Cover Story: Tech mania amid global chip shortage

This article first appeared in Capital, The Edge Malaysia Weekly, on January 25, 2021 - January 31, 2021.
Cover Story: Tech mania amid global chip shortage
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THE tech stock rally this month, which was particularly strong last week, should not come as a surprise to investors as many of the counters have hit all-time highs since last year’s June-to-August market rally.

The spectacular share price performances of these semiconductor and semiconductor-related stocks have been overshadowed by the rubber glove mania last year amid the Covid-19 pandemic. Until lately, that is.

One major factor fuelling the current rally is the global chip shortage, which has pushed up the prices of certain semiconductors and caused automotive firms to halt production.

But it appears that the shortage has become a boon to semiconductor players, including Malaysian companies, as lockdowns and travel restrictions are prompting consumers to buy more smartphones, smart devices, smart TVs, computers and laptops.

The Philadelphia Semiconductor Sector Index, which comprises the 30 largest semiconductor giants, is at an all-time high. It has gained 500% in five years, from 500 to 3,000 points.

The share prices of ASML Holding, Analog Devices Inc, Advanced Micro Devices Inc, Broadcom Inc, Lam Research Corp, Micron Technology Inc, Nvidia Corp, Qualcomm Inc and Taiwan Semiconductor Manufacturing Co have either more than doubled, doubled or almost doubled since the global market crash in March last year.

On the home front, the Bursa Malaysia Technology Index has gone up 220% within a year, from 25 to 80 points.

Like the global multinational corporations (MNCs), locally listed major outsourced semiconductor assembly and test (OSAT) companies such as Inari Amertron Bhd, Unisem (M) Bhd and Malaysian Pacific Industries Bhd (MPI), as well as automated test equipment (ATE) manufacturers such as ViTrox Corp Bhd and Greatech Technology Bhd also saw their market capitalisations grow significantly over the last 12 months.

The rise in their share prices means that their stock valuations have increased steadily. On average, the OSAT companies are valued at about 61 times today, compared with 36 times a year ago. Meanwhile, the ATE makers are now valued at 73 times, compared with 31 times a year before (see table on Page 32).

In other words, investors are willing to pay more to own these tech stocks owing to bullish expectations of their future potential. Why is this the case?

Consumer electronics versus automotive industry

Car manufacturers around the world have been hit hard in recent weeks by a worsening global semiconductor shortage that has led to production cuts and staff layoffs. It was reported that chips used in vehicles are harder to come by because semiconductor manufacturers allocated more capacity to meet soaring demand from consumer electronics makers.

The general perception is that chipmakers usually favour consumer electronics customers because their orders are larger than those of automakers. Moreover, it is said that car manufacturing is a lower-margin business, leaving manufacturers unwilling to bid up chip prices as they want to avoid a risk to their profitability.

But is that really the case?

According to Pentamaster Corp Bhd co-founder and chairman Chuah Choon Bin, beside the stockpiling of inventories, the current global chip shortage is also due to the rebound in demand for electronic components in the automotive industry and consumer electronics, such as computers and the fifth generation (5G) phones.

“While the rapid growth of the electric vehicle (EV) market has increased automotive demand for semiconductor components, so does the latest 5G phone, which requires 40% more electronic components than the 4G or older versions,” he tells The Edge.

With both the automotive and consumer electronics sectors competing for semiconductor components, the global shortage was further exacerbated. As a result, some carmakers have been forced to cut production because they could not obtain critical semiconductor components.

Chuah points out that another crucial factor for the shortage is the unexpected resurgence in Covid-19 infections, which has led semiconductor factories to extend periods of closures or reduce working hours and workforce. “The shortages started to occur in the second half of 2020. I believe the situation will continue to persist until the second half of 2021 or even 2022, depending on the pandemic situation.”

Pentamaster is a Penang-based high-technology firm specialising in factory automation equipment as well as systems and information and communications technology solutions for industrial and commercial customers.

Chuah acknowledges that chipmakers usually prefer to deal with customers in the consumer electronics industry because of their higher volumes as well as less stringent requirements. For perspective, he says, the annual volume for smartphones is more than a billion, compared with less than 200 million cars.

“However, semiconductor makers cannot deny the fact that automotive electronics is expected to be the fastest-growing market in the semiconductor industry in the near future. The semiconductor content per car will grow from US$300 to US$600 by 2022,” he adds.

With the oversaturation of smartphones, Chuah is of the view that semiconductor players will be forced to venture into the upcoming lucrative market for the automotive semiconductor sector to broaden their portfolios and diversify revenue streams.

JF Technology Bhd CEO Dillon Atma Singh highlights that in 2020, there was a sudden spike in demand for work-from-home (WFH) devices and the supporting ecosystem owing to the Covid-19 pandemic, whose impact no one could have predicted. “The surge in demand for smart devices, notebook computers and components supporting the WFH ecosystem such as data servers caused many wafer foundries and factories to run at full capacity,” he tells The Edge.

