According to Morgan Stanley, there is a "recovery story" in the semiconductor market this year.

This is the memory sector, which includes DRAM, or dynamic random access memory - a type of semiconductor memory needed for data processing - and NAND, another type of memory that remains viable without a power source.

"The memory sector is going through a recovery cycle this year - and typical of this first phase is that it is a multiple expansion and anticipation of many good things to come," Morgan Stanley analysts said in a Sept. 7 report.

"On the earnings front, this is clearly evident in AI/[high-bandwidth memory] driven stocks, and we now expect NAND growth to drive the next stage of revisions."

High-bandwidth memory (HBM) is a segment within the DRAM sector and is a key component needed to run advanced processors that conventional DRAM cannot run. Analysts have been bullish on this segment this year as the hype around artificial intelligence has shed light on the advanced processors needed for AI applications.

"Preferred plays" and "least preferred plays"
According to the bank, the valuation is justified by growth and the duration of earnings.

It said South Korean chipmaker SK Hynix, US-based Western Digital Corporation (WDC) and Taiwanese firms Winbond and Phison are its "preferred plays". These are benefiting from NAND's resurgence in cash flow and a "strong competitive position" in high-bandwidth memory, the bank said.

Meanwhile, the potential for NAND improvement in the U.S. appears to be "most positive" for Western Digital, which is not discounting a substantial recovery in NAND earnings, Morgan Stanley said.

However, it added that "we would be conservative on peak earnings potential over the next 2 to 3 years as markets remain significantly oversupplied as a return to positive gross margins should lead to a restart of idle capacity."

SK Hynix and Samsung are expected to be the main beneficiaries of demand for high-bandwidth memory due to the AI trend, according to the bank.

"From Hynix's perspective, although the stock is rising, the visibility of the company building a solid position in AI keeps us [overweight]. The company is the most substantial beneficiary of the AI spending surge now underway and has one of the best idiosyncratic growth rates among our Asian technology coverage," Morgan Stanley analysts wrote.

"As for HBM, we believe Hynix will maintain its pole position on the AI growth cycle curve," they added.

The bank said its "least favorite" stocks are Micron, Macronix and GigaDevice.

Improving conditions
Morgan Stanley said it has become more optimistic about the memory