Minimal impact in the short term, but not helpful
In the short term, we expect minimal impact both on demand and supply from the Russia/Ukraine conflict for our coverage. Russia and Ukraine represent a very small fraction of sales for the semi industry (e.g. Taiwan semi exports to Russia were $24mn in 2021 vs. TSMC group sales of $57bn), and with current global chip demand outstripping supply, any lost Russia/Ukraine demand should be made up elsewhere. On the supply front we see a more meaningful risk of disruption, particularly around the gas neon used in front-end manufacturing, but see this risk as manageable for the next few quarters at least. The semi industry has significantly reduced its dependency on neon since the 2014 Crimea invasion, but if supply remains heavily constrained we could see an impact as early as 4Q22, particularly given the backdrop of an already extended supply chain. We summarize the impact on our coverage in the table below:
What is neon, and are there alternatives?
Neon is an inert gas that is used heavily in the routine operation of lithography tools, namely for ArF and KrF light sources (DUV). With DUV being used for nodes sub 220nm or below, any form of neon shortage is likely to have a much greater impact on leading edge nodes, with less impact on the mature side (e.g. power/analog). Ukraine represents a significant portion of global neon supply, roughly c50% (Reuters, 11 March 2022), with it being a by-product of its steel industry. While neon remains critical for chip production, the industry uses far less of it today since the initial invasion of Crimea in 2014 where neon prices spiked >600% . Cymer/ASML were able to reduce tool neon consumption significantly (>50%) for all tools shipped from 2015+, along with developing a play book for its customers to reduce consumption further (e.g. neon recycling/gas alternatives). Our channel checks suggest that neon inventories remain sufficient to cover at least the next 1-2 quarters, but should supply remain tight thereafter we would expect chip manufacturers to draw from this play book.
Pallidum and wiring harnesses
The other areas of potential supply disruption are palladium and wire harnesses. While neither would directly impact supply for our semi coverage, it would impact the supply of their automotive customers . Palladium is used as a catalytic convertor in vehicles to manage pollutant output, and has becoming increasing essential as OEMs look to reduce emission output. Russia represents c40% of global palladium supply, so should supply deteriorate it would pose a significant risk to the c80m vehicle units projected for 2022 (Back in reset mode amid Ukraine crisis – 16 March 22). While substitution remains an option, it is regulatory cumbersome and would take multiple months or even quarters. The other material to flag is wire harnesses (bundles cables in vehicles), where Ukraine is a meaningful supplier into Europe. IHS estimates a 0.5-1mn vehicle impact to its 2022 forecasts from Ukraine supplies wire harnesses.
Should we see further cuts to auto production, we see little impact for Infineon and STMicro in the near term as their customers are likely still ordering amid very lean chip inventories. However, a cut to auto production in 2022 is unlikely to be fully made up in 2023, with a significant portion of it likely lost demand. For ams, we see a different dynamic: a cut to 2022 auto production would impact earnings in the near term given that inventories for its parts have returned to normal levels.
Rising input costs manageable in FY22, but risk to FY23+
The arguably larger impact for our semi coverage comes from rising input costs and its impact on margins. We distinguish between energy, material and labour costs. On energy, we expect the impact to be minimal through 2022 with all companies in our coverage having locked into fixed priced contracts for the year before the Ukraine-Russia conflict. Rising material costs will be a larger headwind, but given extreme supply tightness we expect all our companies to be able to pass this on to their customers (see STMicro to raise chip prices in 2Q22) for FY22. Rising inflation, along with the on-going “talent” war, should continue to pressure labour costs through FY23+, particularly for companies where the labour pool remains fairly small (e.g. engineers for ASM). Where we however see the greatest risk is for Infineon and ST, with lower utilisation, rising input costs, and less favourable pricing weighing on margins for FY23/24.