Sep 11, Analyst: Mark Po, CFA; Tel: (852) ;

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1 Sep 11, 2018 TECHNOLOGY HARDWARE INDUSTRY UPDATE Aug 2018 data shows a slowdown in YoY growth after a pick-up in Jul We still suggest investors continue to be selective. Analyst: Mark Po, CFA; Tel: (852) ; markpo@chinastock.com.hk Overall: The August 2018 growth rate slowed down again after a pick-up in July Shares of HK-listed hardware names have been under pressure, given the broad-based market correction and concern about the growth outlook. The Aug 2018 figures released by Sunny Optical [2382.HK], Truly [0732.HK] and Q-Tech [1478.HK] showed a pick-up in the performance of handset component suppliers in the Chinese Android camp in Aug In the Apple camp, Merry (acoustics), Catcher (casings), Largan (lenses), TPK & GIS (touch panels) and Simplo (batteries) reported a good MoM pick-up in turnover in Aug We believe that factors such as Apple s new product launch, trade issues between China and the US, and concern about a peak in the semiconductor cycle will drive share prices of the sector in the near term. The high SEMI Days of Inventory (DOI) and comments from Micron triggered concern about the outlook for the global semi industry, which put pressure on shares of HK-listed foundries, especially Hua Hong [1347.HK]. Shares of Hua Hong have dropped 21.5% since we highlighted on 4 Sep that the visibility for 8 foundries had become unclear for Q after a strong period in Q Q The materials & equipment segment reported a further slowdown in YoY top-line growth in Aug 2018 vs. Jul 2018, but the magnitude was not as significant as the level in Jul We still believe that the slowdown in YoY top-line growth of the materials & equipment segment was due to a delay in capacity expansion by electronic component makers because of trade issues between China and the US and concern about a peak in the semiconductor cycle. We still hold a somewhat cautious view on the whole sector, and we suggest investors continue to be selective on China TMT hardware names. We reiterate the view that apart from specific components, investors should be selective in brands. The Aug 2018 vs. Jul 2018 figures released by Taiwan-listed technology names indicate a slowdown in the YoY growth rate of the hardware sector after a pick-up in Jul We maintain the view that the slowdown in the materials & equipment segment can be considered an alert, which may be the result of a delay in capacity expansion of hardware names due to trade issues between China and the US and concern about a peak in the semiconductor cycle. On average, Hong Kong-listed TMT hardware names underperformed their global peers, except Taiwan, as well as the HSI and MSCI, on a one-month basis, which in our view, was due to concern about the growth outlook, triggered by news flow on the trade war and concern about margin pressure due to increasing market competition in some product categories. Regarding near-term operating performance and news flow, we maintain the view that the market will focus on the Apple camp due to Apple s new product launch on 12 Sep 2018, but again, the Jul and Aug 2018 figures suggest that not all suppliers will benefit. We believe that the Apple camp entered the peak season in Q for the release of new iphones in 2H 2018 and that the Android camp may see weakness in overall shipments in Q3 vs Q2. Now is the better timing to revisit the Android camp. Lens, DRAMs, Components and ODMs outperformed. Most of the Taiwan-listed technology names (materials and equipment, wafers, semiconductors, IC design, wafers, LEDs, optical communications, PCBs, TFT-LCDs, casings, lenses, DRAMs, ODMs, optical components and casings, networking, PCBs, auto electronics, terminals and distribution) reported their Aug 2018 turnover. Sector-wide, wafers, lenses, DRAMs, components, OBMs, distribution and terminals saw higher YoY top-line growth in Aug 2018 vs. Jul Among the major Apple-related companies, TPK, GIS, Inventec and Wistron reported faster turnover growth in Aug 2018 vs. Jul Regarding the PC side, PCB names such as MSI and Gigabyte continued to deliver negative turnover growth in Aug 2018 after Jun and Jul 2018, which may be treated as an alert. Acer s Aug 2018 YoY turnover growth was steady vs. Jun and Jul 2018, while Asustek reported a larger YoY decline in turnover in Aug The major ODMs, including Quanta, Inventec and Wistron reported faster YoY turnover growth in Aug 2018, which may indicate that demand for hyperscale servers and