Jahanara Nissar

Semis had been sailing smoothly for a little over a month until yesterday when the sector ran into a spot of rough weather. Back-to-back squalls had the Street running for cover. Two separate headlines drove semis – ASML down 16% and NVDA down 4% dragged the sector down and forced the bulls to revisit their thesis. Rather than go for a diffuse over-arching negative thesis, we’ll attempt in the following our thoughts on pointed reasons for the headlines and how to trade the volatility.

From a trading perspective, 1) we look to buy the sell-off in AMAT/LRCX following the ASML earnings release, 2) we would not dismiss the NVDA-related media story yesterday speaking to country-specific export caps, we think this story could develop further resulting in NVDA coming under pressure and 3) as for TSM, until the AI export policies are clarified we think it prudent to stay on the sidelines.

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ASML – what happened? In an unexpected pre-release of the earnings packet, the company lowered its revenue outlook for 2025 from €30b-€40bn to €30b-€35bn due to 1) largely expected lowering of revenue contribution from China to 20% vs. 2024 contribution running significantly higher and 2) of much higher concern to the Street, demand push-out of EUV tools due to slower ramp of new nodes at ‘some’ logic foundry customers. No prizes for guessing who is being referred to as ‘some’.

ASML – China export risk – our view: There is some concern in the semicap circles that in the waning days of the Biden administration, more onerous export restrictions could be imposed on the industry. Having said that, we think ASML has had incremental China risk vs. US-based peers. Based on statements from AMAT and LRCX, we think US-based firms have already de-risked export control risks in large measures. Non-US based vendors such as ASML and TEL have pushed back against US pressure for much of the year. Until now. A month ago, it was reported in the media that the Dutch government had imposed new export controls on ASML thereby aligning itself closer to US export policy. We think the large-sized cut in ASML’s 2025 China exposure disclosed by the company yesterday is in response to the new export policy handed down by the Dutch government.

Meanwhile, AMAT and LRCX have already been hewing closely to US government policy, and therefore their incremental risks to further export restrictions may be limited. In this regard, the sell-off in AMAT and LRCX yesterday may have been excessive.

ASML – Advanced logic risk – our view: We think the ‘delayed timing of EUV demand’ is related to INTC. Should this be a surprise to investors? We have been down this road after Intel announced a capex cut at its Q2 earnings call.  We take the view that a significant portion of the ASML miss is due to Intel delaying EUV demand. And just as we did the last time around (link) we will take the view that outside of ASML, the other major semicap names had already dialed out contribution from INTC. We think AMAT/LRCX offset weakness at INTC by strength at TSM wafer foundry and packaging.

Semicap – Net/Net: After the vol subsides, we will be buyers of AMAT and LRCX. But just so that there are no further surprises, we would wait for a few more weeks and get past the US election, before backing the truck up.   

NVDA – what happened?   Bloomberg put out a negative article pre-open, causing NVDA and AMD to sell-off at market open. The article, quoting unnamed sources, reported that the Biden administration was looking to cap sales of advanced AI chips from NVDA and other companies on a ‘country-specific’ basis, to countries beyond China.

This is not the first time this such an idea has made it to the tape. On previous occasions, due to the lack of follow-through from official government sources, the Street shook off the news. However, this time we would not be quite so sanguine. We would not rush in to buy the dip. If confirmation were to emerge from official government sources NVDA could see further downside.

That there is a common theme to the export controls the US government is seeking to slap on export of semicap equipment/consumables and of advanced AI chips cannot be denied – both categories of export controls have a national security angle to them. In the waning days of the Biden administration, it is possible that government agencies are making one last ditch effort to leave a permanent impact; it would be months before the next administration would be in place to make a similar effort, if at all.

NVDA – some questions: We think the key to framing the downside risk lies in assessing which countries could fall under the export capped status. If the targets countries are the Middle East countries mentioned in the Bloomberg article, there may not be much to worry about given NVDA’s low exposure to said countries. But what if countries ranking higher on the revenue exposure scale are under review by the government?

As per NVDA’s latest 10Q, on a 6-month basis, Taiwan and Singapore each account for ~17% vs. the US accounting for 46%. Nearly 90% of NVDA sales in the two most recent quarters are in the data center sector. One infers there is a whole lot of data center GPUs headed to Taiwan and Singapore, countries which do not have the kind of export controls China is subject to.

Combining the revenue contribution from Taiwan, Singapore and China adds up to the contribution from US-based customers. Unlike commodity CPUs, NVDA’s AI GPUs are mostly done direct-to-customer. There isn’t much of a mystery as to who are the direct customers in the US. But who are the direct customers in Taiwan and Singapore? Are there new data centers being built in either of these two countries?

NVDA – Net/net: Is it possible that the countries which could face export caps for advanced AI chips are Taiwan and/or Singapore as opposed to countries in the Middle East the Bloomberg story seems to speculate? If the US government could place pressure on friendly nations such as The Netherlands and Japan to prevent technology leakage of silicon fab equipment, why couldn’t the US government place pressure on friendly nations such as Taiwan and Singapore to prevent leakage of advanced AI chips to China? If indeed it is Taiwan and/or Singapore that the US government is considering putting export cap on, then the risk to NVDA’s revenue could be considerable. Until the identity of the countries facing export caps is understood from official sources, we think it may be unwise to step in and buy the dip.

TSM – thoughts into print: The narrative out of TSM is largely anticipated 1) further pull-in of CoWoS capacity spending in order to support extraordinary demand from AI and 2) unchanged and muted demand from end markets outside of AI. The stock ran up into print in the expectation of 2024 revenue beating the previous guidance ‘modestly above mid-20s’ now running perhaps closer to 30%.

In order for the stock to make a new high, TSM management needs to 1) provide a qualitative view into 2025 and/or 2) raise the 5-year for AI revenue above the 50% CAGR outlook provided at the March’24 earnings call.

TSM – Net/Net: Rather than TSM being a bellwether for semis like it used to, given the outsized influence of NVDA, TSM may be under the gravitational pull of NVDA. Negative headlines for NVDA, like the one yesterday, are likely to weigh on TSM as well. While we are comfortable with our NT$1250 PT, we are not looking to add to position until there is some improvement in the traditional end markets. For now, we will stay on the sidelines.

• KC Rajkumar