Away from the outbreak, the fundamental backdrop for the sector remains healthy, as many of the positive trends of recent years continue to drive the market. These include faster network speeds, capital spending on cloud data centres, and the continuing momentum of online commerce.
China remains centre stage
A host of global companies have issued warnings in recent weeks about the effect of COVID-19 on their operations, and the technology sector was no exception, as these included portfolio holdings Apple and Microsoft. Perhaps this should have been unsurprising to investors, given that the virus originated in China. The country has become crucial to the technology industry, as both a supply-chain partner and a source of revenue. (Apple derived about 15% of its sales from China in 2019’s fourth quarter).
China has imposed measures such as travel restrictions in response, a problematic issue for technology firms. While activity seems to be resuming, Apple and Microsoft have shown that this process will take time. More positively, the number of coronavirus cases in China does seem to be levelling off.
While acknowledging the still imperfect information about the depth and duration of social distancing and its economic impact, followed by uncertainty about the slope of the recovery, we continue to go through the process of updating our models to reflect revised estimates and price targets. Data Centre and PCs should hold up better than other areas – Enterprise data centre had been weak in 2019, so this area should not have to reduce estimates from peak levels. PC demand was thought to be weak but may likely improve as there should be a ‘gearing up’ phase where businesses and students need to buy additional PCs and monitors to work or study remotely from home. Meanwhile, Cloud should benefit from more daily activities moving online.
Enterprise networking spending is typically less volatile than other parts of Enterprise hardware IT. Governments may also consider pulling forward infrastructure projects like 5G and increasing size, similar to what China did in 2009 with 4G.
Wafer Fab Equipment (WFE) and memory are levered to computing and handsets and appear to be coming off trough levels in 2019. These companies should hold up better given some of the positive trends in computing and communication.
In the near-term, mixed trends within computing remain strong, and 5G phones still should have a strong cycle, albeit later than previously expected, are among the reasons to believe that WFE spending should hold up relatively well. Against that, however, is an expectation that the economic impact caused by COVID-19 with a sharp downtick in economic activity in Q2, 2020 and Q3, 2020, will likely result in a pullback in both consumer and corporate spending, which will eventually impact the magnitude of WFE spending. Long-term, we continue to like the WFE sector because it is a long-term sustainable business driven by growing semiconductor intensity in the economy with growing content and a broadening out of applications, such as Artificial Intelligence.
While the COVID-19 situation remains fluid, we remain of the view that the coronavirus outbreak doesn't wipe out the long-term transformational technological trends of cloud computing, 5G, electric vehicles, streaming and cyber security for the next few years. We continue to monitor the situation and remain on alert for any significant disconnect between industry valuations and underlying fundamentals.
We remain committed to our time-tested and disciplined investment process, which relies on deep fundamental analysis to identify those companies that trade at attractive valuations and have the best growth prospects and the potential to deliver solid investment returns over time.