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Analysts keep 'overweight' call on tech sector despite potential headwinds

Felicia Tan
Felicia Tan • 11 min read
Analysts keep 'overweight' call on tech sector despite potential headwinds
Analysts from RHB and UOBKH have identified Venture Corp and Frencken as their top picks.
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Analysts from RHB Group Research and UOB Kay Hian are keeping their “overweight” call on the Singapore technology sector.

To RHB analyst Jarick Seet, his call comes despite potential headwinds such as rising operational costs that may erode margins and amid a potential slowdown in the semiconductor industry.

In his report dated July 22, the analyst notes that the chip sector may be facing a slowdown, with the Taiwan Semiconductor Manufacturing Company (TSMC) announcing that it will trim spending on expansions by as much as 9% compared to its initial projections on July 14.

TSMC also said that it will delay some capital expenditure (capex) spending to 2023 despite surging revenues.

“We believe this is a huge indicator on concerns about elevating inventory in the US$550 billion ($765.72 billion) semiconductor industry, as well as the longer-term impact of a potential global recession due to rising interest rates and the ongoing Russo-Ukrainian war,” Seet says.

“Micron Technology’s recent weak outlook forecast also served as a red flag, or a signal of a potential incoming slowdown,” he adds. “The memory chip firm is now shifting to a more conservative posture on adding capacity, and expects capex on wafer fabrication equipment in the August 2023 fiscal year to be down from the roughly US$12 billion it expected to spend in 2022.”

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He continues: “In the next few months, we expect broad capex cuts announcements from memory chip companies and second-tier foundries, as well as potential delays at top-tier foundries.”

Valuations attractive, says RHB’s Seet

That said, the RHB analyst sees the sector’s valuations as attractive after tech stocks corrected by some 50% to 70%, especially SGX-listed counters.

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“We believe a company’s ability to pass on costs to its customers will likely determine its earnings resiliency against that of peers,” he writes.

In his view, manufacturers with strong demand such as Venture Corporation will do “much better” in 2022.

Venture Corp had reported strong numbers for the 1QFY2022 ended March. It will be releasing its results for the 1HFY2022 ended June on Aug 5.

“Manufacturing stocks have been largely impacted by the global component shortages of the last two years,” says Seet. “However, we think that this will likely ease in 2HFY2022, which will lead to a much better performance for this year and – possibly – lead to a positive sector re-rating,” he adds.

“While semiconductor stocks rallied in 2020 and 2021, electronics manufacturing services players’ stock prices have typically remained muted. This could change in 2HFY2022,” he continues

Within the tech sector, RHB has coverage on Avi-Tech Holdings, Frencken Group, Fu Yu Corp, Valuetronics and Venture Corp with “buy”, “buy”, “neutral”, “neutral” and “buy” recommendations respectively.

RHB has given Avi-Tech a target price of 42 cents, while Frencken Group’s target price is pegged at $1.24. Fu Yu Corp, Valuetronics and Venture Corp have been given target prices of 28 cents, 53 cents and $22.75 respectively.

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In his report, Seet’s top picks are Frencken and Venture Corp.

UOBKH’s top picks are also Venture and Frencken

Analyst John Cheong is also remaining positive on the sector ahead of the release of their results for the 2QFY2022.

Tech-related companies in Singapore are slated to release their results for the quarter between July 25 and Aug 15.

In his report dated July 21, Cheong has also highlighted his top picks as being Venture and Frencken, same as Seet’s top picks.

“We believe their diversified customer base and majority of productions in Malaysia, which have fully relaxed its Covid-19 restrictions, should reduce the negative impact of weaker demand as well as supply chain disruptions,” he writes.

In addition, Venture should be able to continue delivering “a good set of results” in 2QFY2022 as it continues to see healthy demand from most of its customers. Venture’s customers are diversified across seven domains. The group also has proven capability in managing supply chain disruptions, says Cheong.

“In addition, Venture should be able to manage costs and pass on higher prices to customers given its differentiated capabilities,” he adds.