Meanwhile, automotive makers were rather cautious about their inventories, owing to the uncertainties brought about by the pandemic, and when demand for automotive vehicles started to increase, there was a capacity gridlock in the semiconductor supply chain.

“The overall capacity situation is expected to improve in the near term as many foundries and factories are aggressively investing in capital expenditure (capex) to increase their capacity,” says Dillon.

Founded in 1999, JF Tech designs and manufactures electronic products and components, including test probes, test sockets and test interface solutions, for the semiconductor industry worldwide.

Generally, in the semiconductor industry, capacity is reserved and allocated based on customer forecasts and the ability to meet them, says Dillon. “If companies start outbidding each other to secure capacity through higher prices, it will create a lot of upheaval in our industry, which could result in higher prices for end-consumers and is not desirable. We believe the current situation regarding prices is an exception and not the norm as capacity shortages are being aggressively addressed across the entire supply chain.”

Globetronics Technology Bhd CEO Datuk Heng Huck Lee says the chip shortage could be compounded by the Covid-19 supply chain disruption from last year and the depletion of inventories lately as most companies have been quite cautious about capacity planning during this pandemic period. However, he points out that the company does not favour its consumer electronics clients over automotive customers.

“From my knowledge and experience, I am not aware of such a practice. We treat every customer with equal priority. But it is true that the lead time of automotive products is normally longer with additional testing and reliability monitoring requirements,” Heng tells The Edge.

Globetronics is involved in the assembly and testing of integrated circuits (ICs), the manufacturing of light-emitting-­diode (LED) components, as well as the development and assembly of sensors and optical products for smart mobile and wearable applications.

Malaysian players set to benefit

MI Technovation Bhd group CEO Oh Kuang Eng believes the global chip shortage will have a positive impact on Malaysian semiconductor and semiconductor-related companies as strong demand has increased capacity utilisation in general.

“The semiconductor companies in Malaysia are mostly in-source for OSATs and IDMs (integrated device manufacturers) and not involved in IC design and foundry. Hence, they need to be cautious in weighing the opportunities arising from the current surge in demand — whether they are worth the investment for future expansion, bearing in mind the chances of being overbooked,” he tells The Edge.

Mi Technovation is clear on its future direction and investment plan, says Oh. “While we welcome the short-term surge in demand, this will not serve as an indicator or catalyst that impacts our long-term road map,” he stresses.

The company is primarily involved in the design, development, manufacturing and sale of wafer level chip scale packaging and sorting machines with inspection and testing capabilities for the semiconductor industry.

Oh goes on to say that the US-China trade war was the trigger point for the global shortage and the dispute between the two countries came to a head when the Trump administration imposed sanctions on Huawei as well as its chip subsidiary HiSilicon Technologies Co.

The trade tensions and uncertainty over the 5G rollout in 2019 caused most of the semiconductor players to put on hold their capacity expansion plans. However, the signing of the initial trade deal between the US and China, coupled with the outbreak of the coronavirus pandemic in early 2020, changed the outlook for the semiconductor industry.

“Covid-19 will lead to an enduring change in how we ultimately work and live. Transition to the new normal with stay at home or WFH has accelerated the digital transformation and boosted demand for consumer electronics items such as notebooks, PCs, TVs, cameras and webcams, to support everything from remote work and education to healthcare and home entertainment. This is a real demand,” says Oh.

“On the other hand, the high demand from the automotive and EV segments is mainly driven by future expectation of environmentally friendly vehicles and the new programmes pushed to encourage consumers to buy battery-powered vehicles, especially in Europe, where the governments in the EU are committed to lowering carbon dioxide emissions. The sustainability of the demand is rather questionable at this stage.”

Pentamaster’s Chuah says the surge in chip demand has helped boost the sales of Malaysian semiconductor companies in recent months. He adds that the global chip shortage, especially in the automotive segment, has resulted in the company seeing an increase in sales orders for its assembly and test equipment.

“The local OSAT companies and MNCs spending more on capex by ordering ATE in recent months to cope with the increase in demand. This is very positive news for semiconductor automation companies,” says Chuah.

Dillon concurs that the global chip shortage will positively impact Malaysian semiconductor and semiconductor-related companies, including JF Tech. “We are well positioned to service the needs of our customers, who are major players in the consumer electronics and automotive segments,” he says.

“JF Tech is proactively working to add factory space and capacity both locally and at our new venture in China to position us well to not only capitalise on the near-term surge in demand for semiconductors caused by the pandemic but also longer term with the advent of 5G, and subsequent 6G, technologies.”

He adds that 5G and 6G are expected to continue driving global demand for semiconductors, with new applications and refresh of smart devices utilising 5G and beyond speeds and technology.

Are tech stocks overvalued?

Interestingly, opinions are divided over whether the rally in the tech stocks still has legs and, more importantly, whether the shares are expensive in terms of their valuation.

Regional private equity investor and former investment banker Ian Yoong says Malaysian semiconductor-related stocks have significantly outperformed regional semiconductor stocks.

“Price-earnings multiples of large-cap semiconductor-related stocks on Bursa are about 10% to 100% higher than that of similar companies in other bourses,” he says.

