As  we  approach  the  upcoming  3QCY12  results  season,  we  examine  some  of  the global  technology  industry's  key  indicators  and  assess  their  potential  impact  on technology  manufacturers  under  our  coverage.  We  also  see  the  gloom  in  the global  PC  market  in  2H  shrouding  the  HDD  industry.  That  said,  the  global semiconductor  market  would  also  see  sub-par  numbers.  Despite  the  bleakoutlook,  we  are  retaining  our  NEUTRAL  call  on  the  sector  in  view  of  the inexpensive valuation of the stocks under our coverage.

Mediocre  2H  PC  sales  seen.  PC  sales  tend  to  be  stronger  in  2H  but  according  to International  Data  Corporation  (IDC),  the  3QCY12  back-to-school  season  was  a challenging period due to potential demand being deferred to 4Q. Meanwhile, we do not think  that  Windows  8  (W8),  which  we  understand  is  poised  to  make  a  debut  later  this month, could dominate the market like Windows 7 (W7) did. Thus, we are reiterating our previous forecast that 2H PC shipments will grow by a low single-digit.

HDD  makers  brace  for  poor  3QCY12.  Mirroring  the  global  PC  market,  the  worldwide HDD  industry  has  been  experiencing  muted  demand  and  inventory  rebalancing.  Seagate  and  Western  Digital  (WDC)  have  slashed  their  upcoming  3QCY12  revenue forecasts by 5%-7%. The two global giants have also revised lower their expected total addressable market (TAM) for the September quarter from 157m units to 140m units.

Worldwide semiconductor sales to  remain flat in 2H. The worldwide semiconductor sales  of  USD24.3bn  in  August  marked  the  second  consecutive  month  of  flat  growth (+0.1%  m-o-m).  Meanwhile,  the  book-to-bill  ratio  of  semiconductor  equipment manufacturers  has  stayed  below  parity  (at  0.84)  for  the  third  consecutive  month.  The global semiconductor industry's outlook will remain challenging for the remainder of the year given the muted demand from technological products other than smartphones and tablets.  We  are  reiterating  our  prior  expectation  of  flat  growth  for  2012  given  that  the 8MCY12 global semiconductor sales are already down 4.7% y-o-y.

Maintain NEUTRAL. Given the headwinds faced by the global HDD market, we cut our earnings estimates by 13% for JCY and 9% for Notion for FY13. However, strictly based on valuation, we find both stocks inexpensive and thusupgrade JCY (FV: RM0.88) and Notion  (FV:  RM1.20)  to  TRADING  BUYs.  Meanwhile,  our  forecasts  and  FVs  for  local semiconductor  packaging  and  testing  companies  are  unchanged.  MPI  (FV:  RM2.72) remains  NEUTRAL  although  we  are  upgrading  Unisem  (FV:  RM1.21)  to  TRADING BUY since the stock offers a potential upside of 21%. Despite the three TRADING BUYs versus  one  NEUTRAL  call  in  our  technology  universe,  we  are  retaining  our  NEUTRAL recommendation on the sector. We are keeping a close eye on all  developments within the global PC, HDD and semiconductor space.

Headwinds  in  global  PC market.  PC shipments  have been  sluggish  for  the  past  seven quarters, posting  flat  to  single-digit  growths,  despite  the  recent  introduction  of  the  ultrabook.  Typically,  PC sales  tend  to  be  stronger  in  2H  but  according  to  IDC, 3QCY12's back-to-school  season  was  a challenging period. We understand that W8 is poised for a debut later this month and a small group of consumers may be waiting for the new batch of PCs to be pre-installed with the new OS, thereby potentially backloading demand. However, giant PC makers from the US, Hewlett Packard and Dell, think otherwise and have warned of slower demand for the remaining of the year. We also noticed a shift in consumer preferences towards smartphones and tablets, which served another blow to the mature PC market.

