Global Chip Shortage Engulfs A Growing List Of Tech Players

We have noted in recent reports the heavy toll that chip shortages are inflicting on the auto sector. S&P Global Ratings believes the effects are broadening, disrupting the supply, operations, and prices of the smartphone and PC makers, and also the semiconductor firms that rely heavily on contract suppliers. We believe chip shortfalls will be the major variable affecting the revenues and profits of key global entities that we cover, for at least the next 12 months.

Chip shortages have so far been mainly about power management integrated circuits (ICs) and driver ICs. Firms outsource production of the chips to older fabs to control costs. And as these older fabs already operate at a high utilization, they have less flexibility to meet sudden surges in demand. These chips are used in everything from smartphones to automobiles.

Chip demand has exploded. This is driven by working-from-home arrangements, rising interest in chip-intensive electric vehicles, the rollout of 5G cellular services, automation trends, and the like. Our economists have also noted the tendency of people to replace their use of offline services with the consumption of goods during the pandemic. For example, instead of eating at a restaurant, people may buy a new iPad (see “Asia, We Have A Demand Problem,” Feb. 4, 2021).

The chip shortage may cap the revenue growth of some PC and smartphone makers, and impede their ability to capitalize on surging consumption. Chip vendors also need to manage rising costs as fabs increase prices amid a surge in demand for their services.

We expect chip vendors to be able to largely pass on these higher costs to customers. Original equipment manufacturers that are unable to procure sufficient components to meet orders for their products may feel more pain.

The issue is most severe in the auto industry. Many carmakers have announced factory shutdowns and prioritized production based on an entity’s ability to procure critical parts.

However, other sectors are now also getting squeezed. Some smartphone manufacturers and even some home appliance producers in China are reporting production issues related to chip shortages.

Recently Qualcomm Inc. acknowledged that its output was not meeting demand, hitting Android phone makers such as Xiaomi Corp. that rely on Qualcomm’s chips and modems.

Our base case is that the spike in demand will ease in the second half of 2021, returning the supply chain to equilibrium. However, there’s always a chance that demand does not abate or that a fresh supply shock could trigger yet more acute shortages.

This was illustrated by the sudden shutdown of Texan fabs operated by Samsung Electronics Co. Ltd., Infineon Technologies AG, and NXP Semiconductors N.V. when power failures rolled through the state in February 2021. The March closure of a Japanese fab operated by Renesas Electronics Corp. due to a fire outbreak was another example.

Broad Demand Keeps Semiconductor Firms At High Utilization

In semiconductors, strong demand and high utilization will lift revenues and margins, in our view. Demand is broad, with strong orders coming from high-performance computing, autos, and communication, etc. This is across technology nodes–both mature (28 nanometers and above) and advanced (14 nanometers and below). Good revenue growth should help to offset high capital expenditure (capex) to expand capacity.

Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC):  TSMC will continue to benefit from strong demand for its leading-edge process technology, in our opinion. The firm’s revenue and EBITDA should grow strongly in 2021 as it aggressively adds capacity.

TSMC is also likely to further outpace rivals with its cutting-edge process technology, and therefore expand its market share in 2021. The entity has made huge investments in technology nodes below 7 nanometers. We do not expect TSMC’s enormous capital spending budget of up to US$30 billion for 2021 to materially weaken its capital structure, given its strong EBITDA growth. TMSC generated NT$901.3 billion (about US$30.6 billion) in EBITDA in 2020.

Semiconductor Manufacturing International Corp. (SMIC):  The recent chip shortages will likely encourage the Chinese government to support its semiconductor sector. SMIC stands to be a prime beneficiary. Strong demand is bolstering the company’s utilization rates and its average selling price per wafer.

Nonetheless, the U.S. government has placed critical export restrictions on SMIC. This has created key supply chain risks. If the U.S. semiconductor equipment suppliers are unable to obtain export licenses to sell to SMIC, the company could face significant disruption to its operations, which is why we have a negative outlook on our rating on the company.

Renesas Electronics Corp.:  Renesas is likely to miss out of some the strong demand coming up in the auto and industrial sectors because of a fire in its core Japanese factory in Japan in late March 2021. We estimate that the company’s 2021 operating profits could decline by 15%-20% year on year given the lost sales.

Renesas estimates that it will return to pre-fire production levels in about one month. The customized nature of Renesas’ products will make it harder for its customers to quickly switch to other suppliers. At the same time, industry shortages should lift chip prices.

Our ratings on Renesas remain on CreditWatch with negative implications, but this mainly due to its plan to acquire Dialog Semiconductor PLC, which could significantly increase Renesas’ leverage.

Memory Sector Set For A Bullish 2021

Memory players are seeing tighter supply for dynamic random access memory (DRAM) given the robust demand across all end markets and relatively disciplined capacity expansions in recent years. This should support prices over the next several quarters and lead to good industry growth and profitability in 2021.

SK Hynix Inc.:  We expect SK Hynix’s operating performance to be strong over the next 12 months. Demand remains robust for its products, and component shortages have not hit the group much. Mobility restrictions rolled out to control the pandemic have sharply increased demand for computers, and for the servers used in data centers and by cloud-service providers. This has helped entities such as SK Hynix, which make the DRAM and flash memory chips (known as NAND) that feature heavily in these goods.

