Sunday, October 20

Trade war puts E&E on the fritz

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The ongoing clash between several major economic countries such as US and China and more recently, Japan and South Korea, have without a doubt affected many emerging market economies including Malaysia.

Countries across the Asean region are feeling the pinch from ongoing trade wars, with Singapore reporting a plunge in its exports and seeing its worst growth rates in a decade, fuelling concerns about the outlook of its neighbouring countries.

Singapore, which is highly dependent on trade, has traditionally been one of the first places in Asia to be hit during global downturns – with ripples typically spreading out across the region.

Following this, Malaysia’s Department of Statistics reported that trade in June was hit by these tensions as exports declined, most notably being the slump in electrical and electronics (E&E).

In June 2019, exports and imports fell 3.1 per cent y-o-y (May 2019: 2.5 per cent y-o-y) and 9.2 per cent y-o-y (May 2019: 1.4 per cent y-o-y) as US-China trade tension re-escalated.

“Despite exports marginally up 0.2 per cent y-o-y in 2Q19, the 3.1 per cent y-o-y drop in June 2019 point to the disruptive breakdown in US-China ‘Trade Truce & Talk 1.0’ in early-May 2019.

Source: CEIC, MIDFR

“This led to another round of US-China ‘tit-for-tat’ tariff actions in mid-May 2019/early-June 2019 and exacerbated by intensification of tech war,” the research arm of Maybank Investment Bank Bhd (Maybank IB Research) said in a note.

Trade outlook remained weak as global manufacturing PMI stayed sub-50 for the third consecutive month in July 2019 on weak global output and new orders amid decline in global trade volumes, it added.

Malaysia’s trade surplus also returned to above RM10 billion.

MIDF Amanah Investment Bank Bhd (MIDF Research) cited that trade surplus increased to RM10.3 billion in June 2019 for the first time in this year as imports fell harder than exports.

“Both exports and imports growth plunged to negative territory of 3.1 per cent y-o-y and 9.2 per cent y-o-y respectively after maintaining positive growth in the previous two months.

“Such weak external trade performances could be the result of multiple headwinds took place during the month. June 2019 was the first full month of US tariff on Chinese imports after the truce and US ban on Huawei, both deteriorate global sentiment.

“Sector wise, manufacturing and agriculture exports contracted by five per cent y-o-y and 0.8 per cent y-o-y respectively.

Source: Department of Statistics

“In contrast, mining exports rebounded sharply to a double digit positive growth of 15.4 per cent y-o-y,” it explained.

More significantly hit by the escalating trade wars was the E&E sector as exports saw a sharp drop of six per cent in June, led by a 31.4 per cent plunge in shipments in office machines & data processing equipment (mostly personal computers), while exports of electrical machinery & apparatus (mostly semiconductors) also slipped into a decline.

“Overall, the escalating trade tensions and downturn in the semiconductor cycle is beginning to hit Malaysia’s E&E sector.

“This was despite a stronger-than-expected showing in previous months,” RHB Research Sdn Bhd (RHB Research) commented.

“Looking ahead, we expect export growth to ease further to 2.2 per cent for 2019 from 6.7 per cent in 2018.

“However, recent developments on the global trade front – the US’ 10 per cent tariffs on the remaining US$300 billion in Chinese imports – has further increased the downside risks for Malaysia’s external trade and could weigh further on the economy,” it added.

With that, BizHive Weekly delves into the impact of the current trade war on Malaysia’s major exports industry – the E&E sector.

 

Malaysia’s E&E takes a beating as exports fall

Known as Malaysia’s trade ‘golden goose’ for the last few years, the E&E industry has been a big contributor to Malaysia’s trade scene thanks to the massive global demand for E&E products brought on by rapid changes in the tech sector.

However, the industry’s prospects of late have grown hazier as the trade war between US and China, and other economic powerhouses continue to impact open-trade economies such as Malaysia’s.

In June 2019, Malaysia’s E&E exports, which comprises of 36.9 per cent of Malaysia’s total exports, saw a decline for the first time since 2013, dropping six per cent on a year-on-year (y-o-y) basis to RM28.1 billion.

On a month-on-month (m-o-m) basis, E&E product exports shrank RM1.3 billion or 4.3 per cent from RM29.3 billion.

According to Malaysia’s Department of Statistics (DoS), the two major destinations for Malaysia’s exports in June 2019 were Singapore and China. Exports to Singapore amounted RM10.6 billion, decreased RM92.2 million (down 0.9 per cent) as compared to the previous year.

