Earnings concerns on expensive tech stocks

Currently, the top three most expensive tech stocks are Notion VTEC Bhd, KESM Industries Bhd and ViTrox Corp Bhd(pic), with PEs of 56.58 times, 53.44 times and 45.93 times respectively.

AFTER a strong rally in 2019 and despite the broader market volatility, it is no surprise that technology stocks on Bursa Malaysia have become more expensive on the back of rising valuations.

Last year, the Bursa Malaysia Technology Index surged by 29%, outperforming the FBM KLCI which had declined by 6.02% in the one-year period.

This led the overall valuation of the Technology Index – as measured by its price-to-earnings (PE) ratio – to rise sharply from 21.46 times as at end-2018 to 32.5 times by end-2019.

As of yesterday, the PE has risen further 35.21 times, based on Bloomberg data.

Currently, the top three most expensive tech stocks are Notion VTEC Bhd, KESM Industries Bhd and Vitrox Corp Bhd, with PEs of 56.58 times, 53.44 times and 45.93 times respectively.

While higher valuations are typically an indicator of investor confidence on a stock’s growth prospects, the company will need to post continued strong earnings growth in order to sustain its valuation.

Any disappointment in earnings delivery could drag down the share price and result in lower returns for investors.

Moving further into 2020, the concern is whether the future earnings of Malaysian tech stocks would be able to support their high valuations.

The question is, could the novel coronavirus (Covid-19) outbreak, which has disrupted China’s supply chain particularly within the electrical and electronics segment, drag down the sector’s future earnings?

The concern on the technology sectors’ earnings rose after Apple warned its investors that it may not meet its revenue guidance for the second quarter ending March 31.

The California-based iPhone maker said it is affected by the temporary constraint in iPhone supply and the lower demand for Apple products within China due to the Covid-19 outbreak.

Factories in China had just jumped back to work a week ago after the end of the extended closure on Feb 10 but most of them extended the break further until Feb 14.

And even with most of the plants resuming operations, they are still far below their operating capacities due to a labour shortage.

Speaking to StarBizWeek, Maybank IB Research analyst Kevin Wong says that it is still early to gauge the impact of Covid-19 on the tech companies such as semiconductor players.

“We are seeing mixed reports from the companies. Some say they will be affected significantly by the virus outbreak, while some see minimal impact, ” he says.

Thomas Yong of Fortress Capital says that investors could consider profit taking, since the valuation of tech stocks are on the high side.

However, he does not think that the tech stocks’ earnings would be much affected by the Covid-19 impact in China.

“Malaysian tech stocks are more exposed to Apple’s supply chain instead of Android’s as Apple’s supply chain in Asia is business as usual, ” he says.

Yong expects tech companies to see further demand in the second half of 2020 (2H20), on the back of higher take up of 5G phones.

“In my opinion, during the start of 5G cycle, equipment players like Pentamaster and Mi Technovation would be a suitable pick, whereas outsourced semiconductor assembly and test players like Inari and Globetronics would be more of a play in 2H20.

“Semiconductor equipment players with more diversification efforts into other industries namely Pentamaster and Mi Technovation would be a better pick for growth stories, ” he says.

Covid-19 impact on tech players

A source close to the Malaysian plant of a Fortune 500 semiconductor manufacturer says the company’s production has been disrupted as a result of Covid-19.

“On one hand, the inventory in the semiconductor sector is depleting, which means we are slowing seeing rising signs of demand.

“However, on the other hand, our production is affected as about 40% of our raw materials come from China. It is not easy to immediately source raw materials from other parties as it will take some time to do the due diligence such as quality check.

“Not only that, our machine suppliers and vendors are also from China. With the virus outbreak, we are facing difficulties in getting the machines and it is also difficult for the machine experts from China to fly into Malaysia in case of any repair works, ” he says.

However, a source with a German semiconductor company in northern Peninsular Malaysia says that the company’s exposure to China is small, and hence sees little impact.

“The company has recently changed its direction to different products. Not much dealing with China.

“We also do not see any issue with sourcing of raw materials so far, given the virus outbreak, ” she says.

The source, however, points out that the company’s new product focus are Apple items.

“Since Apple has recently given a warning on its production and revenue, we might see an impact on our production, moving forward, ” she says.

In a note, AmInvestment Bank Research says the Covid-19 has rattled the tech industry but will have lesser impact on the electronics manufacturing services (EMS) sector.

“From our channel checks, we have gathered that the companies under our coverage would be impacted by Covid-19 in differing ways.

“For example, companies with operations in China such as V.S. Industry and Malaysian Pacific Industries have risks of potential delays in production directly impacting earnings, companies who partially import raw materials from China such as V.S. Industry and ATA IMS have materials sourcing risk and indirect impact on demand of products in the telecommunications and automotive industry which impacts the sector as a whole, ” it says.

The research firm remains “neutral” on the tech sector but has an “overweight” view on the EMS sector.

“Even though long-term prospects remain intact, short-term risks related to the global supply chain due to the Covid-19 outbreak cause uncertainties on the performance of semiconductor players, ” says the research house.

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