FROM our previous article “Semiconductors: Downgrade to 2.5 Stars ‘Neutral’ on Lofty Valuations and Greater Near-Term Risk” where we warned about technology stocks especially semiconductors moving into overvalued territory, the KLTEC (Bursa Malaysia Technology) Index that measures the performance of technology stocks in Malaysia is down -32% year-to-date (YTD).
The reason behind this was regulatory crackdown in China’s technology sector and fears over aggressive interest rate hikes. When the interest rate is higher, the discount method on future earnings will be reinstated, meaning that investors cannot command those high valuations anymore.
However, we see brighter days ahead for the Malaysian technology sector due to positive earnings growth in the future and that it is trading at reasonable valuation.
The semiconductor industry consist of manufacturing semiconductor and other technology equipment. Given that the semiconductor industry holds a significant weightage in the technology index, we look to expand our view and reason to have a bullish call on the industry in this article.
Among the semiconductor supply chain, assembly and packaging showed exceptional growth across all regions, resulting in an 87% market increase in 2021 while total test equipment sales rose 30%.
Malaysia plays an important role in the semiconductor global supply chain. According to worldwide Semiconductor Industry Association (SIA), Malaysia accounts for 7% (RM367.57 bil) of total trade flows.
Meanwhile, it is also the US’ largest semiconductor trading partner with a 24% market share. As a semiconductor exporter, Malaysia is a leading hub for semiconductor’s assembly, test and packaging of semiconductor equipment and integrate circuit (IC).
Total semiconductor export in February 2022 is valued at RM24.9 bil, slipped from the peak of RM31.4 bil in December 2021 amid global supply chain disruptions from Russia/Ukraine tensions but still recorded a 42% year-on-year (yoy) increase.
Malaysia’s semiconductor mostly consist of outsourced semiconductor assembly and test (OSAT) players, a third-party service that suppliers around the world which consists of, as the name implies, semiconductor assembly, packaging and testing of IC.
As of 2020, the OSAT market is valued at US$31.64 bil and is expected to reach US$49.71 bil at a CAGR (compound annual growth rate) of 7.3% over the next five to six years.
Structural growth drivers
- 5G infrastructure roll-out: The smartphone segment has been the biggest source of revenue for OSAT providers with more than 1 billion shipments every year. The average semiconductor value of a 4G phone is US$ $126.1 while a typical 5G phone semiconductor value is at US$$233.9 which makes a 185% difference.
- Electronic vehicle (EV) growth: The increasing demand for reducing carbon emissions and developing more advanced and fast-charging stations has driven the electric vehicle market to grow at an astonishing pace. As of 2021, total EV sales have reached 6.6 million and successfully captured a 8.6% global market share.
- Artificial intelligence (AI): The intelligent ability that helps to reduce human work is powered by high-performing AI chips (GPUs, ASICs and MCUs), thus it also has an impact on semiconductor demand.
- Cloud computing: This has also boosted demand for semiconductors as they require build-in GPU, DRAMs, CPU and ICs.
Headwinds: Softening demand
Despite great potential growth in the future, demand is expected to normalise as last year’s rally was partly due to being ‘too bullish’.
While the sudden and sharp rise in demand that we have seen over the past two years can be explained by excess demand amid global supply chain disruptions and the growing adoption of digital technology, demand will not be weaken as much as the average selling price (ASP) for glove counters in 2021 due to underlying structural growth for technology stocks.
Valuations at attractive levels
The KLTEC index is setting sights on longer-term growth despite the sharp sell-off over the past two months as there is a mismatch in fundamentals and valuations at this current share price level.
Based on our analysis, we expect the earnings growth for the Bursa Malaysia technology sector in 2022Y to be 13.4%, the forward P/E (price-to-earnings ratio) in 2024Y is expected to be 15.78 times, trading at a discount of the five-year average P/E of 27.4 times.
Although the historical P/E ratio is sitting at roughly 21, investors will be willing to pay a slightly higher valuation if the growth potential is high. Therefore, we opine that the forward P/E ratio is very attractive. Tech companies’ earnings are foreseeable with their contracts and orders in hand.
Key takeaways
In our point of view, Malaysia still has a strong ecosystem in the semiconductor space with many of the companies having quite a competitive edge.
As for upside potential, the KLTEC is now trading at 15.68 times P/E based on 2024F estimated earnings which is below the fair P/E of two times which translated into a 27.5% upside potential, signifying attractive valuation with ample room for upside growth.
The downside risk is that our “overweight” call on the Malaysian technology sector include but not limited to (i) demand slump more than expected amid global supply chain ease; and (ii) companies failed to meet high expected earnings growth due to “over-hyped” extreme earnings forecast. – May 17, 2022
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The views expressed are solely of the author and do not necessarily reflect those of Focus Malaysia.
