AmInvest Research Reports

Technology - Gradual Recovery for Semiconductor Segment in 2024

AmInvest
Publish date: Thu, 26 Oct 2023, 09:44 AM
AmInvest
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Investment Highlights

  • Signs of modest recovery in the semiconductor segment. According to Semiconductor Industry Association (SIA) data, global semiconductor industry sales recorded a modest growth rate ranging from 0.4%-3.7% over the past 6 consecutive months since March 2023 (Exhibit 2). This positive growth momentum suggests that companies are undergoing inventory correction from advanced orders placed at the height of semiconductor shortages during the pandemic-driven supply chain disruptions.
  • Slight recovery in front-end semiconductor order books. We recently visited UWC (UNRATED) and Greatech (UNRATED) in Penang. UWC’s order book stood at RM125mil as at 4QFY23 vs. RM120mil as at 3QFY23 with the semiconductor segment making up 70% of total outstanding orders. We gather that Greatech’s semiconductor segment accounted for an insignificant 1% of its RM610mil outstanding order book as at end of Aug 2023. Notably, UWC and Greatech experienced a slight pickup in orders compared to 2QCY23 with small orders secured from their US front-end customers in 2HCY23. Pentamaster (Penta) (HOLD; FV: RM5.50) maintains its view of a slower recovery for the group’s semiconductor segment, with an improvement in 2HFY24 on the back of new chip advancements that could help expand its customer base. This was consistent with its outlook guided in the group’s earlier 2QFY23 results briefing. We anticipate the contribution for Penta’s semiconductor segment to remain at 15%-20% of the total FY23F revenue due to the slowdown of the industry in 1HCY23.
  • Turning point for semiconductor segment. Overall, we expect that the decline in orders bottomed out in 3QCY23 as technology companies are gradually securing more orders in 4QCY23. UWC is seen as more bullish on the uptick of recovery of this segment while others remain cautiously optimistic with a modest recovery outlook. Order visibility has become clearer for 1QCY24, and this is expected to be followed by a stronger recovery in 2HFY24.
  • Bullish on the automotive segment over the longer term. According to Mordor Intelligence, the power electronics market size is projected to grow at a 5-year compound annual growth rate (CAGR) of 4.5% to USD37bil by 2028 while Precedence Research has forecasted a 10-year CAGR of 23% to USD1.7tril for the electric vehicle (EV) market by 2032 (Exhibits 4 & 5). Over the longer term, growth for this segment will be propelled by: (i) increasing adoption of vehicle electrification and autonomous driving, especially in USA and China, (ii) government initiatives and subsidies to encourage consumers to buy, and (iii) declining costs of EV batteries from technological breakthroughs.
  • Healthy order books for automotive segment. Greatech’s automotive segment constituted 24% of its total outstanding book of RM610mil as at end of Aug and the group is confident to secure more contracts amounting to RM250mil by end of FY23F. Meanwhile, Penta’s automotive segment share improved by 23%-points YoY to 58% of total 1HFY23 revenue. (Exhibit 8 & 9). Penta’s 2HFY23 sales will be supported by the automotive segment as demand remains stable despite economic challenges. To recap, the group expanded its clientele in this segment to more than 30 customers from 5 in FY21. The mix comprised largely of customers from USA (33%), China (29%), Vietnam (25%) and Japan (4%). Penta is also focusing to widen its foothold in Japan and Germany to provide silicon carbide (SiC) wafer burn-in equipment as the 2 countries are the leaders in leading-end automotive technology.
  • Short-term hiccups as automotive segment will not be spared from economic cycle downturn. In the near term, we are cautious about automotive sales growth due to rising interest rates and credit tightening, which will dampen potential consumer spending with higher borrowing costs. This will lead to an oversupply situation in the market and price competition for new vehicles.
  • More positive outlook on medtech segment ahead. Fortune Business Insights forecasted the North American medical devices market size to grow at a 10-year CAGR of 5.9% to USD800bil by 2030 (Exhibit 6). Increase in demand for innovative new medical devices/consumables and shifts to homecare of portable medical devices together with rising prevalence of chronic diseases and ageing populations will be driving the growth of the medical technology (medtech) market. Hence, this is expected to benefit local medical equipment manufacturers. Additionally, more multinational medical companies are seen expanding their manufacturing base while enhancing local supply chains.
  • Medtech order books to expand by capturing opportunities from potential launches of new medical devices. Greatech and Penta are seeing a stronger growth in the medtech segment from the increase in demand for automated processing lines on various medical devices. Medtech accounted for 16% of Greatech’s total outstanding order book of RM610mil as at end of Aug 2023 and the group is targeting to secure 2-3 new medical customers in FY23. We understand that Greatech has given quotations to 3 customers for a substantive RM500mil project. However, due to plant capacity constraints, the company expects to secure only a portion of this project. To address this limitation, the company is actively seeking out land in the vicinity of its existing plants to expand the production capacity for this segment.
