SK Hynix ( KS) DRAM market to enter Goldilocks phase. Technology. Buy. Results Comment

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1 ( KS) DRAM market to enter Goldilocks phase Technology Results Comment (Maintain) Buy Target Price (1M, W) 3, Share Price (1/3/13, W) 3,85 Expected Return 31% OP (13F, Wbn) 3,399 Consensus OP (13F, Wbn) 3,98 EPS Growth (13F, %) TTB Market EPS Growth (13F, %) 17. P/E (13F, x) 8. Market P/E (13F, x) 11. KOSPI,59.58 Market Cap (Wbn) 3,33 Shares Outstanding (mn) 71 Free Float 77.3 Foreign Ownership.7 Beta (1M) Week Low (W) 3, 5-Week High (W) 35, 1M M 1M Absolute Relative Share price KOSPI 1/1 /13 /13 1/13 Daewoo Securities Co., Ltd. Semiconductor James Song james.song@dwsec.com Joon-ho Jang joonho.jang@dwsec.com What s new: Record 3Q earnings attest to strong crisis management capability Record-high 3Q13 earnings: delivered historic-high results for 3Q, posting revenue of W.8tr (+% QoQ, +9% YoY) and operating profit of W1.1tr (+5% QoQ; turning to profit YoY; OP margin of 8.5%). In 3Q, EBITDA margin was %, and cash holdings rose to W3.1tr. DRAM shipment inched down % QoQ, but NAND shipment grew 11% QoQ. DRAM ASP rose 5% QoQ, while NAND ASP fell % QoQ. Wuxi fire crisis management: What makes the 3Q record results more impressive is that the company managed to do so amidst the Wuxi fab fire. In particular, the chipmaker s decision to slash capacity for less-profitable NAND and ramp up DRAM production at its M1 line proved to be a smart move. Also, the company reduced its inventory assets to W1.15tr in 3Q from W1.tr in Q, taking advantage of the rally in PC DRAM prices. Catalyst: V-shaped earnings recovery in 1Q1; Soft landing for DRAM price Q13 forecast: Management aims to resume operation of the Wuxi fab by the end of November, but hinted that the delivery of certain equipment could be delayed. As such, a temporary deterioration in Q earnings appears inevitable. However, given management s guidance for Q DRAM bit growth (negative low-1% level), we believe the chipmaker will aggressively push ahead with: 1) DRAM production at the M1 line, ) continued inventory reductions, and 3) nm process migration. We thus expect decent Q earnings, with revenue of W3.tr and operating profit of Wbn. Raise 1Q1 estimates: There are widespread fears that DRAM prices will fall once the Wuxi fab comes back online. However, it should be noted that industry capacity growth will be limited. 1) plans to convert DRAM capacity at its M1 line to NAND immediately after the normalization of the Wuxi fab. ) It is also believed that Samsung Electronics (SEC) capacity addition (an estimated 3, wafers) will mostly be mobile DRAM for the company s internal demand. As such, we expect to display a V shaped earnings recovery in 1Q1, generating revenue of W3.9tr and operating profit of W985.bn. Valuation: Revise up 1F OP to W.tr, and raise TP by 13% to W3, Raise 1 estimates: We believe the global DRAM market is set to enter a Goldilocks period in 1, driven by: 1) minimal capacity expansion, ) inventory depletion following the Wuxi fab fire, and 3) increasing technological challenges of process migration. During this period, DRAM prices should become less volatile than before. We thus raised our 1 revenue projection to W1.7tr (+17% YoY) and our 1 operating profit estimate by 11% to W.tr (+9% YoY, OP margin of.3%). Lift TP to W3,: Currently, the stock is trading at 13-1F P/Bs of 1.95x and 1.9x, and 13-1F P/Es of 8.x and.3x, respectively. In comparison, Hynix s biggest foreign rival, Micron, is currently valued at US$18.1bn, or a 13F P/E of 15.5x. In light of our 1 upward earnings revisions and the upcoming Goldilocks phase for DRAM makers, we lift our target price on by 13% to W3, (1F P/B of.x) from W38,. FY (Dec.) 1/1 1/11 1/1 1/13F 1/1F 1/15F Revenue (Wbn) 1,1 1,39 1,1 1,38 1,7 17,939 OP (Wbn), ,399,389,1 OP Margin NP (Wbn), ,5 3,5 3,5 EPS (W), ,7 5,55 5,189 ROE P/E (x) P/B (x) Notes: All figures are based on consolidated K-IFRS; NP refers to net profit attributable to controlling interests Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S. PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES & DISCLAIMERS IN APPENDIX 1 AT THE END OF REPORT.

