Nvidia-linked chip play at eight times the win

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SK Hynix is ​​a stock pick from our broker upgrade screen from earlier this week.

Innovation in the semiconductor industry does not always follow obvious lines.

AAA rating Nvidia (US:NVDA), for example, designed its graphics processors for the gaming industry before it noticed researchers in California using them in AI projects and enthusiastically embraced the opportunity. The development of high bandwidth memory chips (HBM) by Korea’s AAA rating SK Hynix (KR:000660), meanwhile, also had only niche applications in gaming, until they got stuck next to Nvidia’s graphics processing unit (GPU) for AI.

‘Hynix has been investing in HBM chips since 2013; That has given them an edge over competitors, especially Samsung Electronics, who are still in the testing phase with Nvidia but supply Advanced Micro Devices,” said Elite Investor Michael Bourke, who holds Hynix in his M&G Global Emerging Markets fund.

It appears that Hynix’s leadership in HBM chips could be very lucrative. But even after rising 85% in the past year (and 44% since we first hinted at compelling upgrades in January), the shares are valued at just 8.2 times expected earnings for the next twelve months.

Meanwhile, HBM orders are pouring in, rapidly pushing up profit expectations.

The orders represent all HBM capacity well into 2025 at Hynix, the world’s second-largest memory chip maker.

“There is a risk that bottlenecks will emerge, both on the production side and on the end-customer side, as Nvidia customers rush to build out large server farms to deploy this AI capability,” Bourke said. ‘Undoubtedly, the development of AI is a huge boost for the memory industry that will last for years.’

Including Bourke, Hynix shares are owned by a total of eight Elite Investors, each of which ranks in the top 3% of the 10,000 global equity managers whose investments are tracked by Citywire. The substantial smart-money support places Hynix at a top AAA Elite Companies rating.

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How Citywire Elite Companies Works.

Top Three Elite Funders

Sources: Citywire/Morningstar, latest holding data.

On the heels of Hynix

Although much more expensive than conventional memory, HBM offers more capacity, faster data access and improved energy efficiency. These features are ideally suited for the massive amounts of data that need to be analyzed and stored when running AI programs.

Only two other companies make HBM chips: an American memory specialist with an AAA rating Micron (US:MU) and a Korean electronics giant with an AAA rating Samsung electronics (KR:005930). However, Hynix is ​​the company leading the way, putting it in a prime position to capture the most valuable business from big-spending AI customers.

But Bourke is skeptical about how long Hynix can stay ahead.

He said: ‘We believe it is only a matter of time before Samsung overtakes Hynix, especially as Nvidia has indicated that they want to engage Samsung to reduce Hynix’s dominance and ultimately drive down HBM prices. Samsung is also the only player in the sector that has the balance sheet capacity to invest in factory capacity.”

Fabs are the multi-billion dollar factories that make semiconductors.

Bourke recently cut his stake in Hynix after big gains, while adding ‘laggard’ Samsung.

However, there is a recent development deal between Hynix and the AAA-rated chip leader Taiwanese semiconductor manufacturing (TW:2330) – TSMC for short – could help extend the life of the HBM leadership.

As chip miniaturization reaches its physical limits, it is expected that smartly combining different chips will become increasingly important for increasing computing power. TSMC has expertise in GPU manufacturing, but not in memory, while the reverse is true for Hynix. That makes them a great potential match.

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Bad memories

While HBM chips represent an exciting opportunity, Hynix’s traditional Dram and Nand memory chip business has been abysmal since 2018.

Hynix suffered five quarters of losses until the end of 2023, while inventories and debt have soared.

But in the first three months of 2024, light appeared at the end of the tunnel. In addition to demand for HBM, an increase in Dram and Nand sales prices and a positive reversal in inventory valuations, the company reported an operating profit of KRW 2.9 trillion and an operating margin of 23% for the first quarter.

The company is confident that a recovery in its highly cyclical market is finally underway, and this is expected to accelerate in the second half of the year.

Brokers predict that net debt, which stood at KRW24.3 trillion ($17.4 billion) at the end of 2024, will decline rapidly and leave the company with net cash by the end of 2026.

Meanwhile, there are some early signs that AI phones and PCs could trigger a major upgrade cycle that would drive demand. The server market may also see tailwinds as machines purchased during the big cloud computing spend in 2017-2018 are upgraded.

Industry-wide capacity constraints, meanwhile, could add to upward price pressure after a period of low investment by beaten-up memory chip makers.

Stuck in the middle

With much of its production in China, along with 31% of revenue and 24% of assets, Hynix is ​​walking a tightrope in the US-China chip war.

Rumors are circulating about a possible divestment from China, including from the Dalian company that it bought from Intel for $9 billion in 2020. Hynix has denied this.

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There are also reports that the company is storing old equipment to prevent it from ending up in the wrong hands when sold.

On the plus side, memory chips are generally considered less political than logic chips, such as GPUs and CPUs (central processing units). Korean companies have also been granted an indefinite exemption from the ban on the import of US semiconductor manufacturing equipment.

One benefit from the politicization of silicon could come from incentives offered to chipmakers, including the US$39 billion Chips Act, a new US$19 billion South Korean government bailout package, and China’s recent push of $47.5 billion to his ‘Big Fund’.

Political risks are extremely difficult to quantify, but a lot can be included in the price.

For example, Micron, which has less exposure to China and has also seen its shares rise on excitement about HBM chips and a broader recovery in the memory market, is valued at 21 times forward earnings compared to Hynix’s eight times.

Key facts – SK hynix Inc.
Market capitalization 147,420 billion krW Price KRW 202,500
Net debt KRW 23,494 billion Net debt/Ebitda 4.0x
52 weeks high/low 210,000 KRW / 106,000 KRW Return on invested capital
F’cst price for profit 8.2 F’cst dividend yield 0.8%
F’cst growth in earnings per share 2092.3% Share price over 12 months 85.4%

Source: FactSet. EPS = earnings per share. Ebitda = earnings before interest, taxes, depreciation and amortization. Forecasts based on the next 12 months.

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