JOINING the US tech stock rally, Bursa Malaysia-listed semiconductor and semiconductor-related companies have risen between 22% and 250% this year. Year to date, the Bursa Malaysia Technology Index has soared 70% to 37.59 points, its highest level since 2005.

Local technology companies and investors are bullish about the sector’s prospects, mainly due to its long-term earnings sustainability, underpinned by the diversification of products and customer base.

Indeed, 2017 is promising to be another good year for the semiconductor supply chain with device, material and equipment suppliers expecting revenue and earnings growth for the year. According to information technology research and advisory firm Gartner Inc, worldwide semiconductor revenue is forecast to total US$386 billion this year, an increase of 12.3% from last year.

Favourable market conditions that gained momentum in the second half of 2016, particularly for commodity memory, have accelerated and raised the outlook for the market in 2017 and 2018.

Unit production estimates for premium smartphones, graphic cards, video game consoles and automotive applications have improved and contributed to the stronger outlook this year.

Gartner also projected global semiconductor capital spending to increase 10.2% to US$77.7 billion this year.

“This growth rate is up from the previous quarter’s forecast of 1.4% due to continued aggressive investment in memory and leading-edge logic, which is driving spending in wafer-level equipment,” it said in an Aug 2 press release on its 2Q2017 update.

It added that the concentration this year is due to strong manufacturing demand in memory and leading-edge logic.

On a separate note, global microelectronics industry association SEMI projects that the semiconductor material market will expand 2% this year in light of growth expectations for the device market.

Market forecasts for the semiconductor market this year are also optimistic, with growth projections ranging from 3% to 11%. Given current capital expenditure announcements and the strong equipment order activity throughout 2H2016, prospects for the semiconductor equipment subsector look bright as well.

Where are Malaysian players on the value chain?

Basically, local semiconductor firms are involved in the mid-to-lower end of the value chain, serving foreign semiconductor manufacturers, brand owners, integrated circuit (IC) developers and fabricators. They can be divided into three groups (see Table 1).

The first group comprises outsourced semiconductor assembly and test (OSAT) companies such as Unisem (M) Bhd, Globetronics Technology Bhd, Inari Amertron Bhd and Malaysian Pacific Industries Bhd (MPI), which provide outsourced services, including assembly, packaging, fabrication and testing.

The second group consists of automated test equipment (ATE) manufacturers like ViTrox Corp Bhd, Elsoft Research Bhd, Aemulus Holdings Bhd, MMS Ventures Bhd (MMSV), VisDynamics Holdings Bhd and Pentamaster Corp Bhd, which serve the OSAT companies and other multinational semiconductor manufacturers.

The third group comprises the likes of JF Technology Bhd and FoundPac Group Bhd, which design and manufacture high-performance test sockets and other materials for OSAT companies and semiconductor firms.

And then, there are the likes of V.S. Industry Bhd and SKP Resources Bhd, whose businesses are similar to that of Taiwanese contract manufacturing giant Hon Hai Precision Industry Co Ltd, better known as Foxconn Technology Group.

V.S. Industry and SKP Resources are generally categorised as electronic manufacturing service providers and are located lower in the value chain and, hence, are not considered semiconductor companies.

It is worth noting that most of the local semiconductor-related companies, including Globetronics, Inari Amertron, ViTrox, Elsoft, MMSV, Aemulus, Pentamaster and FoundPac, are headquartered in Penang — the Silicon Valley of Malaysia.

Higher and higher?

On average, the share prices of OSAT companies have risen over 70% YTD while ATE manufacturers have jumped more than 200% (see Table 2 on Page 60).

For instance, the share prices of Unisem, Globetronics, Inari Amertron and MPI have gained between 48% and 81%, whereas ViTrox, Elsoft, Aemulus, MMSV, VisDynamics and Pentamaster have skyrocketed between 100% and 250%.

JF Technology and FoundPac also saw their share prices advance 243% and 22% respectively.

Joining the global party, valuations for Malaysian semiconductor and semiconductor-related stocks have been rising since early this year (see PER charts).

To recap, about two years ago, OSAT companies were trading at an average trailing 12-month price-earnings ratio (TTM PER) of 17 times, with an average forward PER of 13 times. ATE manufacturers were trading at an average TTM PER of 13 times.

In comparison, OSAT companies today are trading at a higher average TTM PER of 30 times and average forward PER of 21 times. Similarly, ATE manufacturers are also trading at a significantly higher average TTM PER of 23 times.

Given the rally they have seen, is there any upside left for these stocks? A quick check on Bloomberg shows that OSAT companies merely offer a potential upside of 4% while ATE manufacturers seem to have overshot by 19%, based on analysts’ consensus target prices.

On valuations, Elsoft CEO Tan Cheik Eaik says the share prices of ATE manufacturers may have moved ahead of fundamentals.

“If we look at the current activities, I think the shares [of ATE manufacturers] are overvalued, because most of us are trading at a PER of more than 20 times,” he tells The Edge.

“To be fair, I think everyone’s valuation is high at the moment. Our share prices have gone up to where we have never imagined before. I don’t know how to explain this.”

Tan, however, highlights that if investors are pricing in the future growth of tech companies, their valuations may not be as high as they seem to be.

“Not too long ago, a prominent investor bought our shares at a price that I thought was already very high. But our share price continues to go up, and today, he is making some money. My point is, I may be wrong again (about stock valuation being too high),” he says.

ViTrox Corp CEO and president Chu Jenn Weng stresses that stock valuation and share price performance are mostly market-driven and, hence, beyond the company’s control.