2 3Q13 earnings release feedback DRAM market to enter Goldilocks phase During its 3Q13 earnings call, stated that it aimed to resume operation of its Wuxi fab by the end of November, but hinted that the delivery of certain equipment could be delayed. Factoring in the DRAM capacity increased at the M1 line (an estimated, wafers), we expect DRAM capacity to decline roughly % in Q compared to pre-fire levels. Management guided respective Q DRAM and NAND bit growth in the negative low-1% level and negative mid-1% level. We thus expect the company to unload further inventory in Q to capitalize on soaring DRAM prices. The chipmaker s inventory assets declined to W1.15tr in 3Q. Although there are worries that the Wuxi fab s normalization will slow the upside momentum of DRAM prices and exacerbate supply/demand conditions, management stressed that its rivals capacity growth is modest, and that the Wuxi fab s resumption has been progressing at a slower than expected pace. In addition, once the Wuxi fab comes back online, the company plans to convert DRAM capacity at its M1 line to NAND. We believe the chipmaker s decision to slash capacity for less-profitable NAND in favor of DRAM at its M1 line underscores its strong crisis management capability. Hence, the PC and server DRAM market is likely to remain bullish in Q. Table 1. DRAM capacity before and after Wuxi fire (k wafers/m, k wafers/q) Oct. Nov. Dec. Q13 Jan. Feb. Mar. 1Q1 Before fire M Wuxi Total 8 8 After fire M Wuxi M1 1 5 Total QoQ -% % Source: estimates As for concerns of mobile DRAM prices falling in 1H1, the company stated that inventories were not that high, considering supply shortages at Chinese customers. The company expects mobile DRAM to remain in short supply through 1Q1, and thus projects only modest downside to prices. In 1, mobile DRAM demand is expected to increase to over % of overall DRAM demand, and 3GB (Gb*) chips are likely to become the standard mobile DRAM for high-end smartphones. Regarding DRAM technology migration, the company said Ynm is currently in production following the completion of development, and that it is currently developing Znm and plans to go into mass production in 1. In particular, the company cautioned that the migration to Znm will likely stall and cost significantly more. As such, DRAM bit growth next year is unlikely to be much higher than this year s mid-% level. Meanwhile, management stated that the company will start providing client samples of 3D NAND in 1H1, and begin mass production in H1. Capex plans for 1 have not yet been determined. With the global DRAM industry consolidated into essentially three suppliers, the Wuxi fab fire has significantly changed market dynamics by stabilizing DRAM supply/demand conditions. Furthermore, capacity growth after the fire is likely to be limited. As such, we expect the DRAM market to enter a Goldilocks phase in 1, during which prices become less volatile and major suppliers enjoy continued profits.

