WHAT’S THE STORY.
WHAT’S THE STORY.
Share-price correction worrisome: The tech sector is facing growing concerns oversliding memory chip prices and chances of an industry peak. Shares in semiconductormaterials suppliers and equipment makers, including our top pick SK Materials, havecorrected substantially, the magnitude surely a matter of concern. Yet, we maintain ourinvestment ratings after answering the following questions.
Satisfactory 2Q17 results. The company released satisfactory 2Q operating profit atKRW3.05trn (+24% q-o-q, +573% y-o-y) with historically high sales of KRW6.69trn(+6% q-o-q, +70% y-o-y), and OP margin improved to 46% from 39% in 1Q due to 1)higher blended ASP and 2) cost reduction from DRAM 21nm crossover. As wehighlighted in our memory report, Broader server impact on DRAM ASP andearnings, (28 June), steep increase in server contribution to mid-30% of DRAM salesin 2Q from 30% in 1Q led to higher ASP and better margin. However, revenue was4% below our expectation due to slightly lower bit growth at 3% q-o-q (vs. our 5% qo-q) in DRAM and -6% q-o-q (vs. our +5% q-o-q) in NAND. It looks as though slowerChina smartphone sales were a negative impact, as the company has c25-30%China smartphone exposure.
Our recent supply chain check shows that: 1) demand for certain memory products isfalling short of market estimates; and 2) consumers are becoming more resistant to pricehikes. Changing demand remains insufficient to significantly influence AI or big datatrends, but clients are showing signs of resisting price hikes by curbing purchases.
May is a critical month for the tech sector, as 1H performances and supply chaininventories are key in determining 2H outlooks. Historically, investor excitement hasportended a sell-off, while worries have signaled room for more buying.
Will semiconductor materials/equipment stocks keep rallying when shares inSamsung Electronics and SK Hynix trend down?A limited correction in semiconductor materials/equipment stocks seemed unavoidable.
Steep sequential earnings growth in 3Q17e. Driven by 1) strong peak seasondemand in smartphone and 2) positive impact from continuously rising servercontribution, we expect the company will show 22% q-o-q operating profit increase in3Q at KRW3.7trn with sales of KRW7.7trn (16% q-o-q, 83% y-o-y). We assumehigher-margin, higher-price server portion to reach 40% of total by end-2017 from30% in 1Q amidst strong demand for content growth from data center customers.
Tech was an obvious darling at last week’s Samsung Global Investors Conference. It waseasy to arrange meetings, and investors were happy with returns thus far—but we saw nosign of irrational exuberance after solid 1Q results. Questions focused on the sustainabilityof a sector upturn, capex discipline, and demand drivers such as big data. Companiesoffered bright guidance for 2H but warned investors not to get too excited.
After it ends, however, investors realize industry risks and eye small caps upstream thatshould benefit from hikes in both chipmaker investments and raw-material costs, withboth increases providing the foundation of our investment ideas. Robust top-line growthupstream should increasingly draw attention while chipmakers valuations are stuckbetween expectations of stable earnings and concerns over an industry peak.
Also, we expect blended ASP to rise at both DRAM and NAND on the back of server,PC and mobile DRAM price hikes and significant production of higher-priced 3DNAND. In particular, we expect NAND will show margin improvement throughimproved economies of scale in 3D NAND as it reaches 45% of total by year-endfrom 10% in 2016. We forecast NAND margin to reach 26% in 3Q, from 24% in 2Q.
Orders for enterprise server SSD have fallen short of previous expectations while there areno visible changes in demand for data centers or servers, implying NAND price hikes areseemingly slowing conversion to SSD or curtailing its density per box. Price resistancefrom tier-2 companies is nothing new, but reduced orders by tier-1 data center players arebeing seen for the first time. In response, NAND suppliers are promoting high-densitySSD (vs price discounts) to increase per-server storage.
Post-conference, two of our five analysts said they believed the sector would keep rallying,while three felt expectations have become slightly excessive. We see this as evidence ofnervousness in the market, and against this backdrop foresee more upside for the sector.
How long will the correction persist?The correction may not end anytime soon as the semiconductor supply chain had ralliedsharply over the past month and global tech shares are also correcting. Yet, we see a lowchance of long-term weakness as the construction of fabs by the clients suggests supplywill fall short of demand for the time being. The current slide in shares is likely to ease ifmemory prices hold up well and companies post better-than-expected results.
