We see the data center and smartphone sectors entering more exciting growth stages. Following a 12-18 month data center construction phase, we expect the fit-out phase to start between 4QCY24 and 1HCY25, offering significant opportunities for companies like PIE (OP, TP: RM6.35), NATGATE (OP, TP: RM2.30), and INARI (OP, TP: RM4.05) to leverage on the rising AI infrastructure. Additionally, Generative AI smartphones, which transition user interactions from touch to voice, are projected to experience more than a 3-fold increase in 2024, with another 73% growth expected in 2025. Despite these positive trends, the automotive semiconductor segment faces near-term headwinds due to recent tariff hikes on Chinese EVs. Overall, the sharp decline in the Bursa Malaysia Technology Index presents a compelling buying opportunity for tech stocks. We maintain our earnings forecast and remain confident in our top picks for the quarter are INARI, PIE, NATGATE, and KGB (OP, TP: RM4.16) - all of which are well-positioned with strong earnings visibility and exposure to high-growth areas such as AI-related infrastructure.

Semiconductor surge continues. The global semiconductor market is projected to continue its strong growth trajectory in CY24 and CY25. As of July 2024, semiconductor sales jumped 18.7% YoY (which marks the sales increased for the fourth consecutive month) to USD51.3b, driven by robust demand across the Americas, China, and Asia Pacific, while Japan and Europe experienced slight declines. The World Semiconductor Trade Statistics (WSTS) forecasts 16% growth in 2024, led by the Logic and Memory segments. By 2025, the market is expected to expand by another 12.5% to USD687b, with Memory and Logic surpassing USD200b each. Other segments, including Discrete, Optoelectronics, Sensors, and Analog, are expected to see moderate growth.

Data center expansion presents key opportunities. Malaysia’s data center sector is poised for significant growth, with IT capacity set to increase from 500MW to over 3,000MW. The AI server market alone, valued at RM97.8b, presents substantial opportunities for local technology players. Following a 12-18 month construction phase, the fit-out phase is expected to commence in 4QCY24 through 1HCY25. Companies such as PIE, NATGATE, and INARI are well-positioned to capitalize on this growth. PIE has secured a key server switcher client, NATGATE aims to deliver 1,000 AI servers by yearend, and INARI is increasing production of 800G optical transceivers to meet the growing demand for faster data transfers.

AI-powered smartphones to lead growth The global smartphone market grew 6.5% YoY in 2QCY24, reaching 285.4m units. This marks the fourth consecutive quarter of growth, although demand remains uneven across many markets. While Samsung (18.9% market share) and Apple (15.8%) continued to lead the premium segment, Chinese manufacturers are expanding in the mid-and low-end segments to capture volume. The anticipated smartphone replacement cycle, along with generative AI smartphones - expected to shift interactions from touch to intelligent voice commands - will be the next major growth catalyst. Generative AI smartphone shipments are projected to surge by 364% to 234m units in 2024 and reach 912m units by 2028, with a CAGR of 78%, according to IDC.

EV tariffs pose challenges, but opportunities remain. The automotive semiconductor market is expected to experience sustained long-term growth, driven by the increasing adoption of electric vehicles (EVs), advanced driver-assistance systems (ADAS), and autonomous driving technologies. However, recent tariff hikes on Chinese EVs - 100% in the U.S. (effective 1 August 2024) and 27.4%-48.1% in the EU (effective later in 2024)—pose risks to supply chains. Malaysia’s neutral stance in the ongoing trade conflicts positions it as a potential alternative production hub, although lengthy validation processes in the automotive supply chain may delay the impact for local players like MPI (OP, TP: RM38.80) and D&O (OP, TP: RM2.64).

Top Sector Picks: INARI, PIE, NATGATE, and KGB: The Bursa Malaysia Technology Index has fallen by 11.7% over the past month (as of end 20-September), underperforming the FBM KLCI, which gained 1.2%. The sector’s YTD performance of -2.3% reflects a pullback in AI-related optimism, disappointing earnings from local tech firms, and a stronger MYR. Despite these challenges, the recent price correction presents an attractive entry point for quality tech stocks. Our top picks for the quarter namely INARI, PIE, NATGATE, and KGB offer strong earnings visibility and are well-positioned to benefit from the data center fit-out phase and increasing demand for AI-related infrastructure, positioning them for outperformance as the sector rebounds.

Source: Kenanga Research - 2 Oct 2024