For instance, the share price of Taiwan Semiconductor Manufacturing Co Ltd (TSMC) — the world’s largest contract chipmaker — rose 191% in 12 months, whereas Malaysian Pacific Industries Bhd (MPI) — one of the largest OSAT (outsourced semiconductor assembly and test) companies — is up 315% in the same period.

“TSMC is trading at a price-earnings ratio (PER) of 33 times, while MPI is trading at about 34 times. But still, MPI is the most undervalued large-cap semiconductor-related stock on Bursa,” he says.

“Besides, UWC Bhd is trading at 113 times and Greatech Technology Bhd at 101 times. These are astronomical valuations. And if you look at Singapore-listed AEM Holdings Ltd, it is trading at an incredible 14 times,” Yoong adds.

Meanwhile, Bursa Malaysia-listed Pentamaster Corp Bhd is trading at 60 times, while its subsidiary on the Hong Kong Stock Exchange, Pentamaster International, is trading at merely 14 times.

“The wide disparity in valuations is astounding,” Yoong says.

He is of the view that local institutional investors have limited choices when it comes to picking sectors to invest in.

“The vast majority of local funds have mandates to invest solely in local equities. These funds have nowhere to go but stay home. When Tesla and FAANG are flying in the US, many local funds can only buy local technology stocks,” he explains.

 The semiconductor sector, he says, is one of the few with strong earnings growth this year. “Our local institutional investors are therefore compelled to buy up stocks in hot sectors. If last year’s flavour was the glove sector, this year’s is the semiconductor-related sector.”

Yoong adds that the initial buying of the large- and mid-cap technology stocks came from funds. The surge in the share prices of semiconductor-related stocks in the past month, on the other hand, is due to proprietary dealers and retail investors.

“Anecdotal evidence points to much higher proprietary dealer and retail investor participation wherever there is a lockdown,” he says, adding that the rally in semiconductor-related stocks — especially the small- and mid-cap ones — still has legs as trading interest so far is on large-cap semiconductor-related stocks.

Fortress Capital Asset Management (M) Sdn Bhd investment adviser and director Geoffrey Ng Ching Fung says the tech manufacturing sector continues to be well supported by a healthy macro and industry backdrop of increasing demand, inventory build-up and shortage of supply.

“Tech stocks on Bursa Malaysia that have experienced buying momentum are also symptomatic of other markets, which have seen technology names moving up sharply as well. We think it’s a sectoral trade that will last as long as there are continued delays in the ‘reopening’ themes resulting from Covid-19,” he says.

Not as euphoric as glove mania

Ng sees buying interest from both institutional and retail investors, where the former have been buying the larger-cap, more well-established names like Inari Amertron Bhd, Unisem (M) Bhd, MPI and Pentamaster.

“Retail investors have also jumped on the bandwagon to trade these stocks, as well as smaller-cap companies in the tech manufacturing sector. We do see a rotation play from rubber gloves to tech manufacturing, but don’t expect the euphoria experienced in the rubber glove sector to be repeated in the tech manufacturing sector,” he remarks.

Pentamaster co-founder and chairman Chuah Choon Bin advises investors to invest rather than trade while focusing on companies with a clear forward vision.

“Personally, I think technology stocks in Malaysia are overvalued, given the size of revenue and profit generated. I believe the current tech stock rally is mainly fuelled by both local retail and local institutional investors, just like the rubber gloves thematic play that we saw last year.

“It seems like there is [a lot of] rotational and short-term investment play — from rubber gloves to recovery stocks such as banks, airlines and hospitality and now to tech stocks beginning this year — in the local market,” says Chuah.

On the other hand, Globetronics Technology Bhd CEO Datuk Heng Huck Lee does not think Malaysian tech stocks are particularly expensive.

“As a whole, most of our Malaysian technology companies, including Globetronics, are performing well. The valuation for their stocks may seem high relative to the stocks of other sectors, but if you deep dive into their financial situation, they have healthy financial positions with strong cash flow and solid balance sheets.

“If we were to compare Malaysian technology stocks to similar technology stocks from the region, especially from China, I think Malaysian companies are still relatively cheaper,” Heng says.

Nevertheless, he does not think the tech rally is comparable to the glove mania last year.

“The technology sector is expected to bring solutions and applications. My advice is to look into a good and fundamentally strong technology company with a strong future product mix,” he says.

It is worth noting that some tech counters have a low public spread, and certain quarters warn that their shares can be easily cornered.

“It is when it is high priced and also has low liquidity that it’s easy to window dress. If you look at their shareholding structure, in the case of controlling shareholders holding 30% to 50%, plus some institutional funds holding for the long term, the liquidity might be low,” says a corporate observer.

A check on Bloomberg shows that tech companies with a relatively low free float include MPI (23%), Unisem (18%), ViTrox Corp Bhd (29%), Mi Technovation Bhd (20%), Greatech (24%) and JF Technology Bhd (31%).

While views are mixed on the valuation of local tech stocks, the sector will certainly remain the focus of investors given the chip shortage story. — By Liew Jia Teng

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