A closer look at Inari amid talk of a global chip slump

This article first appeared in The Edge Malaysia Weekly, on September 12, 2022 - September 18, 2022.
A closer look at Inari amid talk of a global chip slump
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CALLING Inari Amertron Bhd a bellwether for the local semiconductor industry is no exaggeration. The country’s largest outsourced semiconductor assembly and test (OSAT) player with a market capitalisation of about RM10 billion, Inari is also the largest semiconductor-related firm listed on Bursa Malaysia. On average, the Penang-based group purchases RM500 million worth of equipment from local players every year, creating what some call the “Inari waterfall effect”.

Does that put Inari in a better position to withstand the global chip selloff?

Globally, the semiconductor industry has been struggling with capacity and supply chain constraints throughout the demand upswing since the outbreak of Covid-19 in 2020, even as lockdowns shored up demand for devices supporting remote working and added play time at home. Because of it, the world’s top three biggest chipmaking giants — Intel Corp, Samsung Electronics Co Ltd and Taiwan Semiconductor Manufacturing Co Ltd (TSMC) — have poured in billions to expand the capacity of their semiconductor fabrication plants, commonly called fabs or foundries. The thing is, the new capacity does not come onstream overnight.

As capacity from the outsized capacity expansion comes onstream, however, global demand surge has also come off, causing pundits to warn of the possibility of the global chip shortage turning into a supply glut.

Overcapacity fears have weighed heavily on chip stocks since the beginning of this year. The Philadelphia Semiconductor Sector Index — made up of the 30 largest semiconductor giants — is still down just over a third of its value year-to-date at the time of writing, even though it is about 5% above its recent low on July 1.

All 30 constituents were in the red year to date (YTD) as at Sept 6, of which 19 had fallen at least 30%, Bloomberg data shows. They include the world’s largest contract chipmaker TSMC (-32.1%), Dutch chipmaker ASML Holding NV (-40.8%), Silicon Valley-based supplier of wafer fab equipment Lam Research Corp (-39.8%) and Micron Technology Inc (-39.3%), which warned about slowing demand the same day US President Joe Biden signed the US$52 billion stimulus package (CHIPS and Science Act) to make it cheaper to build factories in the US.

Double-digit YTD stock price declines were also seen at the so-called “fabless” giants that design but rely on others to make their chips, including Broadcom Inc (-23.7%), Qualcomm Inc (-28.7%), Advanced Micro Devices Inc (-44.2%) and Nvidia Corp (-53.6%).

On the home front, the Bursa Malaysia Technology Index has fallen 35% YTD, and shares in Inari also declined 32% to close at RM2.72 on Sept 6, giving it a market capitalisation of RM10.09 billion.

Inari is currently trading at 25.5 times last year’s earnings and 22.7 times estimated earnings for the financial year ending June 30, 2023 (FY2023). Just last year, the counter was trading at 38 times earnings. Two years ago, it was trading at close to 50 times earnings.

In comparison, Inari’s closest OSAT peers Malaysian Pacific Industries Bhd (MPI) and Unisem (M) Bhd were trading about 18 times estimated earnings for FY2023 ending June 30 and FY2022 ending Dec 31 respectively, as their stock prices closed at RM29.50 (RM5.87 billion market cap) and RM2.60 (RM4.2 billion market cap) respectively on Sept 6.

So, would buying into Inari be catching a falling knife or would it be worth it in the long run? Would Inari’s fortunes turn for the better as the global semiconductor industry landscape shifts?

A semiconductor industry veteran tells The Edge that the chip glut, if it happens, will last only six to 12 months.

“Will Inari feel the impact? Maybe. Perhaps we will see a flattish performance by Inari, as I believe the industry has very much found the equilibrium,” he comments.

“But if Inari can sustain at the current earnings level, with a PER (price-earnings ratio) of 25 times, it is still a good valuation. If we use RM3.10 as a benchmark, now could be a good time to look at the stock.”

RM3.10 was the price at which Inari had placed out about 10% of its share base to raise about RM1.03 billion in July last year.

Inari saw its net profit increase 18% to RM390.91 million in FY2022 ended June 30, 2022, against RM330.47 million a year ago. Group turnover increased 8% year on year to RM1.547 billion in FY2022, up from RM1.428 billion. Its stronger financial performance was attributed to growth in all business segments, led by the radio frequency (RF) division.

The Broadcom factor

Now, it is an open secret that Inari has been heavily reliant on US fabless chip designer Broadcom, which is a key component supplier to consumer electronics giant Apple Inc.

In FY2022, Singapore remained the largest geographical market, accounting for 86% of Inari’s revenue, followed by China (8%) and Malaysia (5%).