commercial PCs remained solid. Big Data analysis and the Industrial Internet are still strong. So far, news flow on the PC industry hasn t indicated any significant downside, and the commercial PC refreshment cycle continues to drive the industry growth. Lenovo [0992.HK] has been re-rated after its results announcement due to the solid performance of its PC division and improving sever business. Aug 2018 continued to improve, but investors are somewhat cautious. In the Hong Kong market, we saw an improvement in the operating performance of handset component makers in Aug Truly reported Aug 2018 turnover of HK$1,780m, which was down 0.7% YoY, from HK$1,793m in Aug 2017, but less than the YoY drop in Jan-Jul Q-Tech s [1478.HK] camera module shipments increased 92.5% YoY and 25.5% MoM to about 28.9m units In the camera module segment, 8MP and below increased 101.0% YoY and 38.3% MoM to about 16.5m units in Aug 2018, and 10MP and above rose 82.2% YoY and 11.7% MoM to about 12.4m units. Q-Tech also reported an increase of 70.6% YoY and 25.4% MoM in shipments of fingerprint modules to about 12.0m units. Sunny Optical [2382.HK] reported a 46.2% YoY and 2.6% MoM increase in handset lens shipments to about 90.7m units in Aug The Company s camera module shipments rose 36.4% YoY and 73.3% MoM to about 48.9m units in Aug Sunny Optical s vehicle lens shipments were 3.5m units in Aug 2018, up 14.6% YoY and 3.6% MoM. The major event in the handset component sector is Apple s new product launch on 12 Sep Apple is expected to launch three iphone models a 5.8 OLED (iphone XS), a 6.5 OLED (iphone XS Plus),and a 6.1 LCD (iphone XC). Based on current news flow, the 5.8 OLED and 6.5 OLED will be ready for online sales in Sep 2018 but due to yield issues, the 6.1 LCD will be available only in Nov All three models are equipped with 3D sensing. There is a market rumour suggesting that at least one model will support two SIM cards. The dual SIM iphone, if released, is expected to be available only in the China market. Regarding handset components, we reiterate the view that optical technology is one area in the smartphone segment that will see major developments and upgrades; most likely we will see tri-cam models by Apple, Samsung and Chinese Android makers in 2H 2018 and There is a market rumour suggesting that Apple is planning a world facing ToF 3D-sensing + trim cam iphone for The market may prefer lens makers without exposure to CCM, as they face less margin pressure, especially as LuxVisions may be a disruptive player in the CCM segment. Largan and Genius may be preferred over Sunny Optical, but Sunny Optical is still the only choice (given its leading position in lens and CCM orders from Samsung) for investors in HK and Mainland China. We also suggest that some investors may prefer Q-Tech, but its share price performance is somewhat volatile. As an upstream name, Pentamaster [1665.HK] will benefit as long as multi-cam models continue to gain popularity. Wearables are another focus of Apple in our view, especially AirPods. Luxshare [ CH] will be a major beneficiary of this, and we believe that Pentamaster will also benefit from this trend. Wearables development by Apple is one of the growth drivers for the VSCEL supply chain. The adoption of SL & TOF by Chinese Android phone makers also creates growth potential for the VSCEL supply chain. There is less haptic development in 2H 2018 by Apple, and there is pressure on AAC [2018.HK]. There are no major upgrades in acoustic development and competition from Luxshare and Goertek [ CH], which may put pressure on AAC. The market is waiting for a new equilibrium to reassess AAC in the acoustic segment. Based on their 1H 2018 results, it seems that neither Luxshare nor FIT Hon Teng [6088.HK] are cutting prices to compete, as they reported solid 1H results compared to the other listed handset component makers. USB type-c offers the advantages of faster charging and data transmission; the new iphone, in particular, will have a higher capacity battery. The market seems to prefer internal parts for casings rather than casings themselves, especially since internal design is getting more sophisticated, given tri-cam, 3D sensing and more antennas. This may be the reason Lens Tech and BYDE [0285.HK] are somewhat out of favour. It seems that Apple is unlikely to adopt the underglass fingerprint feature, so the Chinese Android camp will be its main promoters. Again, the market prefers solutions providers, such as Egis [6462.TT] and Goodix Technology [ CH]. 1