“The main product which attributed to the decline is E&E products, which contributed 42.2 per cent of total exports dropped RM127.6 million (down 2.8 per cent) to RM4.5 billion,” it said.

It also explained that exports to China which were valued at RM10.1 billion declined RM1.4 billion (down 12 per cent).

The main products which attributed to the decrease were E&E products, contributing 39.5 per cent of total exports fell RM471.8 million (down 10.6 per cent) to RM4 billion, residual petroleum products (1.9 per cent of total exports) decreasing RM463.3 million or 70.7 per cent to RM192.3 million, and copper (including alloys) – which contributed 1.7 per cent of total exports – decreasing RM180.7 million or 51 per cent to RM173.4 million.

Maybank IB Research noted that manufacturing exports contracted by down 5.5 per cent y-o-y in June 2019, weighed down by lower exports of E&E, manufacturing of metals, machinery, appliances and parts and petroleum products.

“The decline in E&E exports was led by drop in ‘Electronic Integrated Circuits’ which fell for the first time in three years.

“Other drags on E&E exports included lower shipments of ‘Parts and Accessories for Office Machines, etc’ and ‘Other E&E’,” it explained.

It highlighted that the lower E&E exports reflect on-going global tech downcycle as per the slump in global semiconductor sales and semiconductor equipment billings. Looking ahead, the E&E trade prospects will likely face further downward pressure from the ongoing trade rifts between major economies.

RAM Ratings in its trade update report, noted that the Japan-South Korea trade row is envisaged to exert further downside pressure on weak regional trade momentum, particularly for the E&E supply chain.

“This follows Japan’s decision to impose restrictions on exports of high-technology chemicals to South Korea (effective July 4).

“These items are vital to the production of semiconductors and display screens on smart devices – components of South Korea’s prominent E&E sector. Given Japan’s dominance in the supply of these high-technology materials (accounting for a reported 90 per cent of global supply), this will likely exacerbate the already sluggish outlook on South Korea’s E&E exports.

“The direct impact on Malaysia’s exports from a potential shortfall in supply as well as a potential loss in demand from South Korea appears limited, as the former does not rely heavily on the latter’s E&E sector.

“That said, Malaysia could be indirectly affected via a disrupted global E&E production chain,” it said.

“The latest escalation in trade tensions between Japan and South Korea poses key downside risks to the global supply chain for E&E products, especially given the latter’s dominance in the supply of memory chips.

“South Korea accounted for 37.6 per cent of global memory chip exports in 2018. Although first-degree effects may not be significant for Malaysia, the potential over-arching supply bottlenecks for key inputs (such as these chips) in the short term may further stifle the tech cycle and retard the growth of the global E&E industry,” observed RAM Ratings’ head of research Kristina Fong.

Following this, Maybank IB Research expected volatile E&E exports in June to August with a downside risk to continue to September following the slump in South Korea’s semiconductor exports.

“But it could rebound in August 2019 on ‘front-loading’ of shipments ahead of the 10 per cent tariff on additional US$300 billion imports from China currently not affected by US tariff actions so far effective September 1, 2019 announced by President Donald Trump on August 1, 2019.

“The latest tariff will mostly cover consumer electronic products such as cellphones, laptops, video game consoles, flat-panel TVs, computer monitors and storage devices. It will be a dampener on E&E exports outlook post-September 1, 2019,” it added.

 

Trade war and its ripple effects

US-China’s tech war

US and China’s trade war continues to become the bane of today’s global economy as the tit-for-tat trade restrictions and moves between both countries continue to impact trade with other open-trade and emerging economies.

In 2017, US fired off its first warning against China by threatening to impose higher trade tariffs on several of China’s imports to tighten trade between both countries.

As both countries race for technological supremacy, US impeded on this progress by accusing China of intellectual property theft as well as security threats.

While several trade talks have been held between the two countries for the last few years, an agreement has yet to be reached.

Analysts are cautious over the trade war between both US and China which is expected to impact investments to and from US and China and ultimately, lead to a global economic slowdown.

Japan-South Korea tech war

Japan and South Korea’s age-old tensions were reignited again in the form of trade restrictions instead of historical politics. The row between the two countries escalated earlier last month when both countries fail to make progress on a dispute that could threaten global supplies of microchips and smartphone displays.