Despite its high capex and its planned acquisition of Intel’s NAND business, Hynix should maintain robust financial metrics. We assume the firm’s debt-to-EBITDA ratio will fall within 0.4x-0.9x over the next two years. This underpins our positive outlook on our ‘BBB-‘ rating on the company.

Micron Technology Inc.:  Micron’s outlook on both the DRAM and NAND segments continues to improve. A more positive global economic outlook drives strong demand across most of Micron’s end markets including enterprise, cloud, desktop PCs, mobile, autos, and industrial.

Micron commented in a recent earnings call that it sees severe shortages for DRAM. The biggest DRAM makers have been conservative in their capex in recent years. Average selling prices are rising and should remain strong over the next 12 months, improving Micron’s profitability. We expect the company to generate strong sales and positive cash flow over the next several quarters, supporting our rating on the firm.

Disrupted Smartphone Makers Focus On Inventory Management

Smartphone makers are at the painful end of this chip shortage. They face production disruptions and sales that are capped by the limited availability of key components.

This is particularly the case for Android-based entities such as Xiaomi, Samsung, and Lenovo Group Ltd. This is largely due to shortages at Qualcomm, which lacks sufficient power-management ICs needed for its system-on-a-chip products. Samsung has also had reduced foundry capacity following power outages at its plant in Austin, Texas. The shortages have been particularly acute for low- to mid-end smartphones as Qualcomm prioritizes production of components that use its highest-end chips.

If smartphone makers do not manage the chip crunch well, they may lose market share. The setbacks are surely frustrating. The entities would otherwise be ideally positioned to capitalize on surging demand as 5G rolls out, and as Huawei loses smartphone share following U.S. export controls on the firm.

Xiaomi Corp.:  Semiconductor supply shortage may slow Xiaomi’s revenue growth. The supply of key components to its hardware businesses, including smartphones and internet-of-things products could be strained. This could moderate the company’s recent market share gains.

We believe Xiaomi will work closely with component providers and prioritize production of flagship smartphones, to maximize profits and branding benefits. Xiaomi’s working capital is likely to become more volatile, since the company may increase its store of key components (as measured by inventory days) and secure future supply with additional down payments. Nonetheless, Xiaomi’s deep net cash position and free operating cash flow that we estimate at Chinese renminbi (RMB) 7 billion-RMB10 billion over the next two years should support our rating on the firm.

Samsung Electronics Co. Ltd.:  Samsung could experience some manufacturing disruption in its smartphones due to chip shortages in the next few quarters. However, we believe the company will maintain a solid operating performances in 2021 owing to its well-diversified business portfolio and strong standing in the memory chip and home appliance businesses. We also expect Samsung to somewhat benefit from the recent exit of its domestic competitor, LG Electronics Inc., from the mobile-phone business. The smartphone segment represented 30% of Samsung’s operating profit in 2020.

PC Makers Should See Second-Half Sales Uplift

The chip shortage has had a limited effect on PC manufacturers such as HP Inc., Dell Inc., and Lenovo given their strong relationship with chip suppliers and inventory buildup of key components. That said, these companies are experiencing display and chip shortages, limiting revenue upside despite strong work-from-home demand.

Lenovo Group Ltd.:  We expect Lenovo to continue to capture strong PC demand for most of 2021. We recently increased our PC shipment assumptions to 8% growth in 2021, from a previously flattish assumption. Stronger PC sales should boost the company’s profitability (and increase cash flow this year. PCs are Lenovo’s most profitable segment. This will help the company deleverage, and support our stable outlook on our ‘BBB-‘ rating on the firm.

Dell Inc.:  In our view, chip shortages will only minimally affect Dell, and then mostly in the lower-value products such as driver ICs, power ICs and microcontrollers. Dell’s large scale gives it leverage with suppliers, minimizing procurement shortfalls. We expect strong PC demand to continue through at least the first half of 2021. We also anticipate that Dell will meet its component needs given its significant purchasing power across PCs, servers, and storage segments. In our opinion, Dell will be able to mostly pass on higher component costs to its customers. We currently have a stable outlook on our ‘BB+’ rating on Dell. The potential spin-off of VMware Inc. may possibly improve its credit metrics.

HP Inc.:  While component shortages may limit some growth temporarily, we expect HP to be a beneficiary of resurgent PC demand. The firm’s consumer-oriented units should do well in 2021. The company has experienced strong growth in unit sales amid tight supply conditions. This has resulted in a growing order backlog.

HP should retain a strong share of global PC markets, particularly as supply chains normalize.

HP’s PC profitability should continue to benefit from growth in higher-value categories such as premium computers and gaming units. This should offset the thin profits it gets on low-end Chromebooks, a booming but low-margin business. While HP is experiencing a renaissance in PC demand, its free operating cash flow should be somewhat stable. At the same time, the company is revising its printer hardware revenue model, which may lead to some market share erosion.

Related Research

• Global Semiconductor Shortages Could Chip Away At The Auto Sector’s Recovery In 2021, Feb. 10, 2021
• Asia, We Have A Demand Problem, Feb. 4, 2021