Although Inari does not publicly disclose the extent of Broadcom’s contribution to its sales, most equity analysts and industry observers usually assume that a large chunk of the group’s revenue from Singapore is actually derived from the US chip vendor, which operates its Asean sales office in the city state.

What is clear is that Inari’s share price and earnings performance over the past five years have almost mirrored that of the two US tech heavyweights, Broadcom and Apple (see charts).

For perspective, Inari’s earnings grew at a compound annual growth rate (CAGR) of 13% between FY2017 and FY2022, compared to Apple’s 16% and Broadcom’s 32%.

In the last five years, Inari’s stock price has gained 58% even as Broadcom’s doubled (101%) and Apple’s tripled (298%). Broadcom’s semiconductors provide short-range connectivity for many Apple devices, including iPhones.

Interestingly, Broadcom on Sept 1 gave a strong revenue forecast for its fourth quarter, guiding that top line would reach US$8.9 billion, higher than an average analyst estimate of US$8.72 billion.

The bullish outlook suggests Broadcom is sidestepping a broader decline in chip demand, at least for now, according to a recent Bloomberg report. Other suppliers, including Nvidia, Intel and Micron, have predicted a steep sales slowdown — hurt by sluggish orders of PCs and smartphones.

Given that pessimism, Broadcom CEO Tan Hock Eng acknowledges that his company’s report is “somewhat surreal”.

“From our vantage point, infrastructure spending is still very much holding,” he tells analysts during a conference call.

The Penang-born business executive reportedly said Broadcom’s backlog of orders, which cannot be cancelled, is expanding and now sits at US$31 billion.

So, what does that mean for Inari?

The semiconductor industry veteran highlights that Broadcom is trying to stay ahead of its rival Qualcomm, and if Broadcom continues to do well, so will Inari.

“Basically, Broadcom is saying to Inari: ‘We need you to upgrade and change. You’d better follow our pace, because we are not slowing down anytime soon.’ Therefore, if Inari can meet Broadcom’s expectations, it will remain a very good company,” he remarks.

The veteran also points out that Inari has a strong management team, helmed by group CEO and executive director Lau Kean Cheong, better known as K C Lau.

“K C Lau is a very aggressive business executive, and he has the foresight. That’s why Inari has been, and still is, riding the wave on Broadcom,” he says.

A managing director of a locally listed semiconductor equipment maker concurs.

“The management, headed by K C Lau, is level-headed, but I would think succession planning will be an issue for Inari in the next couple of years. Finding a suitable CEO is never an easy task,” he warns.

The managing director adds that Inari could be a good buy now, but investors would need to hold the stock for a while. “It’s not for trading, but more for investing over a mid-term horizon.”

The managing director cautions that the semiconductor slowdown, especially in the area of consumer electronics, might affect Apple, subsequently Broadcom, and eventually Inari.

“But any impact will only be short term. I am a believer of the rise and rise of semiconductors, as they are used in almost every item that we consume, be it phones, tablets, sensors, the Internet of Things or cars. Over the next three to five years, the semiconductor business will be on reasonably good growth,” he says.

There might still be headwinds in the nearer term on the back of slower industry growth, especially if pundits are right about the global chip shortage coming to an end.

In July, Gartner had in its worldwide semiconductor forecast said it expected global semiconductor revenue to grow 7.4% in 2022 to US$639 billion. Not only is the latest projected growth slower than 2021 growth of 26.3%, but it is also lower than its forecast for the previous quarter of 13.6% growth in 2022.

Global semiconductor revenue is projected to decline 2.5% to US$623 billion in 2023, with expected weakness in semiconductor end markets. In the report, Gartner projected that semiconductor revenue from smartphones would see growth decelerate to 3.1% in 2022, while semiconductor revenue from the data centre market would remain resilient for longer at 22% growth in 2022 on the back of continued cloud infrastructure investment.

Given the mixed news for its product segments, Inari remains cautiously positive on the prospects for FY2023.

“The strong US dollar has been favourable to the group in the current quarter (4QFY2022) and its strength is expected to remain for the first half of FY2023 on indications of rising interest rates in the US,” the group said in a filing with Bursa on Aug 19.

Main Market-listed diversified group Insas Bhd — controlled by low-profile businessman Datuk Seri Thong Kok Khee — is Inari’s single-largest shareholder, with a stake of about 14.5%. Other substantial shareholders include Kumpulan Wang Persaraan (Diperbadankan) (KWAP) (9.35% as at Aug 22) and the Employees Provident Fund (8.97% as at Aug 29), stock exchange filings show. K C Lau had about 1% of Inari as at Sept 23 last year, according to its 2021 annual report.


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