ASEAN Technology Sector - DBS Research 2020-07-01: Flying On The Semiconductor Highway


ASEAN Technology Sector - Flying On The Semiconductor Highway

  • Tech was the best performing sector despite recent consolidation, outperformed market by 27% YTD.
  • Players with diversified geographical footprint will benefit from supply chain shift led by trade war and COVID-19.
  • COVID-19 accelerating digital transformation pace – benefits those with exposure to servers, storage, chips.
  • Semiconductor plays still in favour – AEM Holdings (SGX:AWX), UMS Holdings (SGX:558), Frencken Group (SGX:E28); Delta Electronics (DELTA TB) for exposure to data center.

Technology Sector Review

Best performing sector YTD despite recent consolidation.

  • Technology stocks have staged a spectacular performance, especially from mid-March to mid-May, rebounding 32.6% since the trough in March. Although the sector has been consolidating since mid-May, the FTSE Technology Index (FSTTG Index) has outperformed the STI Index by 26.7% YTD, beating all other indices.
  • For Malaysia, the KLSE Technology Index has rebounded by a spectacular 71% from the trough in March, and is up by 7.2% YTD.
  • The adoption of new technologies - Internet of Things, Big Data, Artificial Intelligence and 5G, are driving new demands.
    • Winners include AEM, which has surged 119.7% from its trough in March, mainly driven by a stellar set of 1Q20 business update, followed by bullish sales guidance of 17% to 19% higher than the previous guidance in February 2020.
    • Others include UMS, which jumped 65% from the low in March.

Global Economic Outlook

Expect a long and uneven recovery after a sharp contraction.

  • As most of the technology stocks have global exposure in terms of customers, the global economic outlook plays a key role in determining demand. The International Monetary Fund (IMF) warned that the global economy faces an even deeper downturn than it previously projected. It now expects the global economy to shrink 4.9% this year, a sharper contraction than the 3% projection made in April. The recovery path is likely to be long and uneven.

PMIs still mostly negative but recovering.

  • Though PMIs for most countries are still in negative territory, there are growing signs that the collapse in economic activity caused by the pandemic has bottomed out and a recovery is underway. In extreme conditions, the PMIs may be a better guide to turning points in activity rather than the actual output.
  • The manufacturing gauge in China has recovered and remains in the expansion region (above 50) since March 2020. The US and Europe remain well in contraction territory at 43.1 and 39.5, respectively, in May. However, this is off their lows in April.
  • Barring any resurgence of COVID-19 cases globally and re-escalation of the US-China trade war, we expect technology companies to be on the road to recovery, though the recovery may be slow for some.

Consumer confidence index is improving but still below average.

  • US and Eurozone’s consumer confidence index has bottomed in April 202 and now experiencing an uptick. However, based on the latest information for June 2020, both regions’ confidence index is still below a long-term trend.

Slowdown in automotive demand to weigh down the pace of the sector recovery.

  • Another key underlying application for electronics sector under our coverage, specifically in Thailand, is automotive industry. This end demand is likely to recover slower than others, no thanks to its big-ticket size. Though we expect the unemployment rate to decline sharply after the ease of lockdown, there will be a residual level of higher than historical rate of unemployment. Large ticket consumer discretionary goods are likely to take longer time to recover, though, sales of light vehicles in major region have bottomed in April 2020 during the lockdown. Each region shows a different pace of recovery. Sales of light vehicle in Western Europe is lagging behind other peers in term of recovery.
  • China sales has registered a positive growth in 22 months in May 2020. US’s light vehicles sales show faster recovery in May 2020 as compared to Europe.

Shift in Supply Chain

Shifting out of China.

  • China, being the factory to the world, is where many manufacturing facilities are located. Many technology companies have manufacturing plants in China, mainly to take advantage of the lower labour cost compared to developed markets, a strong ecosystem, and the government’s effort to attract foreign investments.

Push factor - Trade war and COVID-19.

