22 January 2019
The demand for DRAM memory chips is expected to top out in the second quarter of next year. Photo: Bloomberg
The demand for DRAM memory chips is expected to top out in the second quarter of next year. Photo: Bloomberg

Trees don’t grow to the sky, ditto for chip stocks

As the old trading adage goes, “trees don’t grow to the sky”; markets will correct at some stage.

I previously said that economies all over the world were showing positive growth, which is rarely seen, pushing up most of the stock markets. However, change happened in the blink of an eye: some markets have started to fall.

Morgan Stanley has released its 2018 outlook report, lowering its estimates for earnings growth in several markets in Asia next year. In the report, it cuts Korea to “underweight” and Japan to “equal-weight”. It is “overweight” on China equities, expecting a further 10 percent growth in the MSCI China index.

More importantly, Morgan Stanley lowers its ratings on all hardware technology stocks in Asia. Ratings for Samsung Electronics and Taiwan Semiconductor shares are lowered to “equal-weight” from “overweight”.

According to the firm, NAND memory chip prices are already falling, earlier than expected, and coupled with the expected increase in supply, there will be lower flash memory chip prices and meager earnings growth for chip stocks next year.

In addition, the demand for DRAM memory chips is expected to top out in the second quarter of next year, according to the firm. While the demand from hyper-performance computing (HPC) in data centers is still surging, it only accounts for 13 percent of the total market demand, and the remaining 87 percent comes from cyclical products such as personal computers and mobile devices.

The report says major DRAM buyers, including PC maker HP and smartphone giant Apple, keep a high inventory of the memory chip, and thus, the demand for DRAM is likely to drop next year.

Having said that, Morgan Stanley still maintains a very positive outlook for NAND and semiconductor stocks in the middle and long term (probably after 2018).

Several chip stocks fell after the report. Samsung closed down 5 percent, TSMC and SK Hynix fell over 2 percent in Asia trading on Monday.

I believe NAND memory chip prices will be steady in 2018. Even if the prices drop by 20 percent next year, Samsung will maintain its DRAM operating profit ratio because the company is capable of controlling production costs.

If it turns out to be a small-scale correction, we can expect to see a greater jump afterwards, supported by better earnings as well as the market’s revaluation of chip stocks.

Moreover, the semiconductor manufacturing industry may gain from the China factor. Despite its rapid growth, China’s hardware technology sector is still lagging behind the global leaders. Still, shares of domestic players such as Semiconductor Manufacturing International Corp. (00981.HK) and Hua Hong Semiconductor (01347.HK) have rallied strongly.

China’s desire for a bigger share of global semiconductor production will trigger massive changes in the industry, and force further consolidation and acquisition in the sector worldwide. Chinese chipmakers would be more than happy to embark on a shopping spree, targeting peers in the United States, Korea and Japan – as long as they secure the consent of foreign regulators.

There is now a “China put” alive to drive up chip stock prices.

It is also worth mentioning that Morgan Stanley upgrades oil stocks to “overweight”, and expects a strong growth in demand from China and India.

Note that Morgan Stanley is one of the Wall Street firms hired by Saudi Aramco, the kingdom’s national oil company, to assist in its (delayed) mammoth IPO next year. A boost in oil prices is surely helpful to its IPO valuation and progress.

But Morgan Stanley does have a point, as I do believe most investors have been underweight on oil stocks.

If political tensions in Saudi Arabia escalate, oil prices are likely to rise toward US$70 a barrel. Investors would then rush to buy PetroChina (00857.HK), Australia’s Woodside Petroleum and other major oil players.

This article appeared in the Hong Kong Economic Journal on Nov. 28

Translation by Ben Ng with additional reporting

[Chinese version 中文版]

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Eddie Tam is the founder and CEO of Central Asset Investments.

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