According to news reports, Japan moved to tighter trade restrictions on several products from South Korea. It imposed trade curbs on exports of three high-tech materials to South Korea and these products are said to be critical for manufacturing semiconductors.

The new trade restrictions also require Japanese companies to acquire a license for these products to be imported to South Korea and the process is said to take up to 90 days.

Following the move, both countries dropped each other from their respective white list.

Nevertheless, earlier this month, Japan granted the first shipment of high-tech materials to South Korea since its restrictions were enforced.

 

Semiconductor sector not spared

After three consecutive years of growth – locking in yearly growth of 13.2 per cent in 2018 — the latest forecast update to the Semiconductor Applications Forecaster (SAF) from International Data Corporation (IDC) forecasts that worldwide semiconductor revenue will decline to US$440 billion in 2019, down 7.2 per cent from US$474 billion in 2018.

IDC expects market consolidation to begin accelerating as the industry gets more clarity on the trade tariff dispute between China and the US.

“The current market downturn is being driven by a broad weakness in demand specifically centered in China and an ingestion of excess inventories in some of the major markets including automotive, mobile phones, and cloud infrastructure,” said IDC Semiconductors programme vice president Mario Morales.

On the local scene, Maybank IB Research said alongside seasonal weakness for tech equipment and OSAT players in 1Q19, renewed escalation of the trade tension between US and China caused volatile trading for the local tech hardware names.

“Among the bigger players (RM0.5 billion market cap), only a handful recorded gains with VSI leading the pack (up 52 per cent year to date) while Elsoft Research fell the most.

“There were multiple downward earnings revisions for the equipment (Mi Technovation, Elsoft, MMSV) and OSAT (Inari, GTB) players exposed mainly to the smart devices segment after a disappointing 1Q19 earnings season, except Pentamaster which saw upward revisions by consensus.

“Globally, a 24 per cent y-o-y fall in 4M19 equipment billing was also an indication of a cautious stance on major capex decisions,” it said.

AmInvestment Bank Bhd’s research team (AmInvestment) pointed out that China’s population is one of the main reasons that has made it the manufacturing muscle it is today.

However, it said, China might have shown tremendous growth but it is still dependent on the US for certain technologies such as chip designing software and operating software from industry leading companies like Cadence Design Systems (Cadence), Synopsys and Google. HiSilicon (a subsidiary of Huawei), relies on Cadence and Synopsys to build its processors for Huawei smartphone and 5G base station.

“Not helping either is the fact that all these processors are built on chip blueprints licenced by a UK company Arm Holdings (ARM), which may be pressured to sever ties with Huawei due to claims that US technology is present in ARM’s designs,” it said.

Further disrupting the semiconductor industry is the European Union’s (EU) tightening regulations on carbon dioxide (CO2) emissions.

“Languishing car sales in key markets like the EU and China may likely persist due to weak consumer sentiment, thus lowering demand for the automotive semiconductor.

“While the EU saw its first positive sales growth in nine months, it is likely to be short-lived due to tightening EU regulations on CO2 emission where the industry may face potential fines of up to 33 billion euros if requirements are not met.

“EU carmakers have until end-2020 to reduce CO2 emission to 95g per km from the current level of 124.5g per km, which experts regard as the most ambitiousemission target in the automotive industry.

“Instead of increasing R&D cost to battle CO2 emission in combustion engines, carmakers could sell more electric vehicles (EV) to average down emission figures.

“However, carmakers at this juncture are faced with challenges like lower margins on EV compared with combustion engine vehicles, higher selling prices of EV that may dampen sales during times of weak consumer spending, higher demand for semiconductor content in EV which is facing the uncertainty of the US-China trade war, and the looming tariff on EU cars sold to the US,” it added.

Aside from that, there has been a slowdown in the progress of implementing the 5G network due to heightened competitions between countries and companies racing to launch the network as soon as possible.

AmInvestment pointed out that with that smartphones developers are feeling the 4G–5G transition slump.

“The annual trend of flagship smartphone launches will still take place, but we expect tepid demand due to lengthier replacement cycle as consumers may put off purchase in anticipation of 5G.

“While it is a positive sign seeing 5G-ready phones launched in 1H19, sales numbers are still insignificant due tothe lack of 5G infrastructure.

“Prices of 5G phones are still too high to justify a purchase with such limited coverage at this point in time,” it added.

