Huawei ban lifted for the most part, Japanese restriction limited to EUV PR
Since the G20 summit, Washington's restrictions on Huawei have been eased as Huawei is allowed to use US parts as long as these parts do not pose a threat to US national security. We believe, at minimum, smartphones, servers, and notebooks will remain unharmed by the US ban on Huawei. Huawei's servers are mostly sold in China, so Intel's (NASDAQ:INTC) CPU supply would be unaffected. Meanwhile, Japan's restrictions on its Korea-bound exports of three semiconductor materials (photoresist, etching gas, fluorine PI) and its removal of Korea from its "whitelist" of countries that enjoy favorable treatment on trade have exposed the Korean IT parts sector to significant risks. However, so far, it has been confirmed that the restriction on photoresist is limited to EUV. Of course, it is a risk to Samsung Electronics' (OTC:SSNLF) foundry business as customer confidence is the key to the made-to-order foundry business. However, its impact on memory semiconductors, the Korean IT sector's biggest cash cow, will likely be limited.
For etching gas, it is difficult to carry more than three months' worth of inventory, given the material's properties, but we do not expect the worst-case scenario to realize because the tighter supply of Korean memory chips would destroy the global supply chain, and Tokyo would face a barrage of criticism globally. First and foremost, the easing of the Huawei ban is positive for 2H19 demand. It is less positive for Samsung's smartphone business for it was thought to benefit the most from Huawei's pain, but we still believe Huawei smartphones will lose some of its appeal to Western European customers because of concerns over a potential ban, and Samsung smartphones will enjoy greater opportunities overseas.
As for Japan's trade restrictions on Korea over semiconductor materials, the impact on shipments will be almost nonexistent as the restrictions barely affect Korea's memory semiconductor production. Even so, we believe worries that Tokyo may impose new restrictions will provide a much-needed boost to slumping memory chip prices. Indeed, DRAM and NAND spot prices are already moving northwards. ADATA and Phison, in particular, are making substantial purchases in the spot market, consequently driving prices higher.
Electronic materials stocks to re-rate, take a long-term approach
Meanwhile, Taiwan's server supply chain is seeing a gradual MoM increase in sales. Aspeed's monthly sales, which lead memory chips and CPU demand by three months, rose 4% MoM in June while its YTD sales dipped 1.1% YoY. It may be difficult for the firm to satisfy its annual sales growth guidance of 10% YoY, but the pace of sales growth will likely improve on a meaningful scale from July onwards. A major server ODM Inventec also enjoyed a 16.7% MoM sales increase in June. In particular, we expect an increase in demand for notebook PCs with Intel's (INTC) 10nm CPU from 4Q19 to boost the earnings of Quanta Computer and Inventec.
The recent ascent of spot DRAM and NAND prices raises expectations for contract price increases, but we do not see DRAM contract prices rebounding in 3Q19. Cloud computing companies in North America are demanding a further cut in DRAM and NAND prices, citing chipmakers' fat inventory levels. However, in 4Q19, prices will likely stabilize, helped by higher spot prices and lower inventories.
Against this backdrop, we adjust our forecast of server DRAM price declines in 4Q19 from -10% QoQ to -5% QoQ. Our server DRAM price projection for 3Q19 remains unchanged at -15% QoQ, but a potential rise in demand from Chinese cloud computing companies such as Tencent (OTCPK:TCEHY) and Baidu (BIDU) may help slow the pace of decline.
There is a growing need to localize the production of semiconductor materials among private companies and Korean government, after Tokyo imposed restrictions on Korea-bound exports. There is now consensus among all involved parties about the risk of importing key materials. In the past, efforts to localize the production of electronic materials were mainly aimed at reducing the prices of materials made overseas, notably Japan; now, such efforts will be made to ensure the long-term survival of perennial corporations.
The Korean government plans to do its part, by offering subsidies and tax benefits to Korea-based materials suppliers. Large conglomerates will also work to strengthen the relationships with such suppliers by making strategic equity investments. Ultimately, Korean materials suppliers will likely experience EPS growth on the back of tax benefits, and an upgrade of valuation multiples by securing long-term growth catalysts. Among these suppliers, those that attract our attention include Hansol Chemical, Soulbrain, Innox Advanced Materials, SK Materials, Wonik Materials, Dongjin Semichem, ENF Technology, and DNF.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Hyundai Motor Company is a passive shareholder in our bank.