Risk-Reward Is Less Compelling; Valuations Pricing In Strong Expectations

While the sector is still benefitting from a twin supply-demand shock alongside the supply chain reconfiguration, industry risk-reward is less compelling with valuations pricing in strong earnings expectations. Meanwhile, industry indicators are also showing signs of growth moderation. We like INARI and Greatech for their unique value propositions and alpha growths, and VSI for its undemanding valuation vs its superior growth profile. Maintain MARKET WEIGHT.

WHAT’S NEW

Global semiconductor sales are expected to accelerate by 10.1% yoy (revised up from 8.8%), even after the strong 25.1% yoy growth in 2021, according to World Semiconductor Trade Statistics (WSTS). This reflects decent growth across all segments, led by memory (18.4%), followed by sensors (+6.0%) and logic (+8.7%). In our view, this means sales of smartphones, smart devices and automobiles are expected to rebound strongly. We also opine that the whole semiconductor industry, which is represented by the demand for integrated circuits, is expected to recover strongly in 2021 and extend its growth momentum
in 2022.

Industry indicators showing signs of growth moderation. According to the Semiconductor Industry Association (SIA), worldwide semiconductor sales totalled US$144.8b in 3Q21 (+27.6% yoy, +7.4% qoq). While semiconductor shipments reached all time highs in 3Q21, we saw a moderation in growth since Jul21 (after peaking in Jun 21 at 30%), with the latest growth of 24.0% yoy in Oct 21. While one could attribute the moderation to supply chain disruptions (bottlenecks and shipment delays), the previous consecutive yoy growths peaked in the 5th to 18th month over the past 15 years while the current cycle’s consecutive yoy growth peaked in the 19th month before the moderation in the 18th month (Jul 21). The latest product sales forecast for 2022 by WSTS reaffirms this view.

Less compelling risk-reward industry valuations; valuations pricing in strong earnings expectations. Following strong share price performances across the board, the forward PE valuations of outsourced semiconductor assembly and test (OSAT) and semiconductor production equipment (SPE) players are trading close to +2SD to their five-year mean levels, which are also near the previous peak valuations of between +2SD and +2.5SD. Tactically, we advocate investors buy on weakness following the less compelling risk-reward industry valuations and strong earnings expectations, as the precedent performance shows that stretched valuations do not last more than six months. Meanwhile, with the stubbornly high inflation numbers (and hence rising bond yields), high valuations could be eroded as investors typically turn more risk averse by rotating out of high-PE stocks amid increased inflation fears.

ACTION

Maintain MARKET WEIGHT on a cherry-picking approach for structural growth themes. Subpar risk-reward industry valuations are seen with a higher range of 0.7x-2.3x compared with 0.6x-1.4x back then in 6M21. Our strategy prescription is premised on stocks with lower PEG ratios, good growth prospects alongside the respective bellwether position in its subsegments. We like INARI and Greatech for their unique value propositions and alpha growths, as well as VSI for its undemanding valuation vs its superior growth profile.