KLTEC outperformed the broader index in 1H21 (KLTEC +13% vs KLCI -6%). The latest industry average growth projection of 13% is perceived to be rather reserved vs our ~20% estimate. As for 2022, the sector is expected to be in expansionary mode with 9%. Capital spending is expected to reach another record on the back of strong fab construction pipeline. However, weaker greenback outlook may dent the sector’s prospect. We are not overly concern on the rising input prices as tech players are believed to be able pass through the additional costs. Growth is expected to be driven by smartphone, communication, HPC, IoT and auto. We maintain OVERWEIGHT stance and tactically in favour of frontend players. However, on top of Frontken and UWC, we also include Inari Amertron as one of our top picks.

Outperformed in 1H21. Sustaining 2020’s momentum, KLTEC gained 13% vs KLCI’s 6% decline (see Figure #1). Our overweight stance on the sector since the beginning of the year has proven rewarding and all our 1H21 top picks, namely Frontken (+25%), UWC (+4%) and Inari (+15%) generated positive returns.

Global semiconductor sales. 4M21’s 21% growth to USD166bn (see Figure #2) is on track to record another all-time high revenue. The latest industry average growth projection of 13% (see Figure #3) is perceived to be rather conservative. We think the industry will end 2021 closer to 20%. According to WSTS, all product categories are expected to experience expansions (see Figure #4), memory (+32%) leads the pack, followed by sensors (+22%), analog (+22%), discrete (+18%), logic (+17%), opto (+10%) and micro (+8%). The driver behind memory bullish outlook is also due to the strength in memory prices. As for 2022, the sector is expected to be in expansionary mode with 9%.

Equipment spending. Capital investment was strong in 5M21 with 43% gain in 3MA billings to USD16bn (see Figure #5). Based on SEMI’s latest forecast, there will be 19 new high-volume fab constructions by end of this year and break ground on another 10 in 2022 (see Figure #6). Total equipment spending for these 29 fabs (China×8, Taiwan×8, Americas×6, SEA×4 and Others×3) is expected to surpass USD140bn over the next few years. Fabs that produce 300mm wafers will account for most of the new facilities (15) in 2021 and again in 2022, when 7 fabs will begin construction. The remaining 7 fabs planned over the 2-year period will be 100mm, 150mm and 200mm facilities. The 29 fabs could produce as many as 2.6mwpm (in 200mm equivalents).

Weaker greenback. HLIB expects USD to be softer in 2021 averaging RM4.10/USD compared to 2020’s average of RM4.20/USD (see Figure #7). As such, we expect tech firms to be marginally impacted as their sales are majority denominated in USD terms while partly cushioned by the USD cost items.

Higher input costs. Gold, aluminium, copper and steel prices are on the upward trajectories (see Figure #8) and may spell bad news for tech players. While partly offset by weaker USD projection, pricier commodities will exert pressures on margins for packagers and equipment makers. However, we are not overly concerned as industry wide capacity constraint positions tech players with stronger bargaining power to pass through higher material costs.

Segmental view. Recovery in smartphone along with communication segments are expected to be the major growth driver on the back of 5G proliferation. Next would be high-performance computing (HPC) supported by the robust cloud investments by global tech giants. Although IoT device generally has lower IC content, the sheer forecasted volume suggests that this market is too big to ignore. Lastly, demand from automotive is expected to be solid as electric/autonomous vehicle require significantly higher semiconductor content.

Reiterate OVERWEIGHT. We expect tech sector to experience multiyear earnings growths supported by fundamental exponential demand and further enticed by government incentives (see Figure #9). We maintain our tactical position in favour of frontend players as many countries have rushed to develop their semiconductor capabilities, especially in leading edge (≤7nm) frontend fabrication (foundry) to be self-sufficient on the back of national strategic and security interests. However, on top of Frontken (BUY, TP: RM3.88) and UWC (BUY, TP: RM7.00) who have exposures to frontend, we also include Inari Amertron (BUY, TP: RM3.81) as one of our top picks, leveraging on next iteration of iPhone 5G super cycle.

Source: Hong Leong Investment Bank Research - 9 Jul 2021