EQUITY UPDATE: Semiconductors: SemiCon West, Micron, and China

Semiconductors were one of the worst performing sectors last week on the back of escalating trade tensions.

Semiconductors: SemiCon West, Micron and China

Semiconductors were one of the worst performing sectors last week on the back of escalating trade tensions between the US and China. On Friday, the countries each enacted 25% tariffs on US$34 billion worth of goods, with President Donald Trump warning that similar action could be applied to an additional US$16 billion of Chinese goods in two weeks; ultimately going to US$550 billion if Beijing retaliated.

The first set of tariffs targeted 818 Chinese products which are central to President Xi Jinping’s Made in China 2025 initiative. Approximately 25% are technological parts, components, batteries and machinery which are crucial to the global technology supply chain. This should begin to impact many firms involved in manufacturing and selling finished high-tech products just as many companies are planning their ramp for the holiday season. Longer term, this could reduce capex and R&D in affected segments of the sector.

Another fear is that Beijing may retaliate against US firms doing business in China. This worry was manifested last week when the city of Fuzhou issued a preliminary injunction banning Micron from selling 26 of its products; including memory modules, drives, and memory chips used in graphics cards. This was the result of a lawsuit brought about by UMC and their Chinese partner claiming that Micron has violated intellectual property rights. While the impact on the US semi giant is small; accounting for approximately 1% of its annual revenue, it shows the vulnerabilities of American firms to the whims of the Chinese authorities. Additionally, Micron, along with Samsung and Hynix, are under investigation by the Chinese regulators for collusion in keeping chip prices elevated.

These negative short-term headlines are coming at a time when the medium-term fundamentals of the sector are very solid. Last week, the Semiconductor Industry Association (SIA), announced that global sales of semiconductors reached $38.7 billion for the month of May 2018, an increase of 21% y/y and representing the industry's highest-ever monthly sales. The President of SIA commented on the strength of the cycle noting that the, “global semi-market has posted consistent growth of greater than 20% for 14 consecutive months with year-to-year sales increasing solidly across all regions.”

Much of this increase in demand is coming from new market areas such as Artificial Intelligence, Internet of Things (IOT), Blockchain, Machine Learning, Autonomous Vehicles and smart electronics. This week SEMI, the semiconductor industry consortium, is hosting its annual conference, Semicon West, which will not only provide near-term comments from relevant companies, but this year, will focus on the growth potential of these revolutionary technological developments. Autos will be a big focus where adoption has been relatively rapid. According to SEMI, the fast-growing automotive chip market is driving dramatic changes in the IC market as they are turning towards simpler and lower-cost solutions to fit into their manufacturing platforms.

Another interesting event at the conference will be a White House-led panel of government officials which will outline a potential for America’s strategy to ensure that that the US remains the leader in global semiconductor R&D and manufacturing. This throw-back to the ‘80s when the US had an industrial policy to compete against the rise of Japan’s chip behemoths should make for interesting headlines.

The VFTP Thematic Model Portfolio holds a basket of Japan/Asia semiconductor names.

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