KLTEC outperformed the broader index in 2021 (KLTEC +39% vs KLCI -4%). The latest industry average growth projection of 23% exceeds our initial estimate of 20%. As for 2022, the sector is expected to be in expansionary mode with 8%. Capital spending is expected to reach another record on the back of strong fab construction pipeline. Stronger greenback outlook may boost 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 Kobay as one of our top picks.

Outperformed in 2021. Sustaining 2020’s momentum, KLTEC gained 39% vs KLCI’s 4% decline (see Figure #1). Our overweight stance on the sector since the beginning of the year has proven rewarding and all our 2021 top picks, namely Frontken (+73%), UWC (+27%) and Inari (+45%) generated remarkable returns.

Global semiconductor sales. 10M21’s 25% YoY gain to USD450bn (see Figure #2) is on track to record another all-time high revenue. The latest industry average growth projection of 23% (see Figure #3) exceeds our initial estimate of 20%. As for 2022, the sector is expected to be in expansionary mode with 8% (see Figure #4). According to WSTS, all product categories are expected to experience expansions (see Figure #5) in 2022: sensors (+11%) leads the pack, followed by logic (+11%), analog (+9%), memory (+9%), discrete (+7%), opto (+6%) and micro (+6%).

Equipment spending. Capital investment was strong in 11M21 with 44% gain in 3MA billings to USD39bn (see Figure #6). 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 #7). 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).

Stronger greenback. HLIB expects USD to be stronger in 2022 averaging RM4.16/USD compared to 2020’s average of RM4.14/USD (see Figure #8). As such, we expect tech firms to be marginally boosted as their sales are majority denominated in USD terms while partly offset by the USD cost items.

Higher input costs. Gold, aluminium, copper and steel prices are on the upward trajectories (see Figure #9) and may spell bad news for tech players. 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 investments in cloud, crypto and metaverse. 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 #10). 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 and UWC who have exposures to frontend, we also include Kobay as one of our top picks, leveraging on its rapidly growing new business ventures, namely advance data server and solar frame projects.

Frontken. Reiterate BUY with higher TP of RM4.42 (previously RM4.15), pegged to 50x of FY23 EPS (previously mid-FY23 EPS). We like Frontken for its multi-year growth ahead on the back of: (1) sustainable global semiconductor market outlook, (2) robust fab investment, (3) leading edge technology (7nm and below), and (4) strong balance sheet (net cash of RM282m or 18 sen per share) to supports its Taiwan expansion.

UWC. Reiterate BUY with an unchanged TP of RM6.52, pegged to 50x of FY23 EPS. The ongoing trade intensity may eventually benefit UWC which provides a one -stop solution as more companies shift productions out of China to avoid import tariffs.

Kobay. Reiterate BUY with unchanged TP of RM8.00. Due to its diverse business structure, we value Kobay using SOP valuation methodology: (i) manufacturing division is valued based on 45x of (previously 40x) FY23 EPS. This multiple is at discount to what we ascribed to its peers under our coverage; (ii) property development business is valued using FY21 net book value; and (iii) pharmaceutical business is appraised based on 25x of FY23 EPS, in line with industry peers.

Source: Hong Leong Investment Bank Research - 5 Jan 2022