Semiconductors Winners And Losers - A Modified Huawei Ban Could Create Divergence

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Includes: ADI, AMAT, AMD, ASML, AVGO, CREE, CY, ENTG, INTC, IPHI, KLAC, LRCX, MCHP, MKSI, MPWR, MRVL, MU, MXIM, NVDA, NXPI, ON, QCOM, QRVO, SIMO, SLAB, SOXX, SWKS, TER, TSM, TXN, XLNX
by: MarketGyrations
Summary

Semiconductors have outperformed the S&P 500 and some companies have done even better individually.

Semiconductor companies have gone up, but the Huawei ban has given semis problems and put pressure on their stock.

The U.S. government may soon make changes to the Huawei ban that could create winners and losers within the sector.

If government intervention results in winners and losers, then it’s best to select individual names instead of an ETF such as SOXX.

Semiconductors have done extremely well in 2019. If we look at the iShares PHLX Semiconductor ETF (SOXX), an ETF devoted to semiconductor stocks, then we can say that it's up by 32% YTD. However, the ride has not exactly been a smooth one. There have been major bumps along the way, especially in May when the U.S. government imposed sanctions on China's Huawei.

Since semis have done well in the first half of 2019, investors may be wondering if there is more to come or if there is something that could spoil the party. Especially since the Huawei issue remains unresolved. It's, therefore, important that we keep track of the Huawei issue because it has the potential to move semiconductor stocks, just like it did back in May.

Semiconductors winners and losers

SOXX is an ETF that tracks 30 semiconductor companies. They are Broadcom Inc. (AVGO), Intel Corp. (INTC), Texas Instruments Inc. (TXN), Nvidia Corp. (NVDA), Qualcomm Inc. (QCOM), Xilinx Inc. (XLNX), Analog Devices Inc. (ADI), NXP Semiconductors (NXPI), Lam Research Corp. (LRCX), Advanced Micro Devices Inc. (AMD), Applied Materials Inc. (AMAT), Taiwan Semiconductor Manufacturing Company (TSM), Micron Technology Inc. (MU), Microchip Technology Inc. (MCHP), KLA Tencor Corp. (KLAC), Maxim Integrated Products Inc. (MXIM), Skyworks Solutions Inc. (SWKS), Marvell Technology Group (MRVL), ASML Holding (ASML), ON Semiconductor Corp. (ON), Qorvo (QRVO), Teradyne Inc. (TER), Inphi Corp. (IPHI), Monolithic Power Systems (MPWR), Cree Inc. (CREE), Cypress Semiconductor Corp. (CY), Entegris Inc. (ENTG), MKS Instruments Inc. (MKSI), Silicon Laboratories Inc. (SLAB), and Silicon Motion Technology (SIMO).

The table below lists each of the previous companies and how much they have gained or lost recently. Some are more or less in tune with how SOXX has performed, but there are also those who have outperformed SOXX and others who have underperformed.

Stock

Change - 12 months

Change - 6 months

Change - 3 months

Change - 1 month

Change - YTD

AVGO

+39.11%

+15.13%

-9.59%

+4.22%

+13.96%

INTC

-3.50%

+3.76%

-14.72%

+5.43%

+6.41%

TXN

+2.39%

+22.02%

+2.57%

+6.78%

+25.47%

NVDA

-32.92%

+14.34%

-9.14%

+11.32%

+27.48%

QCOM

+26.24%

+34.56%

-5.96%

+3.35%

+30.68%

XLNX

+80.01%

+35.77%

-9.54%

+9.91%

+44.25%

ADI

+18.06%

+33.34%

+1.41%

+5.52%

+35.16%

NXPI

-6.32%

+23.97%

-4.00%

+2.47%

+32.53%

LRCX

+11.84%

+42.87%

+0.99%

+9.86%

+45.58%

AMD

+95.61%

+67.26%

+20.04%

+8.37%

+78.76%

AMAT

+1.84%

+43.19%

+9.75%

+13.85%

+47.13%

TSM

+13.54%

+21.18%

-2.70%

+10.15%

+17.01%

MU

-21.58%

+33.03%

+3.52%

+30.27%

+40.78%

MCHP

-2.26%

+23.73%

-6.42%

+9.29%

+29.17%

KLAC

+25.99%

+46.67%

+7.83%

+19.53%

+49.08%

MXIM

+1.40%

+19.40%

+4.35%

+7.62%

+22.24%

SWKS

-19.93%

+18.34%

-10.70%

+7.53%

+21.49%

MRVL

+21.61%

+58.59%

+6.11%

+7.49%

+63.00%

ASML

+10.92%

+44.11%

+11.45%

+16.40%

+45.64%

ON

-14.18%

+16.39%

-9.16%

+4.75%

+24.29%

QRVO

-13.88%

+16.01%

-6.95%

+9.45%

+17.31%

TER

+14.83%

+46.01%

+3.23%

+1.05%

+47.55%

IPHI

+73.41%

+73.31%

+29.28%

+23.64%

+88.68%

MPWR

+3.24%

+20.23%

-5.91%

+11.85%

+25.53%

CREE

+28.11%

+24.51%

-11.70%

+1.45%

+38.73%

CY

+33.21%

+71.49%

+35.80%

+0.90%

+75.94%

ENTG

+4.19%

+31.46%

-5.75%

+2.29%

+36.33%

MKSI

-20.35%

+12.34%

-20.26%

+8.78%

+24.39%

SLAB

-2.59%

+19.23%

+11.96%

+2.96%

+30.47%

SIMO

-21.95%

+17.47%

-3.39%

-1.41%

+19.65%

SOXX

12.59%

28.77%

-1.97%

+8.76%

+32.23%

Source: iShares

If we look deeper at the individual names in SOXX, we can see that some companies have done much better than the 32% YTD gain posted by SOXX. AMD, for instance, has gained 78% YTD and can be seen as the big winner. On the other hand, Intel has underperformed with only a 6% gain. The two companies are direct competitors and it's safe to say that AMD's gain has come at Intel's expense. Note that Inphi has only recently been added to SOXX in place of Mellanox.

