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June 29, 2017

Is Semiconductor Producer SK Hynix Signaling a Slowdown in Memory?

by David Aurelio.

Break out semiconductors’ new liquid cooler systems because this sector is scorching hot. The Republic of Korea dominates one of the hottest markets in this space: memory production. This article takes a look at one of Korea’s pure play producers, SK Hynix Inc. (000660.KS), to find out if analysts expect the memory cycle to end in a flash.

Exhibit 1: SK Hynix Inc. Analyst Revision Model (ARM) Components

Sources: Thomson Reuters Eikon, Thomson Reuters StarMine

A Perfect Storm

A major shift in technology to 3D NAND is underway at a time when demand for memory is strong. Companies are reducing NAND and DRAM production to bring online and ramp 3D NAND. At the same time, some of the drivers of heavy demand for memory are — data center growth, artificial intelligence, autonomous driving, the internet of things, and an expected smartphone super cycle. 

Thomson Reuters’ Analyst Revisions Model (ARM) measures analyst sentiment by region with a 1 to 100 ranking, where 100 is the most bullish. SK Hynix’s ARM score of 91 places it in the top decile of Emerging Asia Pacific companies. Analysts are bullish that tight supply in conjunction with high demand will drive and sustain higher prices in both DRAM and NAND. Expectations for this perfect storm are reflected in high ARM component scores for Revenue (97), EBITDA (98), and EPS (98).

Exhibit 2: SK Hynix Estimate Revisions to Jun. 2017 Quarter.

Sources: Thomson Reuters Eikon, Thomson Reuters StarMine

Guarded Secrets

DRAM is essentially a commodity and represents over 70% of SK Hynix’s revenue. Companies with high exposure to DRAM are especially sensitive to pricing. DRAM production levels are heavily guarded secrets and historically the booms end due to over supply. However, this time management, equipment suppliers, and analysts agree that the increasing complexities of these processes require longer lead-times, especially in 3D NAND, which will keep the supply side in check. Additionally, consolidation in the industry also helps. This is particularly important in regard to concerns that new Chinese entrants could bring production on-line near-term.

These expectations for favorable supply and demand to remain intact are reflected in the consistent upward revisions to revenue, EBITDA, and EPS estimates for the current quarter, this fiscal year, and next fiscal year. This can be summarized in the blended mean change, which is the average change from the prior 7, 14, 30, 60, and 90 day mean estimates. For example, the blended mean change to EPS estimates for the June 2017 quarter is 6.6%.

Thomson Reuters SmartEstimate® is a weighted average of analyst estimates, with more weight given to more recent estimates and more accurate analysts. Our studies have shown that when the SmartEstimate® differs significantly from the consensus (IBES Mean), the Predicted Surprise accurately predicts the direction of earnings surprises or further revisions 70% of the time. When significant Predicted Surprise for revenue is also present for the period, the accuracy improves to 78%.

The EPS predicted surprise of 3.9% indicates that SK Hynix will see further upward revisions to Jun. 2017 estimates and/or report earnings above the current mean estimate of KRW 3,076 per share.

DRAM is heavily dependent on outlook which makes the positive predicted surprises for all three measures across both this fiscal year and next fiscal year particularly important. These indicate that upward revisions to estimates and/or guidance for these periods will follow.

Hot or Not Drama

In the semiconductor world, memory isn’t the area most associate with excitement and drama. However, the current environment is anything but dry. 

SK Hynix is in the center of a legal drama and bidding war for Toshiba Corp’s (6502.T) flash memory, which would help diversify SK Hynix from DRAM. The situation is heating up due legal opposition from contender Western Digital Corp. (WDC.O), which has a joint venture with Toshiba. You can find more details in this Reuters story, Toshiba misses self-imposed deadline for chip unit sale, sues Western Digital.

Finally, rival Micron Technologies Inc. (MU.O) is scheduled to report quarterly earnings after the Jun. 29 close. Micron’s report is highly likely to have a substantial impact on analysts’ outlook for SK Hynix and will likely result in revisions to estimates and recommendations. SK Hynix’s ARM scores and positive predicted surprises indicate that analysts’ will remain bullish; however, the only certainty is that tomorrow will tell if memory remains hot or not.

Download the full report here.

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