In the last few decades, the way countries wage war has changed. The world has mostly shifted from traditional battles involving soldiers and tanks, to more sophisticated weapons - economic sanctions.

China's growing dominance in the chip manufacturing sector raised alarms in the US. In response, the US is trying to put the brakes on China's technological rise by imposing sanctions and bans on chip exports to China.

The chip war has led to cascading effects globally, creating supply chain issues. Most of the global manufacturing industries, including automobiles and mobile phones, faced chip shortages post-pandemic. As a result, the costs for specialized hardware jumped. The chip supply has now increased as Korea and Japan boosted their production, while countries like India are trying to create a chip manufacturing ecosystem from scratch, via incentives to manufacturers. 

In this week’s Analyticks:

• The chip war creates risk and opportunity: As China and the US clash over semiconductors, countries like India look to take advantage
• Screener: Stocks outperforming their sectors and Nifty 500, with high broker upside and increasing MF buying

Let’s get into it.

US, the dominant chip manufacturing country, defends its territory

The US has been at the epicentre of chip manufacturing since the early 1980s, with a market share of 50%, followed by Japan (40%). Over the years, the US has maintained its market share, and currently holds 48%. In contrast, Japan’s market share has dropped to 9%.

The US accounts for nearly $275 billion of the global market size of $574 billion. The country is home to technologically advanced chip manufacturing companies such as Nvidia, AMD, Intel, and Qualcomm, making it a powerhouse of chip technology. It is followed by China, which has rapidly caught up and now has a market size of $181 billion. 

Semiconductors are the fifth largest exports for the US, after refined oil ($146.2 billion), crude oil ($116.8 billion), natural gas ($96.5 billion) and aircraft ($93.8 billion).

When it comes to investment in chip manufacturing, the US spends nearly $50 billion in R&D, surpassing the combined spending of approximately $40 billion by the rest of the world.

The US Department of Commerce recently announced a $52.7 billion package in August 2022 to further strengthen its semiconductor industry. The US has also passed the CHIPS Act to increase chip manufacturing and counter the rise of Taiwan, South Korea, and China. 

These eye-popping investments in chip technology and its dominant position in the market give the US a strong bargaining chip. 

China wants to dominate chip manufacturing, by fair means or foul

The stakes are high in the semiconductor market - the significance of chips in electronic equipment cannot be overstated. Nearly 56% of chips manufactured worldwide are used to power computers and smartphones. While the assembly cost of a mobile phone is relatively low, the chip inside costs hundreds of dollars.

China has been trying hard to build its chip manufacturing capability and the US has previously accused it of cheating to do it. For example, Micron, a chip maker based out of the US, found itself the target of a heist by Chinese company Fujan Jinhua in 2018, when more than 900 confidential Micron designs and documents were copied onto USB drives and phones to be smuggled out of Micron's Taiwanese office. Chinese companies have also been found selling chip designs very similar to manufacturers like Samsung.

The US has reacted by hitting China where it hurts the most.  American restrictions on chip exports have slowed down China’s electrical and electronic manufacturing. China is the biggest exporter of electrical and electronic equipment in the world, and according to United Nations Comtrade, its exports in this segment was $955 billion in 2022.

By disrupting the chip supply, US will force China to move down the value chain in exports.

US companies control nearly 53% of China's semiconductor market, easily the biggest consumer market worldwide:

Although US chip manufacturers will lose access to the China market with the restrictions, the blow to China will be even greater.

The semiconductor value chain is dominated by the US, followed by Japan, South Korea, Taiwan and the Netherlands. These nations are more aligned with the US even though China is the biggest customer. Following the US, Japan and the Netherlands have also imposed export restrictions on high-end chips (below 14nm size). Companies like Intel, Foxconn, TSMC, NXP, and Qualcomm are increasingly moving their units out of China.

China is a big exporter of rare earth metals crucial for chip manufacturing. According to the US Geological Survey, China supplies over two-thirds of global rare earth metal consumption. So in retaliation, China this week imposed restrictions on the export of Gallium and Germanium, which are necessary for chip manufacturing. It has also banned chip manufacturer Micron and other US players from entering its market.

Why can’t China scale up without the US?

China’s retaliatory measures may impact US revenue in the short term, but in the long run, China is depriving itself of the free flow of technology.

The US has long expressed concerns about unfair trade practices in China. China has always spent less on R&D (7% of its revenue) compared to the US (18.75%), and is trying to take advantage of the US technology, via IP theft and copycat chips.