3 Valuation summary Table. P/B valuation (W,%) 13F 1F Details Share price 3,85 3,85 A 13F BPS 1,35 1,5 B P/B C=A/B 13F ROE 3.9% 5.8% D Earnings yield 11.9% 1.8% E=D/C Risk-free rate (3-year gov t bond).9%.9% F Risk premium 9.% 13.9% G=E-F Target risk premium 1.% 1.% H Target earnings yield 1.% 1.9% I=F+H Target P/B.3. J=D/I Target price 38, 3, K=B*J Table 3. Global memory makers earnings and valuation metrics (Wbn, %, x) Market Revenue OP OP margin NP P/E P/B ROE cap 13F 1F 13F 1F 13F 1F 13F 1F 13F 1F 13F 1F 13F 1F SEC,99 9,3 3,71 39,3 3, ,8 3, ,33 1,38 1,7 3,399, ,5 3, Micron 19,9 1,1 1,91 3,5 3, ,73, Nanya 3,58 1,13 1, Inotera,11 1,815, , Toshiba,7 7,798 9,9 3,3 3, ,3 1, SanDisk 1,9,58 7,19 1,, ,77 1, Average Source: Bloomberg, estimates Figure 1. 1-month forward P/B band Figure. Quarterly OP and share price (W') 5.8x.x (Wbn) 1, Quarterly OP (L) Share price (R) (W') 5 5.x 1, x 1.x.8x , F 1F 3

4 Earnings Outlook Table. Quarterly and annual earnings (Wbn, %) 1Q13 Q13 3Q13P Q13F 1Q1F Q1F 3Q1F Q1F 1 13F 1F 15F Revenue,781 3,933,8 3, 3,935,19,31, 1,1 1,38 1,7 17,939 QoQ growth YoY growth DRAM 1,975,871,9, 3,9 3,38 3,317 3,1 7,1 1,3 13,3 13,18 NAND 1, 1, ,,5 3,5 3,13 3,771 COGS,18,51,379,,3,3,9,5 8,551 8,89 9,835 11,585 Gross profit 73 1,8 1,7 1,9 1,58 1,59 1,7 1,53 1,11 5,3,839,35 SG&A ,839 1,7 1,73,5 Operating profit 317 1,11 1, ,1 1, 1,3-8 3,399,389,1 QoQ growth YoY growth TTB 8.1 TTB TTR TTB DRAM , ,7 1, ,99 3,959 3,9 NAND EBITDA 1,89 1,871 1,87 1,5 1, 1,999,7 1,897,97,57 7,77 8, Net profit ,38 1, ,5 3,5 3,5 GP margin OP margin DRAM NAND EBITDA margin NP margin Notes: Under consolidated K-IFRS; TTR stands for Turn To Red and TTB stands for Turn To Black Table 5. Earnings forecast revisions (Wbn, %) Previous Revised % chg. 13F 1F 13F 1F 13F 1F Revenue 1,8 1,119 1,38 1, OP 3,37 3,98 3,399, Net profit,73 3,33,5 3, OP margin NP margin Source: estimates Notes - DRAM supply/demand and price stability continues Figure 3. Annual operating profit and OP margin Figure. Quarterly operating profit and OP margin (Wtr) (Wbn) Annual OP (L) OP margin (R) 1, Quarterly OP (L) OP margin (R) , , F 1F 15F F 1F

5 Table. Major metrics and forecasts for the DRAM division (Wbn, %, mn units, US$ ) 1Q13 Q13 3Q13P Q13F 1Q1F Q1F 3Q1F Q1F 1 13F 1F 15F Revenue (Wbn) 1,975,871,9, 3,9 3,38 3,317 3,1 7,1 1,3 13,3 13,18 Operating profit (Wbn) , ,7 1, ,99 3,959 3,9 OP margin 1.% 33.% 3.% 9.1% 3.% 3.1% 31.8% 8.1% -3.% 8.7% 9.7% 7.5% Shipments (1Gb eq. mn),37,89,798,378,9 3,1 3,559 3,1 7,773 1,399 13,3 17,191 Bit growth (% chg.) 3.%.% -1.8% -15.% 18.1% 1.1% 9.1%.8% 5.8% 33.8% 9.% 8.% ASP (1Gb eq. US$) ASP growth (%.) 3.9% 15.8% 5.% 5.% -.9% -.9% -9.% -1.% -3.% 9.3% -.8% -.% Note: Under consolidated K-IFRS Table 7. Major metrics and forecasts for the NAND division (Wbn, %, mn units, US$ ) 1Q13 Q13 3Q13P Q13F 1Q1F Q1F 3Q1F Q1F 1 13F 1F 15F Revenue (Wbn) 1, 1, ,,5 3,5 3,13 3,771 Operating profit (Wbn) OP margin.% 1.% 1.9%.5%.% 1.3% 15.% 13.% -1.8% 1.9% 1.3% 7.8% Shipments (1Gb eq. mn) ,9,133,985,39 Bit growth (% chg.) -1.% 9.% 11.% -.% 1.%.5% 18.5% 1.7%.7%.9%.% 5.% ASP (1Gb eq. US$) ASP growth (%.) -7.% 5.3% -3.9% -.5% -5.9% -15.8% -1.7% -8.% -.% -5.5% -.7% -8.% Note: Under consolidated K-IFRS Figure 5. Operating profit by division Figure. OP margin by division (Wbn) 1, DRAM division's OP NAND division's OP DRAM division's OP margin NAND division's OP margin Q 1Q7 1Q8 1Q9 1Q1 1Q11 1Q1 1Q13 1Q1F - 1Q 1Q7 1Q8 1Q9 1Q1 1Q11 1Q1 1Q13 1Q1F Figure 7. Annual EBITDA and EBITDA margin Figure 8. FCF (EBITDA - capex) (Wtr) 1 8 Annual EBITDA (L) EBITDA margin (R) (Wtr) 8 EBITDA - Capex EBITDA Capex F 1F 15F F 1F 15F 5

