Technology - Headwinds ahead for 2013

We are maintaining our NEUTRAL rating on the Technology sector. To recap, all the tech companies under our coverage reported 3Q12 results, which came in below the street as well as our expectations. The visibility of the industry is murky for now as we understand that industry players are still adopting a wait-and-see approach in light of the global economic uncertainties. Going forward, we believe the earnings prospects for tech companies will remain bleak, no  thanks to the flattish top line growth arising from sluggish electronics demand coupled with a higher labour cost structure that led by the new minimum wage ruling and adverse currency fluctuation. In conclusion, our top-down analysis points toward a negative outlook for the sector in 4Q12 and 1Q13. We had revised down most of our earnings for the tech companies and downgraded their respective TPs (target prices) to reflect on our conservative stance. Although the tech stocks under our radar are now already trading at their bear level valuations, we opine that the prolonged external uncertainties are likely to keep most tech stocks trading sideways with downward bias before reaching their very bottoms. As such, we prefer to maintain a Neutral rating on the sector for now despite its low valuations.  We have only MARKET PERFORM calls on MPI (TP: RM2.78), JCY (TP: RM0.85), Unisem (TP: RM0.99), Notion (TP: RM1.07) and Kelington (TP: RM0.53).

3Q12 results round-up.  To recap, aggregated 3Q12 profits of the tech companies in our coverage declined substantially by 70.5% QoQ. This was dragged down by negative top line growth (-3.4% QoQ) that was a reflection of the normalised demand after the high pent-up demand during the Thai flood recovery and the adverse currency fluctuations. On the individual company numbers, results were relatively mixed in the quarter. In general, the HDD companies' results were within our expectations while the semiconductor companies came in below. 

Headwinds to continue in 2013. The visibility of the industry is murky for now as we understand that the industry players are still adopting a wait-and-see approach in light of the global economic uncertainties. According to the Semiconductor Industry Association, YTD global chip sales still declined by 4% YoY despite a MoM improvement that was driven by festive season purchase. Note that Americas and Europe are making two-thirds of the global consumer-electronics markets, thus the prolonged economic uncertainties in these countries could further exacerbate the lackluster demand in electronic devices going forward, in our view. Taking a cue on that, we believe that the book-to-bill ratio would continue to trade below 1.0x parity going forward.

Meanwhile at the bottom line, we believe that the minimum wage ruling that set to commence in January 2013 could erode the margin of tech companies in light of its higher labour cost structure. Meanwhile, adverse currency fluctuation is another potential risk that could weigh on the revenue as well as erode the profitability of tech companies ahead. An appreciation of RM against USD beyond our assumption could further hit the earnings of tech companies. Altogether, these factors remain a threat to the earnings growth of the sector in the short term.

Valuation at bear levels. Due to the unpredictable earnings trend and uncertainties in the global economy, we are using a PB (Price to Book) methodology for our valuation model. For MPI, its PB is trading below the -1SD from its 3-year average. This is at its historical low range and suggests the share price could be near to a bottom. Meanwhile, Unisem is also trading at a -1SD level from its 3-year average. From its historical PB band, we believe that the valuation has not hit rock-bottom yet as the company used to trade at a -2SD level in Mar 2009. For JCY, its PB is trading at -1SD currently and could see further downsides as the stock used to trade at -1.5SD before the Thai flood. Note that Notion is also trading at a -1SD from the mean, which is at its lowest PB band, while Kelington is trading at the mean of its PB band with its historical low set at -1SD from the mean.

 In summary, the sector has still to contend with tougher times ahead. Europe and US are still problem spots for IT demand and the broader economic activity. As a result, we think that the prolonged external uncertainties are likely to keep most tech stocks trading sideways with downward bias in the near term before they reach their very bottoms. As such, we prefer to maintain our Neutral rating on the sector for now despite its low valuations.

Source: Kenanga