Frencken, on the other hand, is expected to show a “marginal decline” in its 1HFY2022 earnings due to the higher material costs, which will affect its gross margin.

However, Cheong expects the group’s earnings for the 2HFY2022 to be “sequentially better” as its management is working to mitigate cost inflation pressures by passing on cost increases through operational initiatives, and is anticipating signs of easing supply chain constraints.

“Also, Frencken’s diversified customer base across five segments should provide better earnings visibility,” says Cheong.

UOBKH sees earnings weakness for stocks with ‘huge China exposure’

Within UOB Kay Hian’s coverage of tech and tech-related companies, Cheong has split them into three groups.

The first group comprises stocks such as Nanofilm, Aztech and Innotek, that have significant exposure to China. These three have majority of their production plants in China, with Nanofilm in Shanghai, Aztech in Dongguan and Innotek in Dongguan and Suzhou.

The second group covers stocks with low exposure to China and a diverse customer base. Names in this group include Venture and Frencken.

The third and final group are pure semiconductor names such as AEM and UMS Holdings.

The first group, according to Cheong, could see negative earnings surprises as the sporadic Covid-19-induced lockdowns in China have caused “persistent challenges” to the manufacturing supply chain.

To Cheong, there are three key challenges that arise from these counters’ exposure to China. This includes the higher costs in sourcing for new materials due to reduced supply and higher logistics costs. Higher labour costs due to the requirement of closed-loop manufacturing are also another challenge.

A slowdown in customers’ demands due to difficulties in sourcing materials and slower productions is also a challenge.

“Also, these manufacturers serve customers in the consumer electronics and auto segments, which are discretionary products in nature, and could see reduced demand in a recession,” he says.

Potential slowdown in semiconductor cycle

In his report, Cheong is expecting pure semiconductor names such as AEM and UMS Holdings to report “healthy earnings” growth in the 2QFY2022.

However, the analyst is “wary” of a slowdown in the semiconductor cycle after two years of strong chip demand.

The strong demand was partly boosted by the supply chain disruptions caused by the Covid-19 pandemic.

“Chipmakers' fortunes rose in the early days of the pandemic as demand for electronics from stuck-at-home consumers and reduced supply due to manufacturing and logistics issues caused semiconductor demand to soar,” Cheong writes.

“Amid the supply crunch, businesses across the chip value chain raced to stockpile chips so they could handle further disruptions. In TSMC’s latest earnings call, it warned that its customers might now draw on those chip reserves rather than place new orders. TSMC also said it would trim its capex for 2022 by 10% to US$40 billion,” he adds.

South Korean chipmaker SK Hynix is also considering reducing its 2023 capex by 25%, while Intel’s CFO, David Zinsner, said that he expected the US chipmaker's 2QFY2022 earnings to take a hit due to customers working through stockpiled inventory instead of placing new orders, notes the analyst.

“In addition, demand for electronics is softening as personal computer (PC) shipments in 2QFY2022 fell 12.6% y-o-y, according to consulting firm Gartner,” says Cheong.

Furthermore, the crypto crash could be “another drag” on the chip market as crypto miners cease operations. Shipments of graphics cards fell 19% y-o-y in 1QFY2022, according to consulting firm Jon Peddie Research, he adds.

UOBKH’s earnings forecast

Cheong has given Venture a “buy” call with a target price of $22.80, which is pegged at +1 standard deviation above its forward mean FY2022 P/E of 19.5x.

The counter currently offers an attractive dividend yield of 4.7%.

In his report, Cheong has forecasted Venture to report 2QFY2022 earnings of $85 million, up 13% y-o-y and 1% q-o-q.

“Venture continues to see healthy demand from most of its customers. Despite the increasingly uncertain environment, Venture should be able to deliver relatively resilient performance given its highly diversified customer base across seven technology domains. In addition, most of Venture’s customers are in industrial segments such as life science, medical and testing, which are less sensitive to consumer sentiment,” he writes.

