Nvidia-related chips increase profits eightfold

SK Hynix was a stock selected from our broker’s update screen earlier this week.

Innovation in the semiconductor industry does not always occur along obvious lines.

AAA rating Nvidia (US: NVDA), for example, developed its GPUs for the gaming industry before noticing that researchers in California were using them in artificial intelligence projects and eagerly seizing the opportunity. Development of High Bandwidth Memory (HBM) chips by AAA rated Korean company SK Hyniks (KR:000660), meanwhile, they also only had niche gaming apps until they started getting stuck next to Nvidia’s graphics processing units (GPUs) for artificial intelligence.

“Hynix has been investing in HBM chips since 2013; which has given them an advantage over competitors, especially Samsung Electronics, which is still in the testing phase with Nvidia but supplies Advanced Micro Devices,” said elite investor Michael Burke, who owns Hynix in his M&G Global Emerging Markets fund.

Hynix’s leadership in HBM chips looks like it could be very profitable. Yet even after rising 85% over the past year (and 44% since we first flagged the ratings surge in January), its shares are valued at just 8.2 times projected earnings for the next 12 months.

Meanwhile, HBM orders are flooding, quickly raising earnings forecasts.

The orders will account for all of HBM’s capacity through 2025 from Hynix, the world’s second-largest memory chip maker.

“There is a risk of bottlenecks on both the production side and the end-customer side as Nvidia customers try to build large server farms to deploy AI capabilities,” Bourke said. “Without a doubt, the development of artificial intelligence is a huge driver for the memory industry and will take years to realize.”

Including Bourke, a total of eight elite investors own Hynix shares, each ranked in the top 3% of the 10,000 global equity managers whose investments are tracked by Citywire. Significant smart money backing puts Hynix in the top AAA elite rankings.

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Sources: Citywire/Morningstar, latest holdings.

On the heels of Hynix

Although HBM is much more expensive than conventional memory, it offers greater capacity, faster data access, and improved power efficiency. These features are ideal for the huge volumes of data that need to be analyzed and stored when running AI programs.

Only two other companies make HBM chips: AAA-rated American memory specialist micron (US: MU) and AAA-rated Korean electronics giant Samsung Electronics (KR:005930). However, Hynix is ​​at the cutting edge, which puts it in a prime position to capture the most lucrative business from large AI clients.

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

He said: “We think it’s only a matter of time before Samsung catches up with Hynix, especially since Nvidia has said it wants Samsung to get the spotlight to reduce Hynix’s dominance and ultimately lower HBM prices.” Samsung is also the only industry player that has the balance sheet capacity to invest in manufacturing capacity.”

Fabs are multi-billion dollar semiconductor manufacturing plants.

Bourke recently cut his stake in Hynix after big profits, while adding to the laggard Samsung.

However, a recent development agreement between Hynix and a leader in advanced AAA-rated chips Taiwan semiconductor manufacturing (TW:2330) – TSMC for short – can help extend the life of the HBM manual.

As chip miniaturization reaches its physical limits, intelligent integration of different chips is expected to become more important to increase computing power. TSMC has experience making GPUs but not memory, while the opposite is true for Hynix. This makes them a great potential contender.

Bad memories

While HBM chips offer exciting opportunities, Hynix’s traditional Dram and Nand memory chip business has been in dire shape since 2018.

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

But in the first three months of 2024, there is light at the end of the tunnel. In addition to demand for HBM, rising selling prices in dram and nanda, and a positive reversal in inventory estimates, the company reported an operating profit of 2.9 trillion won and an operating margin of 23% for the first quarter.

The company is confident that the recovery in its fiercely cyclical market has finally begun and is expected to accelerate in the second half of the year.

Brokers forecast that net debt, which reached 24.3 trillion won ($17.4 billion) at the end of 2024, will decline quickly and leave the company with net cash by the end of 2026.

Meanwhile, there are some early signs that AI-enabled phones and PCs could spark a massive upgrade cycle that will boost demand. The server market could also see a tailwind as machines purchased during the 2017-18 cloud spending surge are upgraded.

Meanwhile, industry-wide capacity constraints could add to pricing pressure after a period of low investment from struggling memory chip makers.

Stuck in the middle

With most of its production in China, as well as 31% of its sales and 24% of its assets, Hynix is ​​on the brink of a US-China chip war.

There have been rumors about a possible sale of the company’s assets from China, including its Dalian factory, which it bought from Intel for $9 billion in 2020. Hynix denies this.

There have also been reports that the company is storing old equipment to prevent it from falling into the wrong hands if it is sold.

On the other hand, memory chips are generally considered less politicized than logic chips such as GPUs and central processing units (CPUs). Korean companies also received an indefinite exemption from the ban on imports of semiconductor manufacturing equipment from the United States.

The politicization of silicon could benefit from incentives offered to chipmakers, including the $39 billion US Chip Act, the South Korean government’s new $19 billion support package, and China’s recent $47.5 billion increase to its “Big Fund”.

Political risks are extremely difficult to quantify, but a lot may already be priced in.

For example, Micron, which has less exposure to China and whose shares have also soared on hype over HBM chips and the broader recovery in the memory market, is valued at 21 times forecast earnings, compared with Hynix’s eight times earnings.

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