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This article first appeared in The Edge Malaysia Weekly, on December 14 - 20, 2015.

 

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INVESTOR have been nothing but optimistic about the semiconductor players listed on Bursa Malaysia but global trends are pointing to moderating growth, especially in the mainstay of the industry: smartphones.

Local semiconductor counters reached new highs in the past year with investors drawn towards their export orientation in times of a weak ringgit.

As at last Thursday’s close, Globetronics Technology Bhd had gained 61.1% year to date; Malaysian Pacific Industries Bhd (MPI), 98.7%; Inari Amertron Bhd, 87.2%; and Unisem (M) Bhd, 41.6%, to name but a few.

While US dollar earnings are producing fat margins for these corporations, volume is not growing in tandem.

In fact, a shipping executive tells The Edge that outgoing shipments from the semiconductor sector have seen a marked decline in recent months. But that is not a true reflection of the sector, just a dipstick indicator.

Still, Kenanga Research is not expecting to see much sales growth at local semiconductor companies next year. “For those companies with wide exposure to the automotive, smartphone, industrial, consumer and personal computer segments, overall sales growth in US dollar terms should be flat — zero to 5% — in 2016,” analyst Desmond Chong tells The Edge.

When it comes to demand for communication devices and smartphones — the darlings of the semiconductor industry — he sees more downside than upside for now. “The slowdown in smartphone demand is quite obvious, predominantly coming from the China side, due to a high base and weak economy,” he adds.

In fact, Chong recently downgraded the sector to “neutral”, saying the risk to reward was no longer compelling, given the valuations were no longer justifiable.

As 2015 draws to a close, American market research, analysis and advisory firm, International Data Corp (IDC), is forecasting global smartphone growth to slow to 10.4% from 27.5% last year. At the end of August, it revised downwards its forecast of 11.3% for 2015. By 2019, it is expecting growth to be just 5.1%.

China, which is joining North America and Western Europe as a mature market, is to be blamed for it. The first sign of slower sales growth came in May when it was reported that China’s smartphone market contracted 4% to 98.8 million units in 1Q2015, the first decline in six years.

Slower worldwide semiconductor sales followed in July, dipping 0.9% year on year to US$27.9 billion, according to the Semiconductor Industry Association (SIA). The October figure came to US$29 billion, down 2.5% y-o-y.

“Global semiconductor sales have shown signs of stabilising in recent months with October marking the third straight month of month-to-month growth (1.9% increase). YTD, sales are narrowly ahead of where they were at the same time last year and slight growth is projected for next year and beyond,” SIA president and chief executive John Neuffer says in a Dec 3 note.

According to Gartner Research, end-user spending for 2015 is forecast to decline 5.7% y-o-y to US$605.6 billion. Beyond that, spending is estimated to grow 1.8% and 1.7% respectively to US$616.7 billion and US$627.1 billion in 2016 and 2017.

“We are bracing for moderate growth next year but we are still optimistic about the quarters ahead,” Unisem group managing director and chairman John Chia tells The Edge.

About half of Unisem’s (fundamental: 1.80; valuation: 1.20) revenue comes from the smartphone market while the rest is from the automotive, power management and computing peripheral segments, according to Chia.

Despite the moderating growth in the sales of smartphones, he maintains that they will still do well because of their addictive nature, which drives demand. At the same time, he is positioning Unisem to capture growth elsewhere.

“We are positioning ourselves to grow in the automotive segment in a big way. Moving forward, the segment will become more important as safety features are increasingly used,” Chia says.

For instance, the European Union requires all new vehicles to have tyre pressure monitoring systems (TPMS) installed by manufacturers. Both Unisem and MPI (fundamental: 2.10; valuation: 1.40) produce TPMS.

Analysts have a consensus target price of RM2.57 on Unisem, indicating a 2% upside from last Thursday’s close of RM2.52. Some 66.7% of analysts have a “buy” call on the stock, 22.2% say “hold” while 11.1% say “sell”.

“Although semiconductor sales in the automotive sector are not as robust as those in the smartphone sector, they provide more earnings certainty and visibility, thanks to remarkable vehicle production growth as well as the increased semiconductor content in cars,” Chong says.

For this reason, MPI is Kenanga’s top pick in the sector with a RM9.71 target price. The stock closed at RM9 last Thursday, indicating a 7.9% upside.

“MPI offers a strategic product mix in the high-growth (smartphone) and defensive (automotive) segment as well as trading at an undemanding valuation,” Chong says.

“Unlike products that go into smartphones, automotive-related products typically require a much longer qualification period for safety reasons. But once you are in, the shelf life is definitely a lot longer than for smartphone components,” says RHB Research analyst Kong Heng Siong.

He is “overweight” on the sector, thanks to the extremely favourable ringgit environment and decent industry outlook.

Kong agrees that high growth numbers for smartphones are probably over, but adds: “In the current environment, investors are struggling to find stocks with good earnings visibility as well as positive growth. So, yes, foreign exchange is an important consideration too.”

He, like many other analysts in the street, likes Inari and Globetronics. All the analysts covering the two stocks have “buy” calls on them for their structural growth stories.

Inari (fundamental: 3; valuation: 1.50) is ramping up capacity with its latest P13 plant, which has a floor space of 160,000 sq ft, doubling its capacity. Analyst have a RM4.64 consensus target price on the stock, indicating a 3.3% upside potential from its RM4.49 close last Thursday.

Globetronics (fundamental: 3; valuation: 1.70) too is spending RM60 million on expanding capacity for new sensor products by mid-2016. The consensus target price of RM7.09 implies 4.9% upside potential from last Thursday’s close of RM6.76.

The single-digit upside potential from consensus numbers itself is proof that the bullishness on the sector is largely priced in — at least until the players or consumer demand provides more reason for another round of rerating.

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