• U/G to OVERWEIGHT from Neutral; Top Picks: Malaysian Pacific Industries (MPI), Unisem (M), and CTOS Digital (CTOS). We advocate for investors to establish positions in the current early phase of the new semiconductor upcycle, as sector demand and earnings have bottomed. Often lagging the front-end space, our local Automated Test Equipment (ATEs) and OSATs are poised for a 2H24 recovery and further growth into FY25. Valuation metrics should also improve with better growth visibility. We see opportunities in the small- to mid-cap space, as the market has already factored in a slow 1H24.

• The new upcycle begins. The 2022-2023 downcycle that lasted for five quarters has come to an end after several delays. The uptick seen in world semiconductor sales and sustained recovery in the memory space – signalling the onset of a new upcycle – is supported by the end of inventory correction and sturdier demand in the smartphone space and AI-related applications, especially in China. In addition, early recovery indications in the ATE space, along with traction in the front-end semiconductor space, bolster our belief in a sustained sector recovery that is expected to gain pace in 2H24.

• Sector earnings have bottomed, with a YoY improvement expected on the back of various indicators and following our recent extensive channel checks. The recalibration of Street expectations, coupled with the up-trending of KLTEC despite consecutive lacklustre quarters underscores this belief. In fact, many investors remain invested in the technology space despite several pushouts in the recovery. Note: The pace of recovery across segments will be uneven, leading to variability in earnings performance. As such, agile trading strategies to navigate changing market dynamics are essential.

• While near-term valuation may appear elevated at 25x FY24F (at the 5-year mean), it often precedes earnings growth in early recovery phases. As sector recovery gains momentum and catches up to global semiconductor players, valuation metrics are expected to improve. Further sector re-rating could be on the cards when a better order visibility and growth guidance in the upcoming briefing meet investors’ excitement. The US Federal Reserve’s potential rate cut cycle later this year could also support valuation re-rating.

• Top picks. MPI and Unisem are the Top Picks for exposure to the sector recovery, given the exposures to the growing demand for power management integrated circuits (ICs) and diverse end applications. Besides, recovery in China’s semiconductor space following two lacklustre years will help to boost of its utilisation rate and economies of scale at their existing plants in China. They also stand to benefit from US-China trade tensions in both of their plants in Malaysia as a neutral ground, as well as from China’s self-sustaining policies.

• For non-semiconductor, the robust domestic economy, inbound tourist arrivals, and various digitalisation initiatives to drive the private sector and SME space should continue to spur demand, in our view. We like CTOS for its domestic-focused business, leading position, and growth prospects from its various digital solutions, analytical insights, and exposure to fintech.

• Downside risks: Softer consumer demand, unfavourable FX, obsolescence of technology, loss of clients/contract, and intensifying geopolitical tensions.

Source: RHB Securities Research - 1 Apr 2024