One key limitation for China is in advanced processor chips below 14nm. With the restrictions in place, China only has access to chips sized 14nm or greater. Even China’s largest chip manufacturer, Huawei, is limited to producing 14nm and above chips. Developing expertise on par with the US will take years.

The technology involved in the chip manufacturing process is controlled by a handful of companies. For instance, Advanced Semiconductor Materials Lithography Holding (ASML) based out of the Netherlands has a 100% market share in advanced lithography tools used for chip manufacturing. Taiwan’s TSMC (Taiwan Semiconductor Manufacturing Company) controls 90% market share for advanced processor chips (5nm and 7nm chips) used in smartphones and computers. The few companies which purify the metals needed for chip manufacturing are located in Japan, a US ally, and the US.

The restrictions imposed by the US, Japan, Netherlands and Taiwan will significantly slow down China's participation in the AI and smartphone race.

India is pushing hard to overcome its challenges in chip manufacturing

The Indian semiconductor market is expected to reach around $55 billion by 2026 and $85 billion by 2030, a big jump from the current $27 billion. Currently, India relies on imports to fulfill nearly 90% of its semiconductor requirements. However, the recent trade war and supply chain issues have highlighted the need for domestic chip manufacturing. The Indian government is trying to incentivize chip manufacturing by allocating Rs 76,000 crore to the sector.

As a late entrant to the industry, India faces multiple challenges. Chip manufacturing requires skilled labour,  ultra-specialized software (which is usually licensed), and precise machine tools to lay down thin films of semiconductors (where thickness is measured in atoms). India currently lacks the necessary infrastructure and access to such processes and systems.

Investments in chip manufacturing run into billions of dollars, while the market size is only around $27 billion. This has been a major barrier for Indian manufacturers. Ideally, an Indian player should partner with a technological provider to scale up operations. Vedanta-Foxconn is currently the only such proposal on the government’s table. However, the JV is still looking for a suitable technological partner that could license them with 28 nm chip technology. 

In a positive development, Micron has announced a $2.5 billion investment in India for chip manufacturing. UK-based SRAM & MRAM has also pledged a Rs 30,000 crore investment for a semiconductor fabrication unit in India.

These investments also align with the China +1 policy, where global companies are finding alternate manufacturing locations to reduce their dependence on China. India needs these foreign firms to establish plants,  source raw materials from China, and drive exports.

While building the industry from the ground up is a difficult task, it's not impossible. India's journey toward chip manufacturing will require coordinated effort, strategic partnerships, and a robust ecosystem. It has the potential to emerge as a significant player in global chip manufacturing if it manages to beat these early roadblocks.

Screener: Stocks outperforming their sectors and Nifty 500, with high broker upside and increasing MF buying

As the Nifty 50 and Sensex hit record highs, we take a look at the outperformers. This screener shows stocks that have outperformed their sectors and the Nifty 500 in the past month, with more than 20% upside in the broker target price, and with mutual fund holdings increasing in the past two months.

The screener has 11 stocks from the Nifty 500 index, including Suzlon Energy, Shyam Metalics & Energy, Kennametal India, Piramal Pharma, KPR Mill and Star Health & Allied Insurance.

Suzlon Energy has grown 66.4% over the past month, outperforming the Nifty 500 by 61.7 percentage points. The stock has an average broker target price upside of 20.2%. According to ICICI Securities, the general industrials company is well-positioned to take advantage of policy changes in the industry after booking orders worth 750 MW for its newly launched 3 MW turbine. However, the stock has been volatile over the past decade due to low industry volumes and high debt after the acquisition of Repower in 2008.  

Shyam Metalics & Energy comes in next with a 17.6 percentage point outperformance of the Nifty 500. The metals & mining company also has the second-highest average broker target price upside of 58.1%. ICICI Securities predicts growth in revenue driven by increased volume of aluminium foil and LC ferrochrome, and growth in rebar sales despite weak demand. 

Piramal Pharma has risen 11.4% over the past 30 days, outperforming the Nifty 500 by 6.7 percentage points. The pharmaceuticals & biotechnology stock has the highest average broker target price upside of 111%. Motilal Oswal expects growth in sales in the medium term owing to rising purchase orders in the contract development and manufacturing operations (CDMO) and complex hospital generics (CHG) segments. 

You can find more popular screeners here.

Signing off this week,

The Trendlyne Team