Apple and Samsung Stocking up on Parts
The authors are analysts of Shinhan Investment Corp. They can be reached at hyungwou@shinhan.com and chanoo9549@shinhan.com, respectively, -- Ed.
Earnings forecasts for 1Q20 will need to undergo downward adjustment with the COVID-19 outbreak causing disruption in production and decline in consumption. However, we expect the extent of the outbreak’s impact to differ by value chain. Companies supplying to Apple and Samsung Electronics are likely to see steadier earnings than suppliers in the value chain of Chinese companies.
The decline in 1Q20 orders for smartphone components from Apple and Samsung Electronics is estimated at 10-20%. Given that the two companies are continuing to stock up on parts, we believe Samsung Electronics and Apple are gearing up to aggressively market their smartphones in 2Q20 and 2H20.
Overall demand should remain sluggish through 1Q20, but we expect to see a rebound in 2H20 for the following reasons. First, the Chinese IT industry is showing signs of recovery, helping to ease worst-case fears. The industry will likely recover from March and mostly return to normal operations by April. Second, economic stimulus from various countries, including monetary measures in the US and efforts to boost consumption in China, could work as expected in shoring up the economy. Third, aiming to secure leadership in the 5G market, smartphone makers are preparing to launch aggressive marketing efforts in 2H20 based on subsidy offerings.
Handset/electronics market outlook based on three scenarios
Our base-case scenario assumes that demand decreases in 1H20 but recovers in 2H20. Permanent loss due to the outbreak should cause demand to fall slightly short of our original forecast. We recommend accumulating shares during the rise in market volatility, with deviation from our original outlook expected to remain limited despite the outbreak.
The best-case scenario assumes that demand drops in 1H20 but records a V-shaped recovery in 2H20. Earlier-than-expected normalization of the IT supply chain in China plus monetary and fiscal stimulus from various countries should help to drive a rebound in demand. Stocks are expected to bounce back from short-term correction caused by the COVID-19 outbreak and continue on an uptrend. Sharp gains are expected for stocks that hadled the market before the outbreak, such as chipmakers, Apple value chain companies, and passive component suppliers.
In the worst-case scenario, the outbreak's impact continues for a prolonged period with recovery in demand limited through 2H20. Monetary and fiscal stimulus fail to offset the impact on demand, leading to secondary shock (financial risks). Stocks as a whole should feel the impact in the worst-case scenario, but historical data points toward relatively steeper share price correction for handset/electronics stocks in the short term.
Top picks: Apple value chain companies and beneficiaries of technological changes
The COVID-19 outbreak is driving up demand uncertainty and stock market volatility. For each market scenario, we recommend taking different approaches on investment.
If market conditions for IT products recover in 2H20, we recommend focusing on stocks that had led the market before the outbreak, such as Apple value chain companies and passive component suppliers. If demand remains sluggish in 2H20, investors should focus on parts suppliers benefiting from technological changes in the industry. Companies seeing sharp growth in parts shipments for foldable smartphones and package substrate suppliers benefiting from technology advancement in semiconductors should continue to grow even if IT demand remains sluggish through 2H20.
We recommend LG Innotek, BH, and Simmtech as our top picks in the handset/electronics sector, followed by Samsung Electro-Mechanics as a second pick.