Look at direction, not speed, of chip earnings forecasts

Park Seok-hyun

The author is an equity strategist at Woori Bank WM Group.

Late-July earnings reports from U.S. Big Tech gave stock markets a lift. None of the four companies leading the expansion in artificial intelligence investment — Microsoft, Alphabet, Amazon and Meta Platforms — said it would cut spending. Three instead unveiled plans to increase capital expenditure despite concerns about overinvestment. Another encouraging development was stronger-than-expected results from AI-related investments, beginning to ease worries over returns that had lingered throughout the first half.

Korean and U.S. markets, however, have diverged. The S&P 500 resumed setting records in August, while the Kospi has remained weak after plunging in July. U.S. stocks have benefited from signs that companies driving AI investment can generate profits. In Korea, weakness in semiconductor shares, which led the market’s first-half surge, has weighed on the Kospi.

Big Tech’s commitment to continued AI investment is clearly positive for Korean memory chipmakers. Their shares nevertheless remain sluggish, apparently because of temporary supply-demand distortions in the stock market and a recent plateau in earnings forecasts.

The distortion affecting semiconductor stocks stems from an abrupt policy reversal involving single-stock leveraged exchange-traded funds, or ETFs. Because this is likely temporary, it should ease over time. The more important question is whether stalled earnings forecasts will continue to constrain chip stocks.

Market estimates for operating profit in the Kospi semiconductor sector this year and next stood at 175 trillion won and 184 trillion won ($123.6 billion and $130 billion) respectively, early this year. By early July, they had surged past 700 trillion won and 1 quadrillion won, a four- to fivefold increase. The extraordinary revisions reflected soaring memory demand, driven largely by massive investment in AI data centers and the resulting need for advanced memory chips.

Yet earnings forecasts have recently flattened despite continued AI investment. One reason appears to be resistance to sharply rising chip prices, prompting buyers and suppliers to expand long-term contracts that lock in prices and provide greater stability for both sides.

It will be difficult for Korean semiconductor earnings forecasts to rise as dramatically as they did in the first half. But a slower earnings trajectory is not necessarily bad news. Expanding long-term contracts make future profits more predictable, which should support valuations.

Samsung Electronics and SK hynix are trading at forward 12-month price-to-earnings ratios below four, leaving them extremely undervalued. The question now is whether greater certainty about future earnings can become the catalyst that finally allows their shares to escape that discount in the period immediately ahead.