The authors are analysts of Shinhan Investment Corp. They can be reached at email@example.com and firstname.lastname@example.org, respectively. -- Ed.
Semiconductor demand will be negatively affected by the COVID-19 outbreak depending on duration, with: 1) suspended production in China disrupting value chains; and 2) consumption declining amid the spread of the virus into developed markets. In particular, concerns are rising over the impact of the outbreak on B2C demand for smartphones.
We expect DRAM makers to flexibly respond to demand concerns with supply cuts, rather than sticking to their initial plans for capacity expansion and output. Companies will continue to focus on reducing inventory levels, raising product prices and increasing earnings. Maintaining a conservative outlook on demand and waiting to increase supply until confirmation of demand growth will be the best strategy for chipmakers aiming to lower inventory levels and drive improvement in market conditions.
As witnessed in 4Q19 following the decline in demand from US-China trade disputes and US sanctions on Huawei in 2019, DRAM makers are fully capable of reducing inventory levels through the adjustment of supply in line with changes in demand. Theoretically, DRAM market conditions are expected to remain on an uptrend unless demand bit growth falls below supply bit growth driven by process migration (roughly 10% per annum).
Meanwhile, server chip demand has remained strong despite the COVID-19 outbreak, thanks to limited impact of value chain disruptions in China and little face-to-face interaction as a B2B business. Despite the outbreak, chipmakers have yet to see a dip in server chip orders from clients as inventory restocking continues ahead of expected price hikes. We are also picking signs of upward adjustment to server chip demand projections.
Server DRAM prices are forecast to jump more than 20% QoQ in 2Q20. In comparison, mobile and PC DRAM prices are expected to rise by5% QoQ and 10-15% QoQ, respectively.
Semiconductor market outlook based on three scenarios
Our base-case scenario assumes that semiconductor demand decreases in 1H20 but recovers in 2H20. Permanent loss due to the outbreak should cause overall demand to fall short of our original forecast. We recommend accumulating semiconductor stocks during the rise in market volatility, given: 1) limited downside risks backed by flexible supply cutbacks; and 2) forecasts for improvement in both BPS and PBR through 2Q-3Q20.
The best-case scenario assumes that semiconductor demand drops in 1H20 but records a V-shaped recovery in 2H20. Monetary and fiscal stimulus from various countries should help to prevent permanent loss in demand from the outbreak. With demand to recover amid reduced supply, stocks are expected to bounce back from short-term correction caused by the COVID-19 outbreak and continue on an uptrend. Sharp gains are expected for stocks that had led the market before the outbreak.
In the worst-case scenario, the outbreak's impact continues for a prolonged period with recovery in demand limited through 2H20. Monetary and fiscal stimulus fail to offset the impact on demand, leading to secondary shock (financial risks). Stocks as a whole should feel the impact in the worst-case scenario, but historical data points toward relatively steeper share price correction for semiconductor stocks in the short term.
Top picks: Samsung Electronics and SK Hynix
Semiconductor stocks will remain relatively attractive even after the COVID-19 outbreak, with: 1) strong B2B demand for server chips to continue; and 2) chipmakers capable of flexibly adjusting supply backed by solid market power. We favor large-caps over small/mid-caps in light of uncertainties in demand, and retain Samsung Electronics and SK Hynix as our top picks in the sector. By reducing supply in line with changes in market demand, large-cap chipmakers should be able to protect margins going forward. Smaller-cap equipment/materials suppliers typically find it harder to flexibly respond to changes in demand. Following overall market correction, however, we note that both large-and small-cap semiconductor stocks tend to move in the same direction.