  • The onset of the US- China trade war, and now the COVID-19 pandemic, has underscored the need to shift the supply chain out of China.
  • Trade War -
    • Majority of shipments out of China to the US are currently subject to tariffs that range from 7.5%-25%.
    • This reignites risks that more companies would diversify their supply chains out of China for fear of a protraction or worsening of the tariff situation.
    • Shift to other ASEAN countries or back to the US. In recent years, ASEAN countries, including Thailand, Vietnam, Indonesia and Myanmar, are gaining popularity as a manufacturing site. As a result, several US companies are shifting their suppliers from China to other ASEAN countries in order to avoid the tax tariffs, while others have shifted to alternative suppliers in the US.
  • COVID-19 pandemic -
    • The disruption to the supply chain as a result of the COVID-19 pandemic has led to many manufacturers to rethink their supply sources, to balance between efficiencies, resilience, costs, and to diversify their production networks instead of relying on a limited number of suppliers. Companies could shift to suppliers closer to its own manufacturing facilities in order to avoid delay in shipments, as well as cut down on transportation costs.

Winners or losers?

  • Most of the companies under our coverage have manufacturing facilities both in China as well as in the ASEAN region. Thus, a shift in supply chain out of China could cut both ways. On one hand, if the customer shifts out of the China plant to other plants in the region within the group to be closer to its end customer, then this would be a win-win situation for both the customer and the group. Cost savings in terms of transportation costs can be derived by being close to the end customer, and for US customers, tax tariffs can be avoided. The group can retain the customer and at the same time provide better service by being near to each other’s manufacturing facilities.
  • However, the group would be impacted if the customer chooses to relocate to a location where the group has no presence. A case in point is Valuetronics (SGX:BN2). The protraction of the US-China trade war, which began in early 2018, had started to weigh on its Consumer Electronics (CE) business in FY19. Due to on-going uncertainties, its smart lighting customer had begun to diversify its supply chain out of China, which resulted in Valuetronics losing some of its business. As a result, revenue from its CE business declined 16.9% y-oy in FY19. See recent initation coverage report: Valuetronics - DBS Research 2020-06-19: Holding On To Its Value; Initiate Coverage With HOLD.
  • Going forward, we expect more of Valuetronics’ customers to shift their supply chains out of China to other regions in ASEAN, or back to the US for those with end-customers in the US. Besides Valuetronics, most of the technology stocks under our coverage also have exposure to US customers.

Diversified manufacturing footprints.

  • Companies with manufacturing facilities outside China could benefit from the shift in supply chains out of China. A diversified manufacturing footprint would allow the group to achieve optimal allocation of resources, explore neighbouring suppliers to reduce transportation costs, and at the same time be closer to its customers.
  • Valuetronics has a manufacturing plant in Vietnam that began production in June 2019. With the launch of its trial production at its second facility in Vietnam, the group is expanding its Vietnam campus to offer existing as well as new customers an alternative to its production site in China. Its Vietnam campus has close to the same floor space as its facility in China and is expected to complete by the end of FY22F. The benefits of an alternative production site will flow in gradually from FY21F-22F.
  • Hi-P International (SGX:H17) has accelerated its expansion plans in Thailand since the onset of the trade war in 2018. Phase 2 of its expansion, which is about 5x bigger than Phase one, is already in operation. UMS is also planning to expand its Penang plant by another 200,000 sq ft by 2022, which is a 40% increase in capacity.
  • Delta Electronics has production facilities in various locations including Thailand, Europe, India and Myanmar. Starting in mid of 2019, Delta Electronics has accelerated its expansion in Thailand in order to carry out the production of Delta Electronics networking.
  • Hana Microelectronics also has production facilities in various countries including Thailand, China, US and Cambodia. In FY19, Hana Microelectronics has transferred orders from its China plant to Thailand as part of trade diversion. Thanks to COVID-19, it has been receiving interest for relocations mainly to its Cambodia and Thailand facilities. However, Hana Microelectronics expects the order to be materialised only in FY22F.
  • SVI is another candidate for EMS service relocation, as it has both Thailand and Cambodia facilities.

