• We favour the non-semiconductor space given the stable demand with domestic-focused business, while the semiconductor market will remain in the doldrums in 1H23 in view of the seasonal softness and ongoing inventory adjustment for consumer products. Sector valuation is fair at its 5-year mean, capped by elevated bond yields with risk of derailed earnings. Keep NEUTRAL; Top Picks: CTOS Digital (CTOS), Unisem (M) and JHM Consolidation (JHMC).

• 4Q22 results recap. We have a mixture of hits and misses, with better-than- expected performance coming from Datasonic Group, Globetronics Technology and Coraza Integrated Technology while Malaysian Pacific Industries underperformed. The sector’s 4Q22 aggregate PATAMI contracted by 6.7% YoY and was flattish QoQ (+1.8%), with all but two companies reporting growth. As such, we lower sector FY23F earnings by 3.1%.

• Slowdown to persist. Non-semiconductor players should see brighter prospects given the sturdy domestic-focused business and full reopening of borders while semiconductor chip-related companies are unexciting in the near term clouded by the worsening macroeconomic outlook and low consumer confidence. The new export regulations imposed by the US on China restricting the supply of advance chips and equipment is still a concern, potentially delaying the recovery of the semiconductor sector as a whole.

• 2023 – a year of consolidation. Global Top 10 foundry showed a sequential decline (4.7%) in 4Q22 for the first time in years and the weakness is expected to carry through in the coming quarters, amid weakening demand and inventory corrections globally on top seasonal slow 1H. World Semiconductor Trade Statistics (WSTS) has forecasted the global semiconductor market to decline by 4.1% YoY to USD557bn in 2023 while IDC projected smartphone sales to decline 1.1% YoY in 2023.

• Sector valuation is fair, hovering around its mean of 23x and will remain capped by quantitative tightening cycle and potential earnings risks amid higher input costs and uncertain demand. That said, their solid balance sheets and the sturdy USD (weakening bias) should partially cushion the exporters from the slowdown. We advocate investors to seek names with resilient earnings profile and an eye for growth at undemanding valuation. Exposure to automotive, servers, and high-performance computing is preferred given the relatively stable demand while monitoring for signs of bottoming out.

• Top Picks. We like CTOS for its domestic-focused business, leading position, and growth prospects with higher demand for its various digital solutions, analytical insights, and exposure to fintech. In the semiconductor space, we believe Unisem’s undemanding valuation relative to the sector makes it a compelling preposition, given its relatively resilient earnings path and expansion-led growth from 2H23. In the smaller-cap space, we like JHMC for the encouraging upsurge in orders in the automotive lighting business and contributions from new projects at an undemanding valuation.

• 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. The sector’s ESG scores range from 2.9 to 3.3, with no major ESG risk concerns.

Source: RHB Research - 28 Mar 2023