Gloomy  prospects  for  Windows  8.  For  the  past  three  years,  Microsoft  has  sold  over  630m Windows 7 (W7) licences and now commands a market share of >40%. Since then, the  operating system (OS) has become the all-time fastest-selling version of Windows. As seen in Figure 2, W7 dominated the OS market swiftly whereas its predecessor Windows Vista had failed to do so. As for the  soon-to-be  released  W8,  we  do  not  think  it  will  become  a  market  mover  given  that  the  early adopters of W7 are only three years old. Other reasons for a potentially slower W8 update include: i) the  advent  of  the  touch  user  interface,  which  is  prompting  existing  users  to  unnecessarily  replace their PC hardware, ii) a strong resistance to change, especially for those who recently switched over to  W7,  iii)  it  requires  major  retraining  for  Windows  users,  iv)  it  is  not  suitable  for  business environments and v) there is a lack of application compatibility.

Microsoft  Surface  a  growth  avenue.  Later  this  month,  Microsoft  will  introduce  its  own  line  of tablets,  Surface,  to  tap  the  fast-growing  market.  This  signals  a  paradigm  shift  in  which  Microsoft ventures  into  the  hardware  space  to  indirectly  compete  with  its  customers  '  the  PC  makers.  The move poses a significant threat to the symbiotic relationship between Microsoft and its PC partners. It  also  implies  that  Microsoft  is  anticipating  greater  growth  prospects  for  Surface  compared  to  its legacy OS products which cater toward the PC market.

2H to see slower PC shipment growth. All in all, we are reiterating our previous expectation of 2H PC  shipments  registering  low  single-digit  growth.  Recall  that  couple  of  months  back,  Gartner  had cut its 2012 global shipment forecast for the second time this year from 4.4% to 2.7%. Meanwhile, IDC expects worldwide PC shipments to grow at a four-year CAGR of 7.1%, down from the previous 2012-2016 forecast of 8.4%.

Seagate  and  WDC  fall  short.  Mirroring  the  global  PC  market,  the  worldwide  HDD  industry  was dragged  down  by  muted  demand  and  inventory  rebalancing.  Seagate  and Western  Digital  (WDC) both slashed their upcoming 3QCY12 revenue forecasts by 5%-7%. Furthermore, they also revised their total TAM target from 157m units to 140m units for the September quarter. However, they were silent  on  ASP trends  but  we  think that it  should  decline  at a  quicker pace  but  still stay  above  pre-Thai flood levels; the current triopolistic HDD market provides better price control than before due to less intense competition.

Thai  floods  not  as  bad  as  last  year.  We  gathered  that  the  recent  floods  in  Thailand  were  less severe compared to last year's. Nonetheless, we remain  vigilant  on  the  situation.  Until  now,  both Seagate  and  WDC  have  not  commented  or  released  any  statements  with  regards  to  their  Thai operations. The former has plants located in Samut Prakan and Nakhon Ratchasima while the latter has  facilities  in  the  Pathum  Thani  and  Ayutthaya  provinces.  Of  these,  only  Ayutthaya  is  currently flooded  (see  Figure  5).  Recall  that  last  year,  WDC  was  badly  affected  by  the  catastrophe  while Seagate was unscathed. We will obtain a clearer picture when both companies hold their 1QFY13 results  conference call  later  this  month.  Nonetheless,  based  on  our  channel  checks  with  JCY and Notion's management, we understand the flood situation in Thailand is not as dire as last year's and their  operations  are  still  intact.  JCY  and  Notion  have  a  presence  in  the  Sraburi  and  Ayutthaya
provinces respectively.

Second  straight  month  of  flat  semiconductor  sales.  According  to  the  Semiconductor  Industry Association  (SIA),  the  August  worldwide  semiconductor  sales  of  USD24.3bn  marked  the  second consecutive month of flat growth (+0.1% m-o-m). Stagnant regions include the Americas (+1.0% m-o-m), Japan (+1.0% m-o-m) and Asia (+0.0% m-o-m), whereas Europe was the only continent that shrank (-1.9% m-o-m). Sales were also down y-o-y and YTD across all regions. The outlook for the global  semiconductor  industry  continues  to  be  challenging  for  the  remainder  of  the  year  given  the muted demand from technological products other than smartphones and tablets.

