Who Wins And Who Loses With China's Metal Restrictions
It is no secret that the trade wars between the United States and China have only intensified over the past several months, with escalations being explicitly made on the chip and semiconductor front. Whoever controls the patents and supply chain to the latest chip-making equipment and technology will likely gain a preferred spot in global trade, as many everyday consumer products require a vast array of chips to be available.
In early July, Chinese officials dealt their latest hand in the conflict, restricting certain exports of critical metals necessary to manufacture chips and semiconductors, further dividing the battlefield into U.S. and China supporters.
Gallium and germanium are two raw materials needed to manufacture chips and semiconductors. China is the world's largest producer, controlling up to 94% of the global gallium supply and 83% of germanium. In today's semiconductor industry, the landscape is the most divided into companies looking to expand their manufacturing footprint in the U.S. versus those looking to invest in the Southeast Asian region.
An excellent example of this dynamic can be Intel (NASDAQ: INTC). This company has dedicated several billion of its free cash flow to building Ohio and Arizona fabs. This move clearly states where the company's geopolitical loyalties lie. On the other hand, Micron Technology (NASDAQ: MU) has announced a nearly $2 billion investment to build fabs in China, setting the firm up on the opposite end of the battlefield.
Considering that geopolitical standings between the two nations will likely play an influential hand, as far as which firms get preferential treatment with these export restrictions, it would be wise for investors to begin diversifying some of their risks. Micron stock has outperformed Intel by as much as 53.8% as of May 2023, whereas today, it still outperforms by 20.2%.
These initial performance gaps can be an initial gauge of what markets are perceiving concerning the future of the two companies, especially amid these challenging developments, which could cost either name a ton in margin levels.
Market perception may be another gauge into the future perception of sales in these two names; considering that earnings per share have been somewhat shaky in the past few months, investors can begin to value these chip manufacturers based on their current and future sales.
Based on today's sales numbers, Intel stock trades at a price-to-sales multiple of 2.8x, significantly below Micron's 3.8x. A similar thread begins when investors take the following twelve-month sales expectations, as Intel trades at a price to forward sales multiple of 2.9x, which is once again lower than Micron's 3.9x.
Some may argue that this only makes Micron the more expensive alternative in the chip war battlefield; however, these valuation multiple differences can be taken as a subtle hint regarding the expected direction of the two stocks. By valuing Micron sales above Intel's, the broader market is essentially implying a higher quality in the underlying sales, and thus willing to pay a higher premium for them when compared to Intel's.
Markets are pricing in the possibility of these export restrictions driving input costs up for Intel and, consequently, down for Micron based on its support for Chinese fabs. This scenario would significantly drive the two firms' gross and net margins apart.
Tailwinds and Headwinds
Investors can diversify their geopolitical risks by investing in both companies, exposing themselves to the possibility of one region's industry rising over the other or an amicable resolution benefitting both of these companies. Considering that the American economy is positioned to face a couple more rate hikes for the remainder of 2022 and a FED tightening the country's money supply like never before, Intel has yet another problem to worry about.
Conversely, Chinese officials seek to stimulate their respective economies with new packages, especially after economic activity measures like the Caixin PMI post lackluster figures.
Micron analyst ratings are pointing to a consensus 19.6% potential upside from today's prices while also posting a top-side price target of $100 per share, which would translate to a 63.3% upside ceiling.
Conversely, Intel analyst ratings are all agreeing on a potential downside of 4.1% from today's prices, which may reflect the same concerns that hover investor's minds today. Only time can tell how and when these geopolitical developments will affect the industry; all investors can do is diversify and hope for the best scenario to play out.