10 March 2017 Asia Pacific/Japan Equity Research Technology Technology sector Research Analysts COMMENT Akinori Kanemoto 81 3 4550 7363 [email protected] Asia feedback report (Hardware): Spring Hideyuki Maekawa 81 3 4550 9723 hasn't yet come [email protected] ■ Summary: In late February/early March, we conducted our customary market Mika Nishimura research in Korea, China, and Taiwan into demand in hardware, semiconductors, 81 3 4550 7369 [email protected] displays, and electronic components. Compared with our previous survey (early December 2016), the server/data-related sectors are stronger than we expected. However, Chinese smartphone production, especially vivo and OPPO, is undergoing adjustment; iPhone-related demand appears somewhat weak near term; and PC-related demand is weak as well, so the talk is not exactly encouraging. In our previous survey, we saw a limited risk of correction in smartphone-related demand in Jan–Mar 2017, but in addition to inventory adjustments at vivo and OPPO, shipments of spring models built on new APs have been pushed back until at least May. In addition to an emerging risk of higher BOM, we also see growing component/materials procurement risk amid the start-up of iPhone 8 production. Full-scale production of the Galaxy S8 will start in Apr–Jun. ■ Focal points for hardware: Production: (1) We estimate total iPhone production as follows: Jan–Mar 2017: 47mn units (−47% QoQ; +18% YoY); Apr–Jun: 40mn (−15%; −2%), Jul–Sep: 48mn (+20%; −15%), and Oct–Dec: 89mn (+85%; +1%). iPhone 8 series production target for Jul–Dec: roughly 100−110mm units (Jul–Sep 25−30mn, Oct–Dec 75−80mn); (2) Samsung started GS8 production in March, with plans to increase volume in Apr–Jun, in line with annual production target of 320mn units. (3) For Chinese smartphone production, we expect a 16% QoQ decline for Jan–Mar versus previous assumption for 9% drop. Production start for new models in April/late-June runs the risk of higher BOM and tight materials/parts procurement. ■ Devices: (1) Smartphone-use NAND supply remains tight. CIS remains tight as well. We see a growing risk of tightness for MLCC in the latter part of 2017 due to sharply higher iPhone 8-related demand. (2) The iPhone 8 will newly feature OLED, iris scan authentication, a USB Type-C connector, SLP (substrate-like PCB), an L- shaped battery, a glass case, and a wireless charger. Interest in Chinese makers is rising on the news that the iPhone 8 will include iris scan authentication. (3) In CIS, Chinese smartphones dual cameras have become standard. (4) In OLED-related, Samsung intends to cut supply to itself and expand shipments to Chinese makers. (5) The USB Type-C install rate has increased sharply since the start of 2017. ■ Stock calls: In electronic components, we recommend near-term caution on stocks with high Chinese smartphone exposure ratios and that investors instead look to firms that have higher sales revenue per phone for the iPhone 8. We expect Nissha Printing, Alps Electric, and Murata Mfg. to attract investor attention. We recommend companies poised to benefit from an iPhone rebound in North America, higher component install rates for Chinese smartphones, and yen depreciation. Our top pick is Alps Electric (6770). We also recommend Murata Mfg. (6981) and Nissha Printing (7915). In the SPE sector, we are downgrading Tokyo Electron and Hitachi Kokusai Electric from Outperform to NEUTRAL based on the risk of semiconductor demand deterioration. We expect Disco (6146) to attract increased attention starting in the latter part of 2017 due to investment related to fingerprint/iris scan authentication sensors. Our top pick in the consumer electronics sector is Sony (6758), where we expect increased CIS demand. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. 10 March 2017 Overview Risk of Chinese smartphone correction, new model production delayed; PC demand weak. Expecting hardware production rebound post-Golden Week. Smartphones We had been concerned about inventory adjustment risks for Chinese smartphones in May–Jun after the production of existing spring models, but in addition to excessive inventories, order adjustments and lowered production forecasts at OPPO and vivo, a change in the Qualcomm chipset design has delayed the start of new model production until late May. We therefore expect Chinese smartphone inventory adjustments to persist through the first half of May. Also, it now appears that iPhone production will be weaker than we expected in Jan–Mar and Apr–Jun. Also, Samsung has delayed GS8 production start, but Jan–Mar production volume will likely be sustained to a certain extent on higher production of the J series and On