Memory sector: Broader server impact on DRAM ASP and earnings

Disclosures & Disclaimer This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it. Issuer of report: The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch View HSBC Global Research at: https://www.research.hsbc.com  We now expect DRAM prices to increase until end-4Q17e  2Q17 preview: anticipating better results thanks to the positive contribution of server DRAM (which is higher price and margin)  Reiterate our Buy on Samsung with new TP of KRW2.8m (from KRW2.6m) and Hynix with KRW86k TP (from KRW75k) Robust server demand should lead to a continuation in DRAM price increases. We reiterate our positive view on the memory sector as we now expect DRAM prices to continue to rise until year-end due to: 1) robust server demand from data centres; 2) still conservative capex implementation, and 3) slower 1xnm migration to limit output growth. Firm server demand, which is mainly coming from expansion of cloud service for artificial intelligence (AI) applications, is leading DRAM makers to allocate more capacity to server from mobile and PC, causing a continuation in supply shortage. We estimate server demand will outgrow the market with 46% yoy bit demand growth (versus 22% yoy industry), accounting for 38% of total DRAM demand by 2018e from 26% in 2016. Given higher margin profile of server, there is less reason to sell PC and mobile DRAM at a discount as long as there is strong server demand, so server is a leading indicator for overall DRAM price going forward. Also, there are less BOM costs since server customers are mainly higher margin B to B customers. 2Q preview: better due to greater server impact on earnings. At Samsung and Hynix, we expect 2Q OP to be 5%/6% better than our prior estimate at KRW13.5tn/KRW3.1tn, respectively, because of the positive impact stemming from the rising contribution of server DRAM. As the price premium of server relative to mobile and PC DRAM has expanded, its impact on DRAM ASP should be greater than we previously expected. Also, as server margin is the highest among DRAMs, its increasing contribution will accelerate margin expansion. This trend will continue throughout the year as we assume server will reach 40% and 30% of total DRAM sales at Hynix and Samsung, respectively, by 4Q17 (from 30% and 19% in 1Q17). For Samsung, better margin profile of OLED due to improved product mix to premium flexible will also help to generate better earnings. Reiterate Buy on Samsung with new TP of KRW2.8m (from KRW2.6m) and Hynix with KRW86k TP (from KRW75k) on earnings upgrade from greater impact of rising server DRAM contribution and valuation base rollover. We raise 2017/18e earnings for Samsung by 6%/8% and Hynix by 8%/14%, and also rollover valuation base to 3Q17-2Q18e for both to reflect the next one year of growth. With ROE rising, we view both Samsung and SK Hynix’s valuations as attractive. 28 June 2017 Ricky Seo* Semiconductor/OLED Analyst The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch rickyjuilseo@kr.hsbc.com +822 37068777 Kenneth Shim* Research Associate, Tech The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch kennyshim@kr.hsbc.com +822 3706 8779 * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Memory sector EQUITIES SEMICONDUCTOR Korea Key changes to ratings and estimates Current ______ TP________ __ Rating ___ Upside/ Company Ticker Currency price Old New Old New downside Market cap (USDm) 3m ADTV (USDm) Samsung Electronics 005930 KS KRW 2,415,000 2,600,000 2,800,000 Buy Buy 15.9% 278,293 439 SK Hynix 000660 KS KRW 69,200 75,000 86,000 Buy Buy 24.3% 44,428 158 Source: Bloomberg, HSBC estimates. Priced as of close at 27 June 2017 Broader server impact on DRAM ASP and earnings  EQUITIES ● SEMICONDUCTOR 28 June 2017 2 DRAM price increases should continue until end-4Q17 due to robust server demand We reiterate our positive view on the memory sector as we now expect DRAM prices to continue to rise until the end of 4Q17. We attribute this mainly to: 1) robust server demand from data centre segment, 2) still conservative capex implementation and 3) slower 1xnm migration to limit output growth. Stronger than expected server demand, which is mainly coming from expansion of cloud service for artificial intelligence (AI) applications, is leading DRAM makers to allocate more capacity to server from mobile and PC, helping supply shortage to continue. We estimate server demand will outgrow the market in 2017e, with 46% yoy annual bit demand growth (versus 22% yoy industry bit demand growth), accounting for 38% of total DRAM demand by 2018e from 26% in 2016. Since there is less reason to sell PC and mobile DRAM at a discount as long as there is strong server demand, which has higher