Paradigm Shifts Post Pandemic

The New ‘Normal’.

  • The COVID-19 pandemic has created a pressing need for companies to begin their digital transformation by adopting technologies to increase their efficiency and competitiveness. Even as we move into life post lockdown, telecommuting and working from home continues to be the new normal for many.
  • The work-from-home policy and online learning have increased the proliferation of certain segments of the technology value chain, in particular, semiconductors, memory and servers. The progress in cloud platforms, software and productivity tools enable a workforce to communicate seamlessly from home.
  • The shift to working from home has also breathed new life into categories that were in decline, such as web cameras. Although the pandemic will recede, the structural changes caused by the pandemic is likely to persist to some degree. This will drive paradigm shifts in tech requirements and consumer behaviour. There will be a sustained demand for this digitisation trend as a result.

Servers, storage, network-related equipment to do well.

  • Other beneficiaries would be segments with exposure to servers and cloud computing. According to data from International Data Corporation (IDC), 1Q20 chip revenue by end markets for servers, storage and wireless networking generated positive y-o-y growth. There are generally more players in this mid to downstream space within the whole technology value chain. Some have indirect exposure, as they could be manufacturers of component parts used in PCs and laptops. Thus, this space tends to be more competitive. Stocks in this space within our coverage include Venture Corp (SGX:V03), Hi-P International, Frencken, Fu Yu (SGX:F13) and Valuetronics. Under Thai Electronics coverage, we have Delta Electronics which has the direct exposure to server and storage, and Hana Microelectronics could be an indirect beneficiary from components parts used in PCs and laptops.

Expect semiconductors to outperform, with or without COVID.

  • With the world emerging from lockdowns, we expect other segments to recover, though the recovery path could be slow and uneven. Those at the front end of the technology value chain, or those with exposure to new technologies - 5G, IoT etc including semiconductor and related plays - are expected to recover faster than the rest. Memory chips are used in a wide range of electronic devices. With the proliferation of technology, memory chips are now on various types of RAM. DRAM memory, used in desktop computers and servers, and NAND, used in smartphones. Thus, more sophisticated equipment and testing processes are needed to produce these chips. Hence, semiconductor equipment and component parts makers are clear beneficiaries. Proxies would include AEM, UMS and Frencken.
  • Both AEM and UMS are semiconductor equipment and parts manufacturers, while Frencken provides essential components and assembly for Wafer Fabrication Tools (Lithography, PVD), die bonding, IC testers and manipulators, and vacuum solutions.
  • Inari (INRI) is a direct exposure to 5G theme, given its close relationship with one of the top RF (radio frequency) chip players in the world.

Bullish forecasts from SEMI.

  • In its June update, Semiconductor Equipment & Materials International (SEMI) expects global fab equipment spending to jump 24% y-o-y in 2021, 10ppt higher than its previous forecast in 1Q 2020. All product segments, including memory fabs, logic and foundry, are expected to do well. In 1Q 2020, global fab equipment spending declined 15%, much narrower than the 26% decline forecast in February. For the full year, fab equipment spending is projected to ease 4% y-o-y in 2020, after an 8% decline in 2019. The trough spending has shifted from 1Q 2020 to 2Q 2020.

US semiconductor equipment billings is on an uptrend.

  • Despite the volatility, the US semiconductor equipment billings are still on a y-o-y uptrend. The May semiconductor equipment billing data published by SEMI, which would have factored in the global shutdown amid COVID-19 outbreak, eased 6% from the end of 2019, but is still up 14% y-o-y, its eighth consecutive y-o-y increase since October last year and we view this as an optimistic sign for the industry.


Resurfacing of US-China trade tensions could reignite risks.