    For UWC, medtech constituted 20% of its overall outstanding order book of RM125mil in 4QFY23, up slightly from RM120mil in 3QFY23. This segment’s share improved by 8%-point YoY to 25% of the group’s total FY23 sales. UWC anticipates a further uptick in orders for 1QCY24 based on customers’ projections.
    Overall, we are optimistic on promising growth prospects of the medtech industry. Companies are garnering increased orders from existing customer bases for both new and existing medical products while also actively broadening their client portfolio locally and overseas. Additionally, these companies are displaying a proactive stance in securing more projects in response to customers’ increasing capital expenditures and investments on newer products. Moreover, surging demand for automated production lines help streamline clients’ operational efficiency and reduce dependencies on labourers.
  • UWC’s continued expansion in production capacity. Despite the slowdown in certain segments, companies remain steadfast in their capex commitments and are confident that increased capacities will be utilised when the economy recovers. UWC is on track to complete its 2nd plant in Batu Kawan by December 2024, which will be used for warehousing and upstream production. Additionally, UWC is expecting the addition of another section (Block 7) to its existing headoffice/plant by November 2023.
  • Robust FAS demand. Penta believes that demand for factory automated solutions (FAS) division will be driven by automation advancement and “plus one” strategy of multinational corporations relocating their manufacturing plants to ASEAN countries due to ongoing geopolitical tensions between US and China. The group also intends to expand its client base by introducing various FAS options to strengthen Penta’s foothold in this segment. This could be supported by the group currently in the preliminary stages of discussions with another potential medical customer specialising in cardiac monitoring systems. Precedence Research has projected a 10-year CAGR of 8% for global cardiovascular devices market by 2032 (Exhibit 7). We believe this reflects substantial opportunities for Penta to capture primary demand for automation equipment given the rising end-customer demand for new medical devices with innovative features.
  • Penta’s Batu Kawan new 3.0 plant to be completed by 1H2024 to accommodate FAS and medical device segment. Penta’s 3rd plant in Batu Kawan, Penang, is currently under construction. The 1st phrase will be completed in 2H2023 followed by 2nd phrase in 1H2024. This plant is specifically designed to accommodate the FAS division and medical device segments, providing a production space of 630k sq ft which is 2.3x larger than both existing plants in Bayan Lepas and Batu Kawan.
  • Sourcing lands for solar/renewable energy segment and medtech. Greatech’s Batu Kawan 4.0 plant is expected to be commissioned by 1H2024 for assembly purposes. The group plans to acquire a 5-acre land located next to its Batu Kawan 1.0 factory to house computer numerical control (CNC) and metal fabrication/production equipment to support a customer’s aggressive expansion in solar panels. Greatech intends to acquire an additional 7 acres of land to cater for prospective orders from both new and existing medtech customers.
  • We maintain our NEUTRAL recommendation on the sector as near-term earnings growth potential will be capped by an expected slowdown in global economic growth. On the bright side, we expect automotive and MTS to help offset weakness in the semiconductor segment next year. Any positive rerating of the sector will depend on signs of faster-than-expected demand recovery of semiconductor and consumer electronic segments.
    We understand that these companies (UWC, Greatech and Penta) adopt a natural hedging approach to mitigate forex risk from a weaker Ringgit as their export proceeds are denominated in USD. For UWC, most of their materials are sourced locally and the group has the ability to pass on any additional input cost with a variance of more than 5% to customers. We observed that Penta has given longer credit terms to customers as seen by longer debtor days and this has lengthened the cash conversion cycle. On the positive note, the companies have healthy leverage and balance sheet with net cash positions as of Aug 2023. These companies are also enjoying lower effective rates due to reinvestment tax benefits from plant expansions or pioneer status on certain products.
    Key risks. (i) escalation of the US-China technology war and geopolitical conflicts, and (ii) concentration risk stemming from high reliance on limited key customers poses significant challenges, especially during global economic slowdowns, for companies such as such as UWC and Greatech. These risks may lead to excess capacities with higher fixed cost structures from plant expansions and inventory accumulation that are likely to impact profitability and cashflows.

Source: AmInvest Research - 26 Oct 2023

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