RHB Investment Bank (RHB) advocates 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, Malaysia’s 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.
RHB, in its Malaysia Sector Update today (Apr 1), said they see opportunities in the small- to mid-cap space, as the market has already factored in a slow 1H24.
RHB updgraded the sector to OVERWEIGHT from Neutral with Top Picks being Malaysian Pacific Industries (MPI), Unisem (M), and CTOS Digital (CTOS).
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 RHB’s 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 push outs 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 their view. RHB likes 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.
Positioning For The Next Upcycle
4Q23 results recap
4Q23 results for the sector were mostly in line with two out of the nine companies under RHB’s coverage reporting stronger-than-expected results – MPI and JHM Consolidation (JHMC), mainly on higher-than-expected margins amid cost rationalisation efforts.
The underperformers are Coraza Integrated Technology (CORAZA), Datasonic Group, GHL Systems (GHLS), and Inari Amertron. Slower toplines and delays in project take-offs, coupled with higher opex and loss of economies of scale, are among the reasons for the miss.
Notably, the aggregate core PATAMI rebounded for the second consecutive quarter, growing 11.4% QoQ from 3Q23 on the back of the seasonally stronger 2H (vs 1H) and signs of recovery in the semiconductor space.
The sector’s 4Q23 aggregate core PATAMI contracted 21% YoY, with only two companies reporting solid YoY growth – CTOS (thanks to solid demand for its data systems reports, digital solutions, and comprehensive portfolio review and analytics services) and MPI amid better cost control and gradual recovery in its utilisation rate at the Suzhou plant in China.
Post the results review season, RHB’s sector’s FY24F earnings are revised upwards marginally by 0.8% for the first time in two years on better optimism, with a growth expectation of 37.8% pencilled in for this FY.
RHB upgraded CORAZA, MPI, and Unisem on the expectation of earnings bottoming out and a firmer outlook for FY24 on a recovery in the semiconductor sector.
Road to recovery
In the fall 2023 edition, the World Semiconductor Trade Statistics (WSTS) made its first upward revision in nearly two years, raising the 2023F and 2024F world semiconductor growth by 1% and 2% to USD520.1bn and USD588.4bn. This increase was primarily fuelled by growth in the memory sector, while the other segments are also expected to record single digit growth rates.
A 9.4% contraction in global semiconductor industry sales was pencilled in for 2023 with a 13.1% recovery forecasted in 2024 – indicating that the sector has bottomed out after experiencing increased demand and reaching the tail-end of inventory correction.
According to SEMI, equipment billings in 2023 exceeded projections, though growth is anticipated to be subdued in the 1H24 due to seasonality. Capital expenditure and fab utilisation rates are expected to see a mild recovery starting in 1Q24, signalling signs of bottoming for equipment billings and set for a recover in 2024.
In 4Q23, worldwide smartphone shipment rebounded, growing by 4% QoQ and 8% YoY from a low base after ten quarters of contraction/flattish performance, according to International Data Corporation (IDC). Despite 2023 marking the lowest annual volume of 1.17bn units (-3.2% YoY) in almost a decade, a stronger 4Q23 and the low base effect are paving for a recovery going into 2024, in which a 2.8% growth is pencilled in.
Growth in the emerging markets, coupled with the traction seen in foldable and AI-enabled smartphones could be the drivers behind the rebound from the low point.
The front-end semiconductor space is experiencing positive momentum, highlighted by the Global Top 10 foundry revenue’s consecutive QoQ increase of 7.9%.
This growth, observed over two quarters, is driven by heightened demand for smartphone components and peripheral Power Management Integrated Circuits or PMICs, particularly as the industry enters the peak season in the latter half of the year.
However, this recovery is not uniform across all sectors, with Taiwan Semiconductor Manufacturing leading the way in advanced processes, propelled by AI applications and volume from premium smartphone launches.
Conversely, shipments for network communications, general consumer electronics, and automotive/industrial control sectors have witnessed declines.
Although the overall utilisation rate of foundries remains subdued, it is expected to show sequential improvement in 1Q24, following a low of 66% in the 4Q23, as reported by SEMI and TechInsights.
This trajectory aligns with guidance from major foundries. Additionally, low utilisation rates are attributed to major expansions globally in recent years, driven by the exponential growth in demand during the pandemic and geopolitical factors.
Back-end semiconductor players often lagging behind front-end and ATE players
RHB’s recent channel checks suggest an uptick in demand for front-end semiconductor process – thanks to expansions of foundry across the major economies, coupled with signs of improved order flow and enquiry for ATE players – indicate a potential recovery in the back end semiconductor space.
In semiconductor cycles, heightened orders for ATE typically precede increased volume loadings in the back-end process. Back-end semiconductor players tend to lag behind front-end players in recovery, as the need for back-end processes arises after wafer fabrication, typically materialising 3-9 months later.
In fact, the PHLX Semiconductor Index or SOX and Nasdaq have recovery strongly, signalling the recovery in the technology space, especially within in the front-end space and various integrated database management.
RHB’s local technology space, which is often lagging behind global semiconductor players, may play catch-up with better growth prospects in FY24 after two lacklustre years.
