There is still uncertainty if these backorders are meant to fulfil a build-up in inventory or for actual real demand, says analyst

by FARA AISYAH & SHAZNI ONG/ pic by TMR FILE

ANALYSTS said the outlook for the local technology and IT services stocks remains clouded with uncertainty due to disruptions in the ecosystem due to the Covid-19 pandemic and trade tensions which are expected to hit consumer demand.

This is despite that the Nasdaq is trading near historic highs led by the FAANG (Facebook Inc, Amazon.com Inc, Apple Inc, Netflix Inc and Google LLC) stocks, and governments are pumping trillions of dollars in stimulus as economies open up and businesses resume their operations.

Affin Hwang Investment Bank Bhd analyst Kevin Low said the tech sector’s above-average earnings growth in 2020-2021E will be watered down by a broad-based recovery in other sectors, albeit from a low base, which may cap inflows.

In the second half of 2020 (2H20) outlook strategy note yesterday, Low stated that uncertainty continues as the weak global economic climate suggests only a modest recovery.

“While factories are gradually ramping up production, backorders are thus being filled. There is still uncertainty if these orders are meant to fulfil a build-up in inventory or for actual real demand,” he said.

Low noted that with high unemployment levels and reduced paychecks, the global economy will only likely show modest recovery over the next year and thus taper any sharp rebound in sector earnings.

“The work-from-home culture has, however, spurred personal computer (PC) demand and the necessary upgrades for bandwidth and data centres. The spotlight will also be on the introduction of more 5G-related models later this year,” he said.

Low expects earnings revision trend to be positive going into the year on the back of tighter inventories, but the negative impact from Covid-19 and its repercussions on global economic growth likely mean that there is downside risk to a preliminary stronger earnings growth recovery.

“While sequential earnings momentum should be positive, having bottomed out in the second quarter of 2020 (2Q20), year-on-year growth may still be negative. We are projecting a 2021E core earnings per share growth of 35.5% after 2020E’s decline of 12.8%, barring any escalation of trade tensions or an appreciation of the ringgit vis-à-vis the US dollar,” he said.

Low added that the equipment manufacturers are trading at a sharp forward price-to-earnings premium of 32.4% over the outsourced semiconductor assembly and test which may support the valuations of the latter.

“We do not expect the discounts to narrow significantly given the downside risk to earnings, as the economic recovery remains frail.

“Nevertheless, given the current market liquidity, we think the sector should trade at historical mean valuations at best. For a longer-term structural theme, we still like the 5G-related names,” he said.

The escalation of trade tensions between the US and China could further disrupt supply chains and the ecosystem, while a Covid-19 second wave leading to further lockdowns could also be disruptive to production.

“For sector exposure, we continue to like structural growth themes within the data and bandwidth space. (We) stick with long- term preferred sector pick, Inari Amertron Bhd (‘Buy’ and target price (TP) of RM2), for a proxy to the 5G story,” he said.

BIMB Securities Sdn Bhd analyst Afifah Abdul Malek believes the new normal has shifted the way people spend, as digital solutions and e-commerce become a more preferable option.

“Malaysia’s short-term National Economic Recovery Plan saw the main highlight pushing digital adoption among micro-entrepreneurs, and small and medium enterprises to ensure the continuation of the business, 24/7.

“In addition, digital payment and contactless usage have surged due to concern of the spread of Covid-19 virus,” she told The Malaysian Reserve (TMR) recently.

BIMB Securities is less sanguine of the sector’s outlook as the initially planned 5G technology adoption, which would have provided a boost to the semiconductor industry in 2020, has been postponed.

The softening in smartphone demand is expected to persist into the year due to cautious spending behaviour.

BIMB Securities’ top sector picks are GHL Systems Bhd and Malaysian Pacific Industries Bhd (MPI). “We continue to like GHL (‘Buy’ call with TP of RM2.15) given its long-term business prospects to remain attractive, owing to the growing digital payment potential in the Asean market which provides strong earnings growth in the long run.

“We also like MPI (‘Buy’ with TP of RM12.75) given its sustainable earnings growth amid challenging times, and diversified businesses and customer-based to mitigate downside risks from the automotive and consumer segment,” she said.

MIDF Amanah Investment Bank Bhd analyst Martin Foo Chuan Loong thinks 2Q20 earnings will be partially supported by the backlog created in the 1Q20 due to the Movement Control Order.

“For the 2H20, we gather from the industry players that the visibility is still poor. They are still adopting a wait-and-see approach and focus more on improving their internal operation efficiency,” he told TMR in a brief reply yesterday.