2 TECHNOLOGY HARDWARE INDUSTRY UPDATE Aug 2018 data shows a slowdown in YoY growth after a pick-up in Jul We still suggest investors continue to be selective. Analyst: Mark Po, CFA; Tel: (852) ; markpo@chinastock.com.hk Semiconductors: In terms of YoY turnover growth in Aug 2018, high tech underperformed low tech. The semiconductor supply chain in Taiwan, including foundries, and packaging & testing, reported slower YoY turnover growth in Aug 2018 vs. Jul Foundries with mature nodes, such as Vangguard and UMC, reported faster turnover growth than TSMC. We believe TSMC s Aug 2018 performance was still dragged down by weak demand from the mining segment. It seems that channel inventory of Nvidia s products is somewhat high. The high SEMI Days of Inventory (DOI) and comments from Micron triggered concern about the outlook for the global semi industry, which put pressure on shares of HK-listed foundries especially Hua Hong [1347.HK], which dropped 21.5% since we highlighted on 4 Sep that the visibility for 8 foundries had become unclear for Q after a strong period from Q to Q We still think there is downside for Hua Hong, given its share price outperformance. We maintain the view that China is a huge IC market, which leading Semi names can t ignore. News flow on the spin-off of operations in China by Taiwanese companies may attract market attention to the China Semi industry, especially OSAT names in the A-share market, including CSP [ CH], Tianshui Huatian [ CH], JCET [ CH], TongFu Microelectronics [ CH] and Jingce [ CH]. PCs: Limited downside surprises, but no positive surprises either. PCB and gaming notebook suppliers, including MSI and Gigabyte, reported a YoY decline in turnover in Jun, Jul and Aug 2018 vs. solid growth in Mar, Apr and May Asustek had weaker YoY turnover growth in Jul 2018, which somewhat confirmed the negative signals from MSI and Gigabyte. But the major ODMs, including Inventec and Quanta, reported faster YoY turnover growth in Aug 2018, which implies that server shipments still look solid. We don t see a major re-rating catalyst for Ju Teng [3336.HK] even though news flow on the PC industry has improved for quite some time. Lenovo [0992.HK] has been re-rated after its results announcement due to the solid performance of its PC division and improving sever business. However, Lenovo s margin trend is one of the key areas to monitor given tight supply of CPUs. The soft figures released by MSI and Gigabyte may be treated as an alert for PCBs and laminates, but the news flow regarding ASP hikes by Kingboard Laminates [1888.HK] and Guangdong Shengyi may boost sentiment on Kingboard Laminates and Kingboard Chemical [0148.HK]. Displays: China shipments improving. AUO reported a smaller YoY decline in turnover in Aug 2018, but Innolux reported a larger YoY decline in turnover in Aug News flow on trade issues between China and the US continues to cap the share price performance of both TCL Electronics [1070.HK] and Skyworth [0751.HK]. We expect TCL Electronics to leverage its diversified production facilities to mitigate the impact of the proposed tariffs initiated by the US government. We also believe that the smart TV platforms of Skyworth and TCL Electronics will create a long-term growth opportunity. Optical communications: LMOs steady performance in Aug LMOs reported a YoY increase in turnover in Aug & Jul 2018 after a major drop in Jun 2018, which confirms our view that the Jun 2018 performance of LMOs was just a short-term issue. The average YoY turnover growth rate of Taiwanese optical communications names continued to improve in Jun 2017, which confirms our positive view of the telecommunications equipment segment, especially optical communication names. 5G is a key topic in HK/China markets. Regarding telecommunications equipment, we believe that wireless names will outperform optical communication names. We maintain the view that O-Net [0877.HK], YFOC [6869.HK] and ZTE [0763.HK] are treated as proxies for optical communications and 5G investment. We also like CCS [0552.HK] and China Tower [0788.HK]. Others: We also believe TUS [0872.HK] may look interesting, given the development of IoV in China, and the Company s recent acquisition of a leading player in V2X field, which will help it provide integrated solutions in ADAS and IoV. 2

3 Figure 1: Monthly YoY turnover growth of Taiwan-listed companies Sources: Bloomberg, CGIS Research 3

4 Figure 2: Peer comparison Sources: Bloomberg, CGIS Research 4

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