6 Figure 9. Annual DRAM bit growth and ASP growth Figure 1. Annual NAND bit growth and ASP growth DRAM Bit Growth (% YoY) ASP % YoY 1 NAND Bit Growth (% YoY) ASP % YoY F 1F F 1F Figure 11. Global smartphone shipments (mn units) 1,5 1, 5 Smartphone shipments (L) % YoY (R) ,8 1, F 15F Figure 1. Global tablet PC shipments (mn units) Global tablet shipments (L) 35 Apple M/S (R) 1 Non-Apple M/S (R) F 1F 15F Figure 13. Gb PC DRAM price trends Figure 1. Gb NAND MLC price trends (US$) 3..5 DDR3 Gb spot price DDR3 Gb contract price Quarterly avg. contract price KDB Daewoo forecasts (US$) NAND Gb MLC spot price NAND Gb MLC contract price Quarterly avg. contract price KDB Daewoo forecasts Elpida bankruptcy Major memory players' expansion of mobile DRAM portion. 1/11 7/11 1/1 7/1 1/13 7/13 1/1F 7/1F Source: DRAMeXchange, estimates 1/11 7/11 1/1 7/1 1/13 7/13 1/1F 7/1F Source: DRAMeXchange, estimates

7 ( KS/Buy/TP: W3,) Comprehensive Income Statement (Summarized) Statement of Financial Condition (Summarized) (Wbn) 1/1 1/13F 1/1F 1/15F (Wbn) 1/1 1/13F 1/1F 1/15F Revenue 1,1 1,38 1,7 17,939 Current Assets 5,31 7,933 1, 1,38 Cost of Sales 8,551 8,89 9,835 11,585 Cash and Cash Equivalents 58 1,97 3,517,98 Gross Profit 1,11 5,33,839,35 AR & Other Receivables 1,83,,91,87 SG&A Expenses 1,839 1,9,5,5 Inventories 1,59 1,51,18,33 Operating Profit (Adj) -7 3,399,389,1 Other Current Assets Operating Profit -7 3,399,389,1 Non-Current Assets 13,335 1,19 1,8 15,91 Non-Operating Profit Investments in Associates Net Financial Income Property, Plant and Equipment 11,58 1,38 13, 13,577 Net Gain from Inv in Associates Intangible Assets 98 1,3 1,5 1,5 Pretax Profit -199,833,7,11 Total Assets 18,9,8 5,9 7,859 Income Tax Current Liabilities,1,9,1,1 Profit from Continuing Operations -159,5 3,51 3,5 AP & Other Payables 1,335 1,51,18,159 Profit from Discontinued Operations Short-Term Financial Liabilities,73 1,911 1,511 1,11 Net Profit -159,5 3,51 3,5 Other Current Liabilities Controlling Interests -159,5 3,5 3,5 Non-Current Liabilities,8 5, 5,37,7 Non-Controlling Interests Long-Term Financial Liabilities 3,75,9 3,59 3,9 Total Comprehensive Profit -,37 3, 3,597 Other Non-Current Liabilities Controlling Interests -,37 3, 3,59 Total Liabilities 8,99 9,91 9,31 8,37 Non-Controlling Interests 3 Controlling Interests 9,7 1,39 15,99 19,19 EBITDA,97,57 7,77 8, Capital Stock 3,88 3,91 3,91 3,91 FCF (Free Cash Flow) -1,55,75,89,5 Capital Surplus 3,5 3, 3, 3, EBITDA Margin Retained Earnings 3,313 5,958 9,5 13,5 Operating Profit Margin Non-Controlling Interests -1 3 Net Profit Margin Stockholders' Equity 9,739 1,391 15,93 19, Cash Flows (Summarized) Forecasts/Valuations (Summarized) (Wbn) 1/1 1/13F 1/1F 1/15F 1/1 1/13F 1/1F 1/15F Cash Flows from Op Activities,393,3,38 7,9 P/E (x) Net Profit -199,71 3,51 3,5 P/CF (x) Non-Cash Income and Expense 3,38 3,938,119,37 P/B (x) Depreciation 3,58,98 3,18 3,93 EV/EBITDA (x) Amortization EPS (W) -33 3,7 5,55 5,189 Others CFPS (W),7 8,38 1,1 11,1 Chg in Working Capital BPS (W) 1,15 1,35 1,5,38 Chg in AR & Other Receivables DPS (W) Chg in Inventories Payout ratio Chg in AP & Other Payables Dividend Yield Income Tax Paid Revenue Growth Cash Flows from Inv Activities -, -,1-3,9 -,5 EBITDA Growth Chg in PP&E -3,737-3,55-3, -,5 Operating Profit Growth TTR TTB Chg in Intangible Assets EPS Growth RR TTB Chg in Financial Assets Accounts Receivable Turnover (x) Others Inventory Turnover (x) Cash Flows from Fin Activities 1, -95-1,11-1,1 Accounts Payable Turnover (x) Chg in Financial Liabilities ROA Chg in Equity,39 ROE Dividends Paid -1-1 ROIC Others Liability to Equity Ratio Increase (Decrease) in Cash ,9 1,1 1,11 Current Ratio Beginning Balance 1, 58 1,97 3,517 Net Debt to Equity Ratio Ending Balance 58 1,97 3,517,98 Interest Coverage Ratio (x)

8 APPENDIX 1 Important Disclosures & Disclaimers Disclosures As of the publication date, Daewoo Securities Co., Ltd. has acted as a liquidity provider for equity-linked warrants backed by shares of as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies. As of the publication date, Daewoo Securities Co., Ltd. issued equity-linked warrants with as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies. Of the equity-linked warrants covered in this report, Daewoo Securities Co., Ltd. has acted as a liquidity provider for equity-linked warrants backed by shares of as underlying assets. (W) 5,, 3,, 1, 11/11 /1 1/1 /13 1/13 Stock Ratings Industry Ratings Buy Relative performance of % or greater Overweight Fundamentals are favorable or improving Trading Buy Relative performance of 1% or greater, but with volatility Neutral Fundamentals are steady without any material changes Hold Relative performance of -1% and 1% Underweight Fundamentals are unfavorable or worsening Sell Relative performance of -1% * Ratings and Target Price History (Share price (----), Target price (----), Not covered ( ), Buy ( ), Trading Buy ( ), Hold ( ), Sell ( )) * Our investment rating is a guide to the relative return of the stock versus the market over the next 1 months. * Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst s estimate of future earnings. The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions. Analyst Certification The research analysts who prepared this report (the Analysts ) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. Daewoo Securities Co., Ltd. policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 1 months and have not been promised the same in connection with this report. No part of the compensation of the Analysts was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report but, like all employees of Daewoo Securities, the Analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Daewoo Securities Co., Ltd. except as otherwise stated herein. Disclaimers This report is published by Daewoo Securities Co., Ltd. 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