We reiterate Buy rating with TP upgrade to KRW88,000 (from KRW86,000) onearnings upgrade. Factoring in 5% and 9% operating profit estimate increase for2017e/18e from higher DRAM ASP assumption in 4Q and better margin outlook, weraise up TP to KRW88,000. Our 2017e/18e operating profit estimates are 6%/17%higher at KRW13.0trn/13.8trn, respectively, than the Street as we see upward pricetrend will persist until 4Q17. We also raise capex for 2017e to KRW9trn (fromKRW8trn), based on faster construction for Wuxi and Cheongju fab, which aretargeted for mass production start from early 2019. Our target price continues to bebased on a 1.64x PB multiple applied to 12-month BVPS (3Q17-2Q18e), to reflectthe next one year of growth. We think the stock is significantly undervalued, trading at1.2x 2018e book, while ROE is improving to 28% from 13% in 2016.
Memory suppliers are reassessing capacity expansion plans amid falling demand.
Do memory capacity expansions benefit semiconductor material andequipment stocks?They certainly do. Fab construction lifts earnings visibility for the following two or threeyears, so that event itself should initiate a rerating. Our real concern, however, layelsewhere. If sentiment sours too much, investors may simply view memory capacityadditions as a sign of oversupply and shun investing in the supply chain. We need todistinguish whether the capex decision is meant to overcome supply shortages or gain theupper hand in competition. The former is positive and the latter is negative, of course, andwe think capacity expansions are currently a result of tight supply.
Samsung Electronics (SEC) is expected to have monthly capacities of 30,000 and 70,000sheets for DRAM and NAND, respectively, on the west wing of the Pyeongtaek fab’ssecond-floor in early 2018. Equipment makers have confirmed orders of 30,000 sheetsapiece for DRAM and NAND next year, but the additional 40,000 sheets for the latter areunconfirmed. With higher prices eroding demand, there is a debate between those callingfor investment cuts or hikes (with the latter citing demand elasticity to price). While SECis expected to dedicate the Pyeongtaek fab’s second-floor east wing to DRAMmanufacturing in 2H18, we do not foresee that any alteration to its investment plans,considering NAND supply shortages are expected in 2019.
Samsung Electronics (SEC) and SK Hynix said memory semiconductor prices have beenrising in 2Q and expect DRAM prices to rise further or at the worst stay flat this quarter—we predict a 3% q-q drop. The chipmakers said the use of more memory per box isnegating weak handset sales in China and server-semiconductor demand is fairly strong.
Conclusion: We remain upbeat on semiconductor materials suppliers as: 1) demandshould stay strong in the long run and competition is unlikely to heat up; 2) the currentcorrection is unlikely to trigger a long-term downturn; 3) chipmakers should ramp upinvestments next year; and 4) an end to the chipmakers share correction should put moreinvestor focus on topline growth at upstream players based on greater demand for rawmaterials. We expect sales of the semiconductor value chain under our coverage to leap21% next year, with those at SK Materials surging 30%.
Despite changing demand, our memory price outlook is unchanged, with NAND priceslikely flat q-q in 4Q17 and set to edge down in 1Q18, while those for DRAM will likely rise5-6% in 4Q17 and continue trending up in 1Q18. It nevertheless remains to be seen iforder declines drive down prices and eventually spur demand hikes.
SSD content per service has jumped more than 50% y-y amid fierce competition to securedata and upgrade demand (all-flash storage). DRAM content per server is also increasingat a mid-20s percentage rate, outpacing DRAM demand growth of around 20% y-y.
iPhone demand concerns….
Investors asked when heavy NAND investments will begin to increase supply, to whichKorean companies explained that investments had been made to construct buildings, andnew production lines will be brought online from 2019 depending on market conditions.
The iPhone X debuted on Nov 3, with our channel check suggesting a mixed bag of initialresponses, and even though its overall sales volume has been largely as forecast, we notethat: 1) sales in the US and Japan have been positive as those in China and Europe havedisappointed; and 2) the 64GB version is struggling, in contrast with the 256GB version,which is seeing wait times of over two weeks and taking over 40% of total sales on lessthan 20% of total manufacturing. Such results have some worried that the iPhone X’sproduct cycle might fizzle out earlier than most had expected once initial demand fromloyal Apple customers wanes.
Questions about the sustainability of earnings are likely to grow as analysts raise forecasts,but we believe the boom will last at least through 2018, and maintain BUY on SEC andHynix.
SEC expects TFT panel prices to fall in 2H as Chinese players start mass production, whileLG Display sees prices per shipment area holding up on growing sales of high valueaddedproducts (eg, UHD). Their views were little changed pre- and post-conference.
Meanwhile, OLED capacity is expanding and expectations for the technology remain high,but we believe order momentum at equipment firms will slow after a concentration oforders was received in 1Q. SEC’s A4 line investments still remain unclear. We remainmore conservative on the display segment than the memory segment.