• Top Picks: CTOS Digital (CTOS) and Coraza Integrated Technology (Coraza). In 3Q22, signs of a slowdown emerged among the companies related to the chip segment, while non-semiconductor players did well. We believe 4Q22 will be another uninspiring quarter, with a prolonged weakening in demand. Meanwhile, any inventory correction may only normalise in 2Q23F, but growth in certain sub-segments should be sustained. Sector valuations are now rather fair, given the potential earnings risks – albeit offset by a less hawkish tone from regulators in the near term. Stay NEUTRAL.

• A mixed quarter. Three out of four OSAT companies reported lower-than- expected 3Q22 results, with a YoY decline in earnings except for Unisem (M). These firms were affected by lower loadings and decreasing economies of scale, amid the slowdown in demand for consumer electronics. Coraza’s results were slightly behind estimates, despite earnings and revenue surging by 37% YoY and 51% YoY, as input costs and additional plant set-up costs rose. The only results that were above expectations come from CTOS, whose core PATAMI almost doubled YoY, supported by strong growth in all business segments and contributions from various acquisitions. Meanwhile, both Datasonic Group (DSON) and GHL Systems booked numbers that were in line, with better YoY growth.

• Sector earnings. The sector’s 3Q22 aggregate core PATAMI grew 5.6% YoY but contracted 2.6% QoQ, with five out of eight companies reporting solid growth – the significantly better numbers from DSON and CTOS offset the weakness from the OSAT players. We cut sector earnings forecasts by 9.5%, mainly on the revisions made on estimates for Inari Amertron and Malaysian Pacific Industries as we expect the weakness to persist in 4Q22, as the sector will likely continue to grapple with decelerating demand.

• Outlook. Overall, the guidance from the chip-related companies is less bullish for the near term, but the non-semiconductor players should see brighter prospects – with the main challenges being labour and material shortages, demand uncertainties, and geopolitical tensions. Overall, the sector is still clouded by weakening demand for consumer products – as people have been affected by spiking and rampant inflation, geopolitical tensions, and the impact of China’s lockdowns and weaknesses in Europe. The few bright spots lie in vehicle electrification, servers and high-performance computing related chips.

• Sector valuations should be capped by rising bond yields and the quantitative tightening cycle. Also, firms being unable to meet their earnings projections due to multiple uncertainties should not be discounted. That said, their solid balance sheets and the strong USD should cushion exporters from feeling the pain of the demand slowdown. We like companies with exposure to front-end players, automotive and high-performance computing, as their outlook remains relatively stable. We like CTOS for its leading position and growth prospects – on the higher demand for its various digital solutions, analytical insights, and exposure to fintech. We also like Coraza – this proxy, on the robust demand for front-end equipment and the E&E ecosystem in Penang. It is on a solid growth path, and powered by a robust orderbook.

• Upside/downside risks: i) Strengthening/softening smartphone sales, ii) favourable/unfavourable FX movements, iii) strong/weak consumer demand, iv) obsolescence of technology, and v) intensifying geopolitical conflicts.

Source: RHB Research - 5 Dec 2022