[ANALYSIS] Worst is over for Samsung, SK stocks in 2023

An employee works on the memory chip production line at Samsung Electronics' plant in Xi'an, China, in this May 9, 2014, file photo. Courtesy of Samsung Electronics

Replacement demand for servers, supply chain stability to back repricing of major chip stocks

By Kim Yoo-chul

The worst is over for Samsung Electronics and SK hynix's stock prices at least for this year, as major investors are confident demand will return in the second half of this year due to massive production cuts by the South Korean chip duo as well as Micron Technology of the U.S., which are clearly helping supply chain inventories return to healthier levels quite quickly, analysts say.

The start of the COVID-19 pandemic drew attention to the huge significance of supply chains, and the semiconductor shortage quickly became the top example of how bottlenecks and disruptions can affect the industry's leading players including NVIDIA, AMD, TSMIC, SK hynix and Samsung Electronics. Before the pandemic, market capitalization of these top-tier semiconductor companies had been growing exponentially.

But as the pandemic deepened, the decline in consumer demand hit the overall sector. In 2021, consumers in many territories had been keen to get their hands on tech products while stuck in lockdowns or social distancing measures. In a move to prevent further disruptions, major tech companies stocked up their inventories by asking chipmakers to increase supply. But as energy prices started to rise, considered as one key factor behind the central bank's moves to hike benchmark rates, global economies slowed down. The result was that having large inventories deteriorated profit margins for chip suppliers.

Analysts contacted by The Korea Times said China's reopening ― the main incentive for the U.S. pursuing semiconductor supply chain resilience ― and more spending in terms of capacity, could provide a boost for chipmakers and chip equipment vendors. Assuming that the U.S. economy avoids a recession this year, they said the worst is likely over for memory chip stocks, at least for 2023, because chip stocks historically tend to perform strongly in recovery after hitting a bottom after repricing has already occurred.

Nvidia co-founder, President and CEO Jensen Huang speaks at a Taiwan Semiconductor Manufacturing Company (TSMC) facility under construction in Phoenix, Arizona, Dec. 6, 2022. AP-Yonhap

"Customer inventories are clearly getting better. Chances are so low that the U.S. economy, the world's largest, would enter a total recession. Also, the growing scale of technology and other structural forces in economies, in addition to the comeback of cyclical factors such as market pricing, will truly make this year an attractive re-entry point for investors," a senior portfolio manager at a U.S.-based investment bank in Seoul told The Korea Times.

AI gold rush

The question is: Can supply match demand? Mainstream thoughts are that difficulties could remain for a while but investors don't predict any major constraints, as the end is in sight for the supply crunch affecting the overall semiconductor industry, which includes both memory and logic chips.

Samsung Electronics' confirmation that it has joined with SK hynix and Micron to reduce its chip production is undoubtedly viewed as a positive factor, as reduced production will help the overall industry lower inventory levels earlier than expected. The global memory chip sector is dominated by these three market players.

While the supply growth is positioned to be limited, thanks to output cuts by the top three players, there is no doubt from a demand perspective that the artificial intelligence (AI) revolution will benefit the South Korean chip duo and their top-tier equipment suppliers, as NVIDIA's lead in the AI sector is expected to encourage established tech giants like Microsoft and newcomers such as OpenAI to invest more into it.

Because AI systems require memory chips with fast read and write capabilities, such as NAND flash, Kim Young-keun, an analyst at Mirae Asset Securities, has advised his clients to increase their holdings in Samsung Electronics and SK hynix.

"Samsung and SK's first-tier semiconductor equipment suppliers will clearly benefit from the overall industry's focus on data-intensive applications such as ChatGPT and easing worries over the demand-supply mismatch amid lower production this year. This will support their profitability next year," he said.

While Samsung Electronics' semiconductor division reported an operating loss of 4.6 trillion won in the first quarter of this year, a recovery is anticipated in the second half. However, revenue from its memory chip business is expected to decline by up to 40 percent this year from the previous year. Similarly, SK hynix's revenue would decline by up to 44 percent year-on-year, and its operating loss for 2023 is projected at between 8 trillion won and 9 trillion won, according to Fitch Ratings estimates.

The logo of Micron Technology is seen on the company's Shanghai office in China, May 25. Reuters-Yonhap

"We forecast stronger DRAM average selling prices (ASPs) as the market moves to new technology, such as DDR5, with demand likely to exceed supply over the medium term. New PCs will include greater memory content. We forecast stronger demand for high-end servers with DDR5 in the second half of this year. Replacement demand for the server market, which has a cycle of four to five years, should pick up from the third quarter of 2023," its analysts Matt Jamieson and Shelley Jang said.

With less volatile raw material costs and a less hawkish monetary policy by the U.S. Federal Reserve, 2023 could also mark a stronger year for the global automotive industry. The baseline is that more stability in the automotive supply chain could lift the earnings momentum of chip suppliers as well.

"Because major vehicle original equipment manufacturers (OEMs) are expected to maintain stable and strong pricing power, they will also have to pursue tight control over inventories, which will help top chipmakers charge more for them. The auto supply chain is on track for normalization following disruptions over the last few years," a portfolio manager at Kookmin Bank in Seoul said on condition of anonymity as he wasn't authorized to give official statements to the media.

China's ban on Micron lacks teeth

Market factors aren't the only essentials that can explain the nature of today's semiconductor industry as the U.S.' prohibition on China's ability to import advanced technology equipment presents risks to the Chinese operations of Samsung, SK hynix and their contractors.

As major economies have felt how vulnerability in chip supply lines can lead to extended and massive shortages of key manufactured goods essential to their backbone economies, the U.S., U.K., Canada, Japan, Taiwan, China, South Korea, the Netherlands and others are now scrambling to apply measures that will boost their domestic chip supply chain systems by offering incentives to foreign manufacturers.

Flags of China and the U.S. are displayed against a printed circuit board with semiconductor chips, in this photo illustration. Reuters-Yonhap

China's ban on Micron, for example, which is viewed as Beijing's response to Washington's crackdown campaign on its technology industries, may "at least partially benefit Samsung and SK" from higher chip prices within China, according to Fitch.

Fitch Ratings clarified that it is seeing a "neutral impact" from the Micron case on the South Korean chip duo, as there are possibilities that Micron will redirect the sales of its memory chips outside China. But a recent U.S. approval for Samsung and SK hynix to grant a waiver that allowed them to continue importing advanced tools for their facilities in China is viewed as a positive factor in terms of investor sentiment, company officials said.

"Despite China's ban on Micron's products, given Samsung and SK's vast chip factory operations there, investors have no big doubts there won't be major long-term supply constraints. The U.S. waiver will be effective until October this year," said a senior executive at a global asset management company in Seoul.

The U.S. urged the South Korean government to dissuade Samsung Electronics and SK hynix from backfilling the gap in local memory sales in China should China end up restricting the sales of Micron's chips. But Fitch Ratings expects the South Korean chip duo to "at least partially fill the gap." It added, "It will be difficult to monitor what capacity lost by Micron is actually filled by the Korean companies, given the commodity-like nature of memory chips."

Representatives at Samsung and SK hynix declined to comment.