  • Even though the Phase One Trade Deal has improved the tariff situation, the remaining US tariffs on China would only be removed in the second phase. However, tensions between the two countries resurfaced after a recent series of events:
    • Spread of the COVID-19 pandemic – The US has blamed China for the spread of the pandemic and has demanded an investigation into the origins of the virus.
    • China tightens its grip on Hong Kong – The US is considering revoking Hong Kong’s special trading status while Hong Kong’s government has warned the US against interfering in its internal affairs.
    • Forced technology transfer – The US has accused China ‘forced technology transfer’ and China has consistently denied the allegations. The Commerce Department has placed Huawei on blacklists aimed at preventing Chinese companies from using US technology for the chips that power its network gear. However, after suppliers found work-arounds, the Commerce tightened rules in May to bar any chipmakers using American equipment from selling to Huawei without US approval.

Weakening of the USD.

  • As the daily new reported COVID-19 cases began to rise in China in mid-January 2020, the USDSGD strengthened rapidly from 1.34 to 1.40 as markets were fearful of the virus developing into an epidemic. In early March 2020, the USDSGD experienced a second sharp spike to 1.46 as the epidemic turned into a pandemic but has since declined to 1.39. Our currencies strategist is expecting USD to stabilize at 1.39 through 2020.
  • The technology companies under our coverage are exposed to USD as the bulk of their sales are in USD while costs are mainly in local currencies. While these companies do not hedge their currency exposures with forward contracts, the impact is mitigated by a partial ‘natural hedge’ through matching their financial assets and financial liabilities or procurement of their raw materials.

Valuation & Recommendation

  • Based on our coverage of Singapore’s technology stocks - AEM, Frencken, Fu Yu, Hi-P International, UMS, Valuetronics, Venture Corp, the current sector forward PE is still below its 10-year average. This is despite the sharp share price rebound from the March 2020 low. However, on a shorter 5-year basis, forward PE is above its 5- year average of 10.4x, mainly skewed by the semiconductor plays, notably AEM, trading above +1 SD of its mean PE, and UMS, near its +1 SD level.
  • Similarly, the Malaysia tech sector which are mainly involved in semiconductor, is also currently trading above its 5-year average of 18.5x forward PE.
  • For Thailand, we have noted that over the past two years, the sector earnings were under major key downward revisions, resulting from trade tension between US-China in 2019 and COVID-19 pandemic in 2020. As a result, the forward PE band has been highly inflated. We have decided to extend the PE band analysis from 5 years to 7 years in order to come up with our recommendation. Among the stocks under our coverage, KCE Electronics and Delta Electronics are historically traded at a premium above the average, thanks to its higher gross margin. At current market price, the sector PE is c.21x of 1-year forward PE. We recommend selective BUY with the company that is going to benefit from structural changes like Delta Electronics.


Exposure to Medical and medical-related segments an added advantage in this pandemic crisis

  • Venture Corp’s business segments include Medical Devices and Equipment, Healthcare & Wellness Technology, and also Life Science, Genomics and Molecular Diagnostics, which is an added advantage during this pandemic.
  • Fu Yu had 18% revenue exposure to the medical segment in 2019 while Frencken has a 13% exposure.
  • Delta Electronics sees strong demand for power supplies for medical equipment, particularly for ventilators. Delta Electronics has roughly 5% revenue exposure to medical segment.

Digital transformation drives demand for servers/PCs/storage.

  • The COVID-19 pandemic has accelerated digital transformation, leading to higher demand for servers/PCs/storage related products. There is a lot of demand for bandwidth and stable Internet connections from working from home and online learning while companies lacking technology and infrastructure required to support productive remote working are beefing up their technology capabilities.

Strong balance sheet and cashflow crucial during times of uncertainty

  • In these uncertain times, it is vital that businesses have enough cash buffers to tide them through. All the companies under our coverage are in net cash position with strong operating cashflow to tide through the current headwinds due to the pandemic. Frencken, Fu Yu and Valuetronics stand out with > 50% of their market capitalisation backed by cash. Dividend payout ratio ranged from 26-95% of their latest historical results and we expect a similar trend going forward.

Lee Keng LING DBS Group Research | Woo Kim TOH DBS Research | Phanthila THARACHATR DBS Research | https://www.dbsvickers.com/ 2020-07-01
SGX Stock Analyst Report BUY MAINTAIN BUY 3.530 SAME 3.530