Maybank IB Research also highlighted that the delay in mass deployment of 5G network coupled with recent US-China tech war (banning of US component/software sales to Huawei) would negatively impact smartphone sales in 2Q19, beyond 1Q19’s decline.

“On an overall basis, we believe that the unresolved US-China trade issue would still suppress consumer sentiment for electronics, especially the premium ones.

“In addition, we believe that consumers would likely adopt a wait-and-see approach pending mass 5G network deployment, effectively prolonging replacement cycle for smartphone. For this, risks remains on the downside for OSAT players with sizeable smartphone exposures,” it added.

 

E&E space still offers a silver lining

Despite the exports slowdown, there is still a glimmer of hope for E&E players as domestic demand are expected to keep the sector afloat while there have been indications that foreign companies are looking at E&E companies from countries such as Malaysia to divert their trade from China or US.

Maybank IB Research commented that tech foreign direct investments (such as Micron and Jabil) into Malaysia, coupled with a substantial number of enquiries for production relocation for local EMS players (inclusive of EMS MNCs based in Malaysia) could translate to contract wins.

“Joint ventures (JV) with Taiwanese EMS players (MCE Holdings with Fortechgrp and Weltronics, EG Industries with Quanta Storage) and some contract flows to local EMS players (VSI from Bissell, Scope Industries from Inventec Appliances) are the recent positives.

“The first wave of beneficiaries would likely be the local equipment players with excess capacity such as Mi Technovation, Elsoft, MMSV and Aemulus,” it said.

RAM Ratings also pointed out that there might still be some room for trade diversion benefits for Malaysia in a bid to manage bottlenecks in the supply chain for inputs arising from export restrictions.

“Demand may be diverted to Malaysian firms. Global E&E players could also capitalise on the existing infrastructure and scale up their output capacity in Malaysia if they decide to diversify their production away from South Korea,” it said.

Several listed E&E companies are already profiting from the current trade wars between economic powerhouses.

One of them is PIE Industries Bhd (PIE) which Kenanga Research noted was a beneficiary from the trade diversion. However, it said that more time needed to see positive impact.

“As we understand, PIE is still receiving multiple enquiries from companies that are looking to shift their supply chain out of China. Among the enquiries, we gathered that a new customer has engaged the group to manufacture PCBA for its product on a consignment basis.

“While revenue potential should be minimal, gross margins could be higher (circa 20 per cent). Apart from this, we believe the management are in talks (preliminary discussions) with a potential new customer.

“We understand that the customer is keen on relocating from China and has made its first visit to PIE’s plant in July 2019. Our guesstimate is that the potential customer could contribute sales of circa RM30 million (assuming full ramp-up),” it said.

It also noted that FoundPac Group Bhd is looking at entering into more lucrative spaces such as the automotive, medical and aerospace segments.

“We believe this is possible, given that the group has already secured license from Malaysian Investment Development Authority (MIDA) for the automotive and medical spaces (likely to manufacture jigs and fixtures).

“On the trade war front, while there have been enquiries, management sees growth mainly coming from repeat orders as companies gear up for the upcoming adoption of 5G. On the ground, the group has already started working with customers towards the adoption of 5G,” it added.

As for the automotive sector, AmInvestment said expected rise in EVs would bode well for Malaysia Pacific Industries Bhd (MPI) given its exposure in automotive semiconductor business.

“Regulators around the world are aiming to lower CO2 emission, encouraging the sale of more EVs which bodes well for MPI given its exposure in automotive semiconductor business.

“Furthermore, MPI’s strong net cash position of RM688 million allows the company to look into meaningful M&A,” it said.

It added, “The relatively new semiconductor automated test equipment (ATE) segment is able to tap onto its existing clientele from the distribution business, where the company distributes tools and materials to semiconductor and automotive customers.

“The ATE segment may lead to margin expansion with fully automated machines commanding four-times higher ASP compared with the existing semi-auto ones. Meanwhile, recurring revenue from its trading and servicing business has shown resilience amid the trade war, cushioning any fall in ATE orders.”

Aside from that, Malaysia is also looking to improve its manufacturing sector with the introduction of the Industry 4WRD, or national policy on Industry 4.0.

The policy focuses on several areas in the manufacturing and related services sectors in line with enhancing Malaysia’s readiness for IR4.0.

Under the policy, the E&E sector has also been highlighted as one of a catalytic and high potential sector.

This is expected to improve the E&E sector and hence improve its reputation as an E&E hub.