• Top Picks: CTOS Digital, Inari Amertron, Datasonic Group. News flow on the iPhone ban and the lack of novelty excitement on the iPhone 15 may spell headwinds for sales volumes, especially in China (likely exacerbated by patriotic sensibilities and Huawei’s comeback). We stay cautious on the overall chip sector, on a protracted slowdown and high valuations. We prefer domestic-focused names, given the relatively stable demand, and advocate a beta play to track the global chip sector run-up. Also, look out for thematic plays on potential beneficiaries of Huawei’s supply chain. Still NEUTRAL.

• 2Q23 results for the sector were mostly in line, following some pre-emptive earnings estimate cuts earlier. Nonetheless, three out of nine companies missed expectations: Unisem, JHM Consolidation, and Coraza Integrated Technology – due to slower demand and the loss of economies of scale, coupled with higher input costs. Meanwhile, Malaysian Pacific Industries came in above expectations on better margins, boosted by the strong USD.

• A Huawei comeback? The new iPhone 15 range (no price increase), with very few new features and improvements (a better camera, titanium casing for Pro models, RAM, and 3-nm A17 Bionic chip) may struggle to lift sales volumes. We note the emergence of patriotic sentiment following the reported ban on iPhones for government workers in China. Also, the impressive resurgence of Huawei – from its new phone line-up in the Mate X5 and Mate 60 range – could shake-up the China market (accounts for 20% of iPhone sales volumes). The once-dominant smartphone giant may regain ground with its home-grown technology breakthrough in 7nm (N+2) chip-making capabilities by SMIC, with an anticipated target volume of 12m this year and 40-60m phones in 2024. Key beneficiaries in Huawei’s smartphone supply chain: JF Technology (JFTB MK, NR) and Oppstar (OPPSTAR MK, NR).

• Earnings may have bottomed, stronger HoH expected. The market is now aggressively pricing in high growth prospects for FY24F and potential new customer wins, with KLTEC trading at 25x P/E vs a 27.1% growth in 2024F, after the recent round of cuts in consensus earnings forecasts. However, investor sentiment has improved on potential new opportunities and clientele, amid expectations that US’ tightening of its monetary policy is close to peaking. We note the sector’s unappealing valuations, as a full-blown recovery remains some way off and some stocks’ valuations are still well above pre-pandemic levels. Solid balance sheets and the sturdy USD should help provide some level of cushion.

• Top Picks: We like CTOS Digital for its domestic-focused business, leading position, and growth prospects in its digital solutions and fintech. Among smaller caps, we like Datasonic as we expect sustained strong demand for its solutions in national security projects and potential new project wins. For semiconductor exposure, we recommend a beta play in Inari Amertron as a proxy to the industry, given its strong liquidity and relatively large market cap. Sector upside/downside risks: i) Stronger/softer consumer demand, ii) favourable/unfavourable FX, iii) obsolescence of technology, iv) new customer wins/loss of clients, v) improving/intensifying geopolitical tensions.

Source: RHB Securities Research - 13 Sept 2023