Sector earnings bottomed out
While the bottoming out of the sector and earnings assures a YoY improvement, the recovery may not be uniform across all segments, potentially leading to variability in earnings performance among companies, particularly in the seasonally weak 1H24. In fact, Street has pencilled in a rather robust growth expectation (+82%) for FY24 from a low base and the expectation of a sector recovery.
For sanity check, RHB compares ther earnings forecasts of stocks under their coverage against consensus. It turns out that our numbers are within a variation of -18% to +30% against Street expectations. While RHB acknowledged that the jury is still out given the uncertainties in the pace of recovery and some earnings disappointment could be inevitable, the market is seemingly well guided with regards to a gradual recovery scenario and is willing to weather through the uncertainties.
Limited downside to share price despite lacklustre earnings
Despite lacklustre quarterly earnings performance from KLTEC (consensus earnings were cut by 25%), the index has rallied 3.1% over the past six months. Market expectations have been recalibrated following various disappointments in earnings from the slowdown over the past 1.5-2 years. Tellingly, it seems that many investors are holding onto their positions in the technology space and weathering through the near-term uncertainties in hope for a recovery in the second half of 2024 and into 2025.
While most local technology players have provided guidance indicating a muted first half of 2024 and a gradual recovery expected in the second half, investor interest has actually increased. This is likely due to the belief that sector earnings have bottomed out and inventory correction is nearing its end. The anticipated recovery of the sector appears to be uneven and gradual, with AI-related applications and the rebound in the smartphone space leading the way.
However, uncertainties in the automotive and industrial control segments may act as a drag on the overall recovery process.
Upgrade to OVERWEIGHT
RHB upgraded the sector rating to OVERWEIGHT (from Neutral) and advocate investors to accumulate positions in the current early phase of the new semiconductor upcycle. Historical evidence suggests that this boom could surpass the previous cycles and potentially last for 2- 3 years.
RHB local technology players in the ATEs and OSATs spaces are poised for recovery and further growth into FY25.
Opportunities in some interesting small-to mid-cap space have emerged given the weak results and expectations of a slow 1H24 have been fully digested by the market. For non-chipmakers, the robust domestic economy, inbound tourist arrivals, and various digitalisation drives in the private sector and SME space should continue to spur demand, in RHB’s view.
The 2022-2023 downcycle, lasting for five quarters has finally concluded after prolonged weakness was exacerbated by slowing demand amidst high inflation rate and double-booking exercises.
There are factors signalling the onset of a new upcycle. Early indications of recovery in the ATE space, along with tractions in the front-end semiconductor space, bolster RHB’s belief in a sustained recovery in the sector, expected to gain pace in the 2H24.
RHB’s channel checks also indicate a more robust FY24 and various new order enquiry are taking places across the sector. They note the world semiconductor sales growth often accompanied the appreciation of KLTEC and SOX and the current early upcycle trend can act as a leading indicator for semiconductor sales as investors take positions for the next upswing.
RHB is of the view that sector demand and earnings have bottomed, ensuring a YoY improvement is almost certain. The recalibration of Street expectations following consecutive lacklustre quarters underscores this belief. However, caution is advised as recovery may vary across segments, potentially leading to disparity in earnings performance among companies.
As such, RHB anticipates volatility and stress on adaptability in trading strategy to navigate through changing market dynamics in this recovery period.
At 25x FY24F P/E, the current valuation for KLTEC may be elevated, this is typical in the early phase of recovery as it precedes earnings growth. Both SOX and Nasdaq have scaled to new highs while Malaysia’s technology space is lagging global semiconductor players.
As such, the sector may even experience a re-rating when the sector recovers with better order visibility, meeting investors’ excitement with higher growth guidance. Besides, a potential rate cut by the US Federal Reserve later this year should further support the valuation re-rating for the technology space, especially for the semiconductor-related space. Market expectations sees three rounds of Federal Funds Rate (FFR) cuts expected to happen sometime in 2H24.
Sector Top Picks. For the semiconductor space, RHB recommended BUY on MPI and UNI to gain exposure on the sector recovery given their diverse exposure to various end applications from smartphones to automotive and various PMIC chips used in servers. Besides, the recovery in China’s semiconductor space following two lacklustre years will help to boost the utilisation rate and economies of scale in their existing plants in China.
They are also stand to benefit from the US-China trade tensions in both of their plants in Malaysia as a neutral ground and self-sustaining policy in China.
In the smaller-cap space, both JHMC and CORAZA may continue to see weak 1H24 numbers, and may lead to certain fluctuations in near-term share price performance. However, they should benefit and see strong growth when the utilisation rate improves and tracks the sector recovery.
For non-semiconductor exposure, RHB likes CTOS for its domestic-focused business, leading position, and growth prospects that track the expansion of the digital economy given the higher demand for its various digital solutions, analytical insights, and exposure to fintech.
Meanwhile, GHLS should continue to benefit on the back of the secular trend of cashless payments (with upticks in margins), coupled with the company’s robust pipeline for its other IT solutions.
Downside risks for the sector include Softening smartphone sales; Unfavourable FX movements; Weak consumer demand; Obsolescence of technology; Loss of clients/contracts; and Intensifying geopolitical conflicts.
