KUALA LUMPUR (Aug 17): CGS-CIMB Securities has maintained its “underweight” rating on the semiconductor sector and said the sector’s current risk-reward is unappealing as there is limited room for upside earnings surprises while valuations are demanding.

In a sector update on Wednesday (Aug 16), the research house said given the recent run-up in tech stocks, the market is of the view that the industry is on the verge of an inflection, with expectations of a strong recovery into the second half of 2023 (2H2023).

On the other hand, CGS-CIMB said a meaningful industry recovery may happen only in 2024 as the current inventory glut could take some time to reverse.

It explained that this is contributed by the exuberant capacity expansion undertaken by industry players over the past two years, combined with softening consumer sentiment, and further amplified by the US-China semiconductor tussle.

“In our view, macro demand remains generally weak despite entering a seasonally stronger period in 2H2023.

“We forecast aggregate sector earnings to grow by 29% in CY2024 (calendar year 2024), as we build in a recovery in demand-supply conditions following a relatively weak 2023,” it said.

That said, the research house added that the risk of further cuts to earnings expectations is still being overlooked, even with the first quarter of CY2023 (1QCY2023) results largely falling short of Bloomberg consensus expectations and unlikely to catch up given the weak macro environment.

CGS-CIMB maintained its "underweight" stance on the tech sector, premised on elevated valuations despite building in fairly aggressive growth expectations, as the sector is trading at 26 times rolling 12-month forward price-earnings, which is well above the pre-pandemic average of 17 times (individual stocks are trading at north of 30 times).

“We believe this likely already factors in expectations of a sharp recovery as soon as 2H2023.

“Top sells are Malaysia Pacific Industries Bhd and Unisem (M) Bhd due to limited valuation support and potential for further earnings disappointments.

“Our top pick is Genetec Technology Bhd, premised on its sizeable exposure to the high-growth EV (electric vehicle) and energy storage space and more reasonable valuations,” it said.

CGS-CIMB downgraded Inari Amertron Bhd to "hold" as the research house thinks current valuations adequately reflect its radio frequency business recovery and earnings upside from new business avenues.

It said Uchi Technologies Bhd provides the highest yield in the sector at 6%-6.5% for financial year 2023 (FY2023) to FY2025 given its solid free cash flow generation and sustained payouts exceeding 90%. Industry upside risks are: stronger-than-expected demand recovery, new product introductions translating into sizeable earnings upside, and easing US-China chip war.