series. GS8 mass production is scheduled to start in March, so we expect higher volume in Apr–Jun. As we expect the start of production of new Chinese smartphone models to coincide with inventory build-ups for the iPhone 8, we see materials/parts procurement risk from mid-2017 onward, especially for Chinese smartphone makers. On the supply chain side, in addition to severe NAND tightness, CIS (CMOS image sensor) supplies remain tight amid product adjustments by Chinese smartphone makers including increased dual camera installations and the shift to higher resolution front cameras. In MLCC, we expect increased utilization in the iPhone 8, increasing the risk of supply tightness from early 2017 onward. Polymer battery supplies are also tight. Supply tightness in APs and crystal devices last year is beginning to ease up. In the OLED field, Samsung plans to cut supply to itself and expand shipments to China. The iPhone 8 will newly feature OLED, iris scan authentication, a USB Type-C connector, SLP, an L-shaped battery, a glass case, and a wireless charger. Given the large number of new functions/devices compared with previous models, we think the risk of bottlenecks in these areas at the mass-production stage warrants caution. Also, amid expectations for higher average unit bill of materials costs (BOM), devices with unchanged design/specifications are likely to come under even greater price pressure. Interest in Chinese makers is rising due to the news that the iPhone 8 will be equipped with an iris scan sensor. Tablets We expect 2017 tablet production for the seven top brands is to continue falling in 2017 (−8% YoY). We see no signs of improvement. Against iPad production of 12mn units in Jul–Sep and 15mn units in Oct–Dec 2016, we assume 13mn units in Jan–Mar, showing only a slight seasonal adjustment due to contributions for new 10.4 inch and 12.9-inch models. Our full-year outlook is for a slight dip YoY. PCs We estimate production of notebook and desktop PCs fell 15% QoQ in Jan–Mar, with desktops falling by 10%. However, PC-related component demand appears to have started running under expectations in late Feb–Mar, fostering uncertainty. Meanwhile, datacenter/cloud-related demand is strong. Technology sector2 10 March 2017 Implications based on hardware production trends Electronic components sector Near term, the electronic components sector is likely to remain encumbered with negatives until around April, including slightly soft iPhone production volume, prolonged Chinese smartphone inventory adjustments, and delayed start-up of spring model production. However, considering the pending start-up of iPhone 8 production in the second half of 2017, we believe the market will buy stocks it expects to see higher sales revenue per phone for the iPhone 8 and turn away from stocks vulnerable to Chinese smartphone inventory adjustments. We believe the stocks poised for higher sales revenue per phone for the iPhone 8 are Nissha Printing, Alps Electric, Murata Mfg., and Taiyo Yuden. We see Nissha Printing benefitting from expansion of OLED models. Its exposure to Chinese smartphone production is very low. Alps Electric has VCM exposure to Chinese smartphones, but we estimate that its iPhone-related business is much larger, so it is another firm likely to see higher sales revenue per phone for the iPhone 8. Murata Mfg. is at risk of Chinese smartphone SAW filter production adjustments, but we expect major benefits from higher sales revenue per phone for iPhone 8 (especially MLCC and MetroCirc). We expect the company’s sales revenue per phone for the iPhone 8 to be 10%+ higher than for the iPhone 7. In particular, we expect a sharp rise in MLCC, with the demand-supply balance likely to tighten in the second half of 2017. Similar to Murata Mfg., Taiyo Yuden has a high exposure to Chinese smartphones, but we expect MLCC growth in the second half of the year. Looking at Japan Aviation Electronics Industry (JAE, 6807), we will be watching closely the degree of any average revenue gap associated with the shift from Lightning to the Type-C connector. Other names with high exposure to Chinese smartphone production are TDK (6762) and Hirose Electric (6806). Semiconductors/SPE sector We forecast an inventory glut throughout the semiconductor supply chain as a hitherto firm DRAM market changes – PC output is weakening and China smartphone inventory is correcting – and delays for new application processors push out a projected rebound for China smartphone output. Although Taiwanese foundries’ 300mm capacity utilization has not corrected yet, we think risk has risen. We expect upside for the broader technology sector to be increasingly capped.