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War on Huawei:
the losers … and the winners
Head of Global Equities
Jun 13, 2019
The US Commerce Department’s Bureau of Industry and Security announced on 16 May it was adding Huawei to an ‘entity list’ due to national security concerns – severely restricting US companies from doing business with the Chinese firm. In retaliation, China has threatened to create its own ‘unreliable entities list’ of foreign companies it believes may damage domestic businesses.
Following the US announcement, the stock market immediately started to discount the possible negative earnings impacts for those businesses forced to suspend activities with Huawei to comply with the new regulations.
For the whole month of May*, the major movers included:
* One-month performance in US dollars from 30 April to 30 May 2019.
The question arises as to whether these negative share moves are related only to the Huawei ban and the news flow surrounding the US-China trade war. In the case of Samsung, we would argue that the company’s announcement earlier this year that it would invest US$116 billion in non-memory chips until 2030 was the reason for initial weakness – and not trade war news flow. Investors are worried that this new long-term plan won’t work out, as it depends heavily on demand and market conditions – which are difficult to forecast given the strong competitive position of TSMC and Samsung’s current 19% market share in non-memory chips.
In fact, should the trade war intensify – for example, should the Chinese decide to ban all Apple products – Samsung could be a big winner over the short term. Any escalation may hurt global memory demand in the near term, but this would be outweighed by Samsung’s potential to gain smartphone market share, as well as further share gains in memory, display, networking equipment and other components.
Given that Samsung is attractively priced, we’ll continue to hold on to this name. Conservative gains in market share, as described above, could easily lead to a 20% increase in earnings estimates over the next 18 months, when the stock is trading on only nine times earnings today.
Taiwan Semiconductor – the world’s largest independent semiconductor foundry – is trading at an attractive 14 times estimated 2020 earnings per share. In contrast to others that have stopped interactions with Huawei or opted to remain silent on the matter, TSMC is one of the few companies to publicly state it would ‘not change [its] shipping practice for the time being’.
We believe TSMC’s decision was based on rigorous legal assessment and careful value evaluation. As a key supplier to Huawei, many worry that TSMC will suffer collateral damage – hence the current share price weakness. Should this negative share price trend continue and the stock drift towards US$35 from its current level of US$38, we are likely to invest in this name given its leading position in non-memory chips and its attractive valuation.
In the case of Google, we estimate a <1% impact on the company’s earnings even if very little revenues are generated from Huawei going forward. Google trades at an estimated 17 times 2020 earnings per share, with US$117 billion of net cash on the balance sheet. We’ll continue to invest in this business on behalf of our investors, given an estimated 15% earnings growth per annum over the next five years and the ability cut down on very heavy capital expenditures in the future, which will lead to even stronger cash flow generation.
In terms of other sectors affected by trade wars in general, we believe sectors like automobiles, machinery, metals and mining, and hardware are most exposed and at risk. Industries such as healthcare providers, information technology services, software and hotels are less at risk, since they’re less reliant on global supply chains. At Sanlam Private Wealth we don’t have exposure to the worst affected sectors in our funds and client portfolios. We’re overweight in some of the unaffected information technology sectors – with investments in Cognizant Technologies, Microsoft, Oracle, Sabre and Bookings Holdings.
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