Book-to-bill ratio stays below 1. The billings of semiconductor equipment manufacturers continue to  outpace  bookings  in  August,  with  the  former  declining  at  a  slower  rate  m-o-m  compared  to  the latter  (-7.4%  vs  -9.2%).  Hence,  the  book-to-bill  ratio  stayed  below  parity  (at  0.84)  for  the  third consecutive month. Also, on the back of reduced demand, Semiconductor Equipment and Materials International  (SEMI)  expect  2H  to  show  a  similar  trend  due  to  persistent  weakness  in  overall industry capex spending cycle.

Flat worldwide semiconductor sales in 2H. We are reiterating our prior expectation of flat growth for  2012  given  that  8MCY12  global  semiconductor  sales  had  already  declined  by  4.7%.  Recently, Intel, the world's largest PC chipmaker, cut its 3QCY12 sales forecast by 6%-9%, citing a sluggish enterprise  PC  market  and  waning  PC  demand  from  emerging  markets.  Recall  that  World Semiconductor  Trade  Statistics  (WSTS)  had  projected  global  semiconductor  sales  growth  of  only 0.4% y-o-y from 2011 and anticipates the industry to grow 4%-7% for the next two years.

VALUATION & RECOMMENDATION 

JCY (TRADING BUY; FV: RM0.88) undervalued. Having reported weak numbers in its last quarter and given the worsening outlook for the global PC and HDD industries, we are cutting JCY's FY13 earnings by 13.1%. We are also lowering our valuation multiple from 6.4x to 4.5x FY13 PE to derive a new FV of RM0.88 (previous FV: RM1.44). The revision is justified, based on the average forward PE  of  Seagate  and WDC (shown  in  Table 3).  At the current  market  price,  JCY  offers  a 12%  price upside  as  well  as  an  attractive  dividend  yield  of  10%.  Despite  the  macro  headwinds,  the  stock  is undervalued. This prompts us to upgrade JCY from NEUTRAL to TRADING BUY.

Notion (TRADING BUY; FV: RM1.20) lifted by its camera segment. Notion's last quarterly results were similarly dragged down by its HDD segment but we saw encouraging numbers from its camera business. However, recent industry statistics from Camera & Imaging Products Association (CIPA) indicated that shipments for cameras with interchangeable lens (CIL) contracted in July (-0.2% m-o-m) and August (-4.8% m-o-m). We are not perturbed, as shipments usually peak in September and October.  Moreover,  2H  is  typically  the  strongest  shipment  period  for  CILs.  That  said,  we  are  still revising  lower  Notion's FY13 earnings by 8.8% to incorporate  the  challenges  facing  the  HDD segment and to err on the conservative. Nevertheless, we are maintaining our valuation multiple of 6.4x FY13 PE given its diversified product base. Notion's 3QFY12 revenue contribution from its HDD:Camera:Auto  segments  stand  at  38%:49%:13%  respectively.  Our  new  FV  of  RM1.20 (previous FV: RM1.30) offers an upside of 14% and hence, we upgrade the stock from NEUTRAL to TRADING BUY.

Feb-March  2013  the  best  time  to  bottom-fish  for  MPI  and  Unisem.  Status  quo  on  MPI  and Unisem  given  that  we  are maintaining  our  prior  outlook  on  the  global semiconductor  industry.  MPI has  a  FV  of  RM2.72  while  Unisem's FV  is  RM1.21.  The  former  remains  a  NEUTRAL  but  we  are upgrading  the  latter  to  TRADING  BUY  since  it  has  a  sizeable  upside  of  21%.  Recall  that  we  had pegged both stocks to 0.8x CY13 P/NTA (40% discount to the historical five-year sector average of 1.4x). That said, we think Feb-March 2013 is the best time to accumulate either stock as we expect to  see  a  rerating  for  the  sector.  Figure  9  indicates  that  the  y-o-y  changes  of  the  monthly  global semiconductor  sales  are  strongly  correlated  to  the  forward  P/NTA  valuation  of  both  MPI  and Unisem.  Thus,  with  the  expectation  that  worldwide  semiconductor  sales  will  be  flat  in  2H  plus  the typical  weak  1Q  for  next  year,  Feb-March  2013  is  the  best  time  to  bottom-fish  and  ride  on  the uptrend for 2QCY13.

Source: OSK