downtrend to persist over the immediate term, as the US Federal Reserve is widely anticipated to raise rates this month. Our in-house USD/MYR forecast is at an average of MYR4.34 for 2016. We estimate that every 1% depreciation in the MYR against the USD could translate into earnings upgrades of 3-5% for the technology manufacturers under our coverage, ceteris paribus. While we acknowledge that the positive impact might not be fully felt as we expect their direct customers to push for more competitive pricing in view of the current MYR weakness, we believe this could help to provide a short-term buffer to mitigate the impact from the ASP erosion upon product maturity.

Industry experts cautiously optimistic on 2016 outlook Overall, industry experts are cautiously optimistic on 2016’s semiconductor sales forecasts with growth estimates ranging from 1.9% to 6.0%. While we acknowledge that the consumer sentiment in major economies such as the US, China and Japan is relatively volatile, we believe the gradually increasing semiconductor content per device under the migration towards IoT would help to sustain demand for semiconductor components over the medium term. More importantly, we expect the earnings growth momentum of the local technology exporters to outpace the global industry as a whole over the medium term.

This is due to the following: i) Malaysia’s relatively small base – the combined revenue share of the semiconductor players under our coverage makes up less than 0.6% of 2015’s global semiconductor sales, and ii) local players strive to penetrate into new products or sub-segments of their existing customers’ portfolios.

IoT-related components growth to outpace smartphone International Data Corp (IDC) reported that 3Q15 global smartphone shipments rose 6.8% YoY to 355.2m units. For 9M15, shipments registered 1.02bn units at an implied YoY growth rate of 12.0%. We deem this within our previous guidance of 10-15% growth. Looking ahead, we expect the growth momentum to slow down to 5%-8% pa in 2016-2020. This is as the higher demand from emerging economies such as India, South Africa, the Middle East and Latin America (in tandem with the rollout of next-generation 4G networks in those regions) would be partly offset by slowing growth in China as the world’s largest market is gradually maturing.

That said, the potential slowdown in growth under the communication segment, in our view, would be offset by the escalating demand for semiconductor components in IoT-related industries. This is because consumers are gradually migrating towards the new ecosystem over the next 2-3 years. Investments in back-end infrastructure and purchases of next-generation electronics devices (not to mention the overall higher semiconductor content per device) would help spur semiconductor sales in the long run. This is consistent with Gartner’s findings, which expects demand for semiconductor components – particularly the automotive and industrial segments – to have the fastest growth rate of 8.2% and 9.7% CAGR respectively over the next five years. We expect industrial demand to be driven by production automation in factories and the establishment of smart homes focusing on light-emitting diode (LED) lightings and digital video surveillance products. In the automotive industry, we believe growth would likely be propelled by the increasing popularity of electric and hybrid cars. Other areas of growth include the introduction of features such as advanced driver assistance systems and various safety-enhancing monitoring and sensor systems

Potential revival of the tablet market 3Q15 global tablet sales declined YoY for the fourth consecutive quarter, with shipments dropping 12.6% YoY to 48.6m. We attribute the continued weakness to the cannibalisation impact from the introduction of bigger-screen phablets and a lack of new innovative launches over the past 6-12 months. We are hoping for a potential revival of interest for tablet purchases come 2016 – with the enterprise market gradually warming up to accepting hybrid tablets as business-friendly devices. Notably, Microsoft (MSFT US, NR) launched its new Surface Book laptop and Surface Pro 4 tablet at end October. Although the official sales numbers have yet to be made available at this juncture, these new products have received rave reviews from professional technology websites (such as www.techradar.com, www.digitaltrends.com and www.ign.com). Apple (AAPL US, NR), meanwhile, has started shipping its 12.9-inch iPad Pro tablet in mid-Nov. The large-screen tablet marks one of the latest initiatives by the technology giant to penetrate into the enterprise market.

PC sales remained sluggish despite positive reviews on Windows 10 On a side note, both Gartner and IDC reaffirmed their bearish stance on the traditional personal computer (PC) market at annual forecasts of -4.4% and -8.7% respectively for 2015. This is consistent with their 9M15 findings, as PC sales remained sluggish. While the newly-launched Windows 10 operating system has received rave reviews, this has yet to spark a revival in the PC replacement cycle. We believe this is due to most users opting for operating system (OS) upgrades, for which Microsoft is offering for free for a year, instead of purchasing a new PC that comes pre-installed with the new OS

Still an OVERWEIGHT stance

All in, we reiterate our OVERWEIGHT call on the technology sector as we move into 2016. Despite the current weakness in the local equity market, we expect near-term sentiment on technology stocks to be supported by the continued weakness in the MYR against the USD. This in turn would further enhance earnings visibility. Our Top Picks are Inari and Globetronics, as the duo’s FY15F-17F earnings growth is likely to ride on: i) resilient demand for existing products, ii) penetration into new sub-segments on their existing customers’ products portfolios, and iii) a favourable forex environment on top of their sturdy balance sheets

Notably, Inari’s RFIC division currently houses 600 units of testers. Management is looking to increase the number to more than 800 units by Oct 2016, to be in line with Avago’s volume requirements. We estimate revenue from Inari’s RFIC division to grow 35%/20%/5% YoY in FY16F/FY17F/FY18F. On a side note, the wafer supply bottleneck at Avago’s level is gradually being resolved as volume picked up in 3Q15. The group is also working closely with Avago to grow its fibre-optic products division by offering value-added services on the latter’s existing fibre-optics connector offerings. It plans to subsequently market these products to Tier-2 and Tier-3 customers that Avago currently does not serve. Inari has set aside MYR100m-120m for its FY16 capex. This includes MYR45m for machinery procurement, MYR35m for a new production facility, while the balance would cater for automation and procurement of wafer probers. We expect this to be funded internally, with the group’s net cash closing at MYR205.6m as at September. Management is currently exploring the possibility of setting up a new site on Penang Island to further expand its RFIC capacity by another 30%. Upon completion of its proposed 1-for-4 bonus issue, our ex-bonus TP would be revised accordingly to MYR3.64.

Globetronics, meanwhile, is set to ride on the introduction of its 3D imaging sensor, which we suspect would be used in the next-generation smartphones that are slated for launch in 2H16. The group has allocated MYR60m-70m in capex over the next two years to ramp up the rollout of this new product. Full production capacity of 30m-40m units per month would likely be achieved by 2Q16. Based on our back-of-envelope calculations, the imaging sensor segment could potentially translate into an additional revenue contribution of MYR200m-250m pa on a full-year basis.

Key risks. Key risks to our bullish stance on the sector include: i) a potential recovery of the MYR against the USD, which could affect the sector’s earnings visibility; ii) a potential decline in the worldwide demand for semiconductor components should the global economic recovery falter; and iii) potential margins erosion in the long run given that packaging and testing services are at the lower-end of the semiconductor supply chain.

Source: RHB Research - 4 Dec 2015