SOXX chart

Impact of banning Huawei on semis

As can be seen from the chart above, semis went through a major decline in May due to Huawei. Last May, Huawei was added to the US Commerce Department's Bureau of Industry and Security ("BIS") Entity List. This designation makes an export license mandatory on all exports, reexports, and transfers of items subject to the US Export Administration Regulations ("EAR"). What this means in practice is that Huawei will be unable to source parts or components from U.S. suppliers, including semiconductor companies, unless they have permission from the U.S. government.

However, the U.S. administration has recently signaled that it intends to soften the ban on Huawei. According to some media reports, Huawei will remain on the Entity List, but licenses will be issued as long as according to Secretary Wilbur Ross "there is no threat to U.S. national security."

In addition, the article points out:

"The actual policy of what is not going to endanger U.S. security is not clear," Washington trade lawyer Doug Jacobson said. "The only way that industry can determine the line is by submitting (license) applications and knowing what types will be approved and which types will be denied."

It's not clear exactly how the government will decide what will and will not be approved.

What is likely to be approved

While the final decision as to whether or not to grant permission is up to the U.S. government, some recent statements by officials give clues as to which direction they're planning to go. For instance, Wilbur Ross states in the prior article that:

Within those confines, we will try to make sure that we don't just transfer revenue from the U.S. to foreign firms,"

This suggests that the U.S. will approve sales of chips that can be sourced from non-U.S. suppliers. This makes sense because there is no point in denying Huawei chips from U.S. companies if there are other suppliers that can provide substitutes to Huawei. Otherwise, the U.S. would only lose out and foreign chip suppliers would gain at the expense of U.S. companies.

A good example would be memory chips from Micron. Both DRAM and NAND chips can be obtained from alternative suppliers such as South Korea's Samsung (OTC:SSNLF) and SK Hynix (OTC:HXSCF). Preventing Micron from selling to Huawei would only benefit sales at these two companies. If Huawei cannot get memory chips from Micron, they can go to Samsung and SK Hynix for supplies. The modified ban on Huawei should, therefore, be a positive development for a company like Micron.

What's also likely to get permission are modem chips from Qualcomm for smartphones. Qualcomm may be the biggest supplier of modem chips, but there are other suppliers out there such as Samsung and Mediatek. Even Huawei makes its own modem chips, which means it does not make a lot of sense to block Qualcomm's sales to Huawei.

What is not likely to be approved

What semiconductor companies apparently will not be allowed to do is supply components that Huawei can use to build 5G cellular networks. Larry Kudlow points to this when he states that:

"Huawei remains on the Entity List. Okay? On the other hand, Huawei - there'll be no U.S. government purchases of Huawei parts, components, or systems. That's not going to change. But with respect to the private markets, I call it general merchandise, we've opened the door, relaxed a bit the licensing requirements from the Commerce Department, where there are no national security influences or consequences. So, for example, what does that mean? Some of the chip companies would be permitted to sell on a limited basis to Huawei. These are things, Kelly, that are available, their products are available. You could buy them in South Korea, Taiwan, Vietnam. We don't hold any great cache. That's the sort of thing that will be opened up, which was closed, all right? So that's important and, I guess, does provide some relief to Huawei, which is in trouble now because of American decisions. But not just the United States. Many other countries now. With respect to 5G, no. No transactions with respect to 5G. But again, generally available. We are opening that up for a limited time period, the Commerce Department will be revisiting its licensing. Secretary Ross will have more to say about that."

A full transcript of the interview with Larry Kudlow can be found here.

What the above statement implies is that anyone who provides chips that can be used in 5G networks will not be allowed to do business with Huawei. If this is correct, then that will be bad news for a company like Xilinx because it provides FPGAs that are needed in 5G base stations. Also affected would be Intel because it supplies FPGAs and silicon photonic optical transceivers that are used in 5G. Basically, any component or part that is related to 5G is almost certain to be denied permission.

Investor takeaways

It's worth pointing out that the Trump administration has the tendency to change course, so it's possible that the final word has not yet been said regarding Huawei. In addition, the U.S. Congress is attempting to block any easing of sanctions on Huawei. It's still possible that Huawei will not be allowed to do business with any U.S. company.

However, if the U.S. administration proceeds with its plans regarding Huawei, the potential exists that we could start to see some divergence between semiconductor companies with some doing better than others. Those that get permission from the government can do business as usual. But some can expect their sales to take a hit because they can't get permission. They will be at a disadvantage.

So what does it all mean? If government intervention results in divergence, then an ETF such as SOXX is not right if someone is interested in maximizing returns. An index will be held back by companies that are hurt by sales restrictions. The better approach would be to avoid these companies and instead focus on companies that are likely to get permission to do business as usual, including selling to Huawei. They should thrive because of it.

Source: Wikimedia Commons

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.