“We were also growing in the past, but our PER was only 15 times or less. Today, our PER is 20 to 30 times. All we can do is continue to grow our revenue and profits by focusing on research and development, trying to come out with a new product every six months so that we can defend and expand our market share,” he tells The Edge.

ViTrox senior vice-president Steven Siaw Kok Tong says the semiconductor stock rally has more to do with rising global demand as foreign semiconductor firms are aggressively expanding capacity and buying equipment.

“As long as the world is stable, consumers will continue to spend and the whole economy will grow. The only possible risk is a worldwide recession like what we saw in 2009, when nobody wanted to buy cars and handphones,” he says.

It is worth noting that Gartner, in its 2Q2017 update, said a cyclical down cycle will emerge in 2018 and 2019 for capital spending compared with 2019 and 2020 in its earlier forecast. It added that spending on wafer fab equipment will follow a similar cycle, peaking in 2018. While it remained optimistic of growth in 2018, there is a concern that the growth will turn negative if the end-user demand in key electronic applications is weaker than expected.

JF Technology managing director and CEO Datuk Foong Wei Kuong is unfazed by the rich valuations of semiconductor stocks as investors are buying forward for the companies’ future growth.

“For JF Technology, we are playing catching up. Our share price run-up is just making up for what we were lagging behind previously,” he says.

UOB Kay Hian analyst Yeoh Bit Kun also opines that the valuation expansion for the sector is justified given that the fundamentals of the companies within the sector are now more solid.

“Companies with proven track records, visibility of multi-year growth legs and currently trading below the sector’s PER could still see upside,” she says in a July 28 report.

Yeoh maintains an “overweight” rating on the technology sector and her top pick is Globetronics.

“We also like ViTrox for its business scalability after moving into Campus 2.0 to triple its manufacturing floor space and JHM Consolidation Bhd for its fast-growing automotive segment and new ventures,” she says.

Automotive the next big thing

When The Edge visited some homegrown technology companies in Penang recently, most captains of industry were bullish about the sector’s long-term prospects.

At a time when personal computers are showing lower contribution and the smartphone market is saturated, most tech companies are banking on the automotive segment to drive future growth.

ViTrox’s Chu says growth from the automotive segment has just started, considering the car will become “the world’s biggest mobile device” in the future.

“In the past, only expensive cars had reverse sensors. But today, almost every [new] car has this device. Not only that, some cars such as the Toyota Vios already have 360° cameras,” he says.

“We are seeing more and more electronic devices going into cars. In the near future, cars will be connected to other cars — they will be able to “talk” to each other.”

At present, says Chu, less than 1% of the cars are connected and these are mostly high-end models such as BMWs and Mercedes Benzes.

“Eventually, even Proton cars will be connected. The automotive segment will drive the electronic devices needed in the world,” he says.

His colleague, Siaw, concurs.

“The automotive segment will be the next big wave after smartphones, and we see tremendous growth there. Previously, cars were all mechanical. Today, they are ‘smarter’. Therefore, a lot of electronic products are being made, even for basic-entry-level cars,” he says.

Moving forward, Unisem chairman and group managing director John Chia Sin Tet says cars will need a lot of sensors as the future of the sector is all about autonomous driving and going electric.

“Even for conventional cars, they will use more and more electronics. And safety features will become mandatory, as opposed to being just ‘good to have’ among the bigger models. Some of these features are already mandatory in the US and Europe,” he tells The Edge over the phone.

As far as Unisem is concerned, Chia says it has a diversified customer base and will be relying less on the smartphone market. The smartphone market currently contributes about 30% to 35% to Unisem’s business. The group is also involved in the power management, automotive and consumer electronic markets.

“We are not dependent on a particular market segment. Our customers are well spread geographically in Asia, the US and Europe. Our clients include multinational corporations and IC design houses, so we are quite resilient. The industry’s ups and downs of the days past are very much over,” he says.

JF Technology’s Foong says the number of IC devices developed for the automotive sector is enormous. Hence, the group has also developed some products specifically for this segment.

In fact, JF Technology’s automotive segment has overtaken other segments, contributing 35% to 40% to the group’s business. Moving forward, the automotive segment is expected to contribute more than 50%.

“Our customers are all rushing into the automotive segment. We are moving away from smartphones to automotive. Companies such as Tesla have triggered a lot of changes ... it is just unbelievable. If you have exposure to automotive, then your future is very bright,” Foong says.

Likewise, Elsoft’s Tan says the automotive segment will be the next big wave for the semiconductor industry in the next one to two years.

He notes that the demand for light-emitting diodes (LEDs) will continue to increase as the world will one day be adopting daytime running light due to safety requirement.

“It is not so much about producing more cars, but more about more LEDs needed in a car. So, there will be a surge in demand for LEDs and this will benefit the LED-making companies as well as equipment companies like us,” he says.

Tan adds that the development of autonomous driving is one of the key big things that is going to happen in the next couple of years as more carmakers will be producing semi-autonomous vehicles.

“What we need is better camera vision in front of the car. At night, you need infrared illumination and 3D sensors to detect obstacles,” he says.

Amid such bright prospects, it is little wonder then that semiconductor-related stocks have risen this year. For those who are excited about the optimistic outlook, any correction presents an opportunity to accumulate shares of these locally-listed players.

And for those who don’t, well, even Warren Buffett, who was historically against investing in the tech sector, changed his mind and eventually invested in IBM in 2011 and subsequently, Apple Inc and satellite radio provider Sirius XM.