Cheong has also given Frencken a “buy” call with a target price of $1.63. The target price is pegged to an FY2022 P/E of 10.4x, based on its historical mean P/E. The counter is currently trading at an “attractive” P/E of 7x for the FY2022.

“We expect [Frencken to report] 2QFY2022 earnings of $13 million (-22% y-o-y / +2% q-o-q) as impacts from supply chain disruptions, higher cost pressures from raw materials, rising energy prices and workforce disruptions will take time to ease,” the analyst says.

“However, we expect 2HFY2022 earnings to be sequentially better as management is working to mitigate cost inflation pressures by passing on cost increases through operational initiatives and is anticipating signs of easing supply chain constraints. In the mid to longer term, Frencken would benefit from positive market trends in 5G, Internet of Things and artificial intelligence,” he adds.

Cheong has given Nanofilm a “hold” call with a target price of $2.72 as he expects the company to report “lacklustre” earnings for the 1HFY2022 due to margin pressures from the production disruptions in China.

“We expect Nanofilm to report 1HFY2022 earnings of $20 million (+12% y-o-y / -55% h-o-h), falling short of our estimated 26% y-o-y growth in 2022 earnings. The weakness can be mainly attributable to production disruptions caused by the two-month lockdown in Shanghai in April and May, and is likely to impact gross margins from higher labour and raw material costs due to logistical challenges,” he writes.

“Moving forward, we also see a more cautious outlook from Nanofilm’s largest customer, as it had announced in July that it is planning to slow hiring and spending growth next year in some divisions to cope with a potential economic downturn,” he adds.

Cheong has given Aztech a “buy” call with a target price of $1.55 as he expects the group to see “marginal earnings growth” for the 2QFY2022 albeit with a more cautious take on consumer sentiment and margin weakness.

“We expect Aztech to report 2QFY2022 earnings of $18 million (+5% y-o-y, +22% q-o-q), where the 1HFY2022 of $30 million will fall short of our expectation of $36 million mainly due to production disruption in China,” he writes.

“Hence, we will be looking at a potential 10% cut in our 2022 earnings estimate of $90 million. This should have an impact on Aztech’s revenue and gross margin as higher logistics and labour costs may not be fully passed on to customers. In addition, Aztech’s key product of surveillance camera, which is discretionary in nature, may see slower demand in a more uncertain environment,” he adds.

Cheong has placed Innotek “under review” pending further information after the company issued a profit guidance on July 14 that it expects to report a net loss for the 1HFY2022. Before this, Cheong had given Innotek a “buy” call with a target price of $1.20 based on an FY2022 P/E of 12x.

Cheong has also given AEM Holdings and UMS Holdings both “buy” calls with target prices of $5.60 and $1.45 respectively.

AEM’s target price is pegged to FY2022 earnings of 15.6x or +2 standard deviation to its historical five-year range.

UMS’s target price is pegged to FY2022 earnings of 15.4x or +2 standard deviation above its historical five-year average.

“We believe UMS could trade at a premium over peers due to its timely new capacity expansion to drive earnings growth above the industry average,” says Cheong.

The analyst is expecting AEM to report 2QFY2022 earnings of $25 million (+52% y-o-y, -39% q-o-q), “with the sequential decline from an exceptionally strong 1QFY2022 mainly driven by the uptake in new generation equipment and tools and the consolidation of CEI Limited, which was acquired in 1HFY2021.”

“We also believe that there could have been some front-loading of orders in 1QFY2022 as the major customer attempts to mitigate the risk of supply chain constraints,” he adds.

For UMS, he expects 2QFY2022 earnings to come in at $19 million (+12% y-o-y/-2% q-o-q), “as the company should enjoy continued strength in semiconductor demand, as well as consolidation of sales from JEP starting in 2QFY2021”.

“We understand that factory utilisation levels at the downstream semiconductor manufacturers, including UMS, will stay elevated in 2022-23. Specifically for UMS, the order backlog for AMAT’s Semi Systems segment has shown sustained growth over the past four consecutive quarters, providing revenue visibility for UMS into 2023,” he says.

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