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UOB Kay Hian: Twin supply-demand shock boon to tech sector but risk-reward unappealing

KUALA LUMPUR (Jan 10): UOB Kay Hian Research said on Monday (Jan 10) that despite the technology sector still benefiting from a twin supply-demand shock, the industry’s risk-reward appears less compelling with valuations pricing in strong earnings expectations.

Its analyst Desmond Chong said in a note following strong share price performances across the board (+84% in 2020 and +38% in 2021), the forward price-earnings (P/E) valuations of outsourced semiconductor assembly and test (OSAT) and semiconductor production equipment (SPE) players are trading close to +2 standard deviation (SD) to their five-year mean levels, which are also near previous peak valuations of between +2SD and +2.5SD.

“Tactically, we advocate investors to buy on weakness following the less compelling risk-reward industry valuations and strong earnings expectations as the precedent performance shows that stretched valuations do not last more than six months.

“With the stubbornly high inflation numbers (and hence rising bond yields), high valuations could be eroded as investors typically turn more risk-averse by rotating out of high-P/E stocks amid increased inflation fears,” he said.

The analyst maintained "market weight" on the technology sector with a “cherry-picking” approach.

According to him, the risk-reward industry valuations are subpar with a higher range of 0.7 times to 3.3 times, compared with 0.6 times to 1.4 times in the cumulative first six months of 2021 (6M21).

“Our strategy prescription is premised on stocks with lower price-earnings to growth ratios and good growth prospects alongside the respective bellwether position in the sub-segments,” he said.

He likes Inari Amertron Bhd and Greatech Technology Bhd for their unique value propositions and alpha growth, and VS Industry Bhd for its undemanding valuation versus superior growth profile.

Chong also noted that findings from his recent Penang trips revealed that expansion in the industry is broad-based amid the twin supply-demand shock alongside supply chain reconfiguration.

“Note that orders and enquiries by multinational corporations piled up after the lockdowns, which were partially reflected in the top line of local technology players in 9M21,” the analyst said, adding that this would further benefit the local supply chain and sustain the industry's growth in the medium term.

He also said the Covid-19 whiplash continued to lead to: i) a new normal in daily activities; ii) stricter lockdowns; iii) a greater degree of automation; and iv) supply chain disruptions due to the lockdowns.

“While this rare twin supply-demand shock continued to cause a severe global chip shortage and negatively impacted end-market production (i.e. automobile), the demand vacuum left by the pandemic’s new normal is still lending strength to semiconductor players.

“Our channel check reveals that demand across all OSAT, SPE and EMS (electronics manufacturing service) players remains strong. Note that lead times for key components, i.e. memory, integrated chip, discrete, analog and passive, have been delayed by multiple weeks, with some up to 52 weeks,” he elaborated.

However, the analyst's channel checks with key tech players also suggested that margins could continue to be under pressure.

According to him, the sector’s margin performance skewed towards negative territory, ranging from -6.6 percentage points (ppts) to +1.6 ppts quarter-on-quarter and -2.7 ppts to +4.9 ppts year-on-year (y-o-y), mainly dragged by higher operating cost.

“We believe the trend of margin compression on higher material, shipment and project/order implementation costs (travelling and subsidies) amid the Covid-19 pandemic could persist at least throughout 1H22 (the first half of 2022),” he said.

The analyst also noted that global industry indicators continued to show signs of growth moderation.

“While semiconductor shipments reached all-time highs in 3Q21 (the third quarter of 2021), we saw a moderation in growth since July 2021 (after peaking in June at more than 30%), with the latest growth of 24% y-o-y in October,” he said.


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