• Stay OVERWEIGHT; Top Picks: Malaysian Pacific Industries, Pentamaster Corp, and CTOS Digital. The Bursa Malaysia Technology Index (KLTEC) gave up its YTD gains, made particularly over the past two months, as the sector is experiencing short-term headwinds. Still, we advocate investors with a medium-term view to be nimble and build positions amid steep share price corrections to attractive levels. The new semiconductor upcycle has only just begun – we believe sector demand is showing early phases of recovery, and expect it to gain pace into FY25 with stronger growth visibility.

• Recovery intact. The Semiconductor Industry Association (SIA) has revised its forecasts upward, consecutively to reach USD611.2bn in 2024 (+16%) and another 12.5% growth into 2025. This uneven recovery is currently supported by the logic and memory chips, thanks to the boom in artificial intelligence (AI)-related servers and equipment. Going into 2025, a broad-base recovery with growth from all segments is expected. Also, early recovery indications in the automated test equipment space, along with traction in the front-end semiconductor space, bolsters our belief for a sustained sector recovery that is expected to gain pace into 2025 –where the replacement cycle intensifies.

• Sector earnings. 2Q24 results for the sector were largely a miss, mainly on slower-than-expected revenue and margin compression and high expectations. In fact, aggregate core PATAMI sustained the YoY growth (+11.6% YoY) on stronger revenue amid the recovery of the semiconductor space and we expect the trend to continue into 2H24 and FY25. Earnings may be underwhelming – given the high growth expectation by Street (+66%) for FY24. However, we believe the market has factored in the headwinds with downsides now limited amid steep share price corrections over the past months. The sector’s valuation is attractive, at only c.20x-22x CY25F P/E – which is around its 5-year historical mean vis-à-vis FY25 growth of +20%.

• FX impact. Sector headwinds on unfavourable FX could temporarily derail the recovery. Semiconductor players’ earnings should be negatively impacted by the stronger MYR (1% change) at c.1-3%. Still, it may be partially hedged by their USD purchases – typically 40-50% of COGS (for OSATs) and 20-40% (equipment makers and those with foreign borrowings). We believe the primary earnings drivers are volume loading and margins compression stemming from negative FX movements that can be passed on to customers via renegotiation, revised quotation, and engineering, and process efficiency.

• PHLX Semiconductor Sector’s (SOX) surge and KLTEC’s plunge implies the market has mispriced the semiconductor sector’s recovery, which is expected to gain pace into 2025 – judging from SOX’s earnings growth expectation (FY25F: 37.2%). Besides, a more optimistic tone from the guidance of semiconductor-related companies – albeit uneven – citing volume recovery (especially in China), various new opportunities, and clientele from the ongoing trade war. The beginning of the US Federal Funds Rate cuts should be a boon to the valuation of high-growth sectors like technology. Downside risks: Softer consumer demand, unfavourable FX, obsolescence of technology, loss of clients/contract, and intensifying geopolitical tensions.

Source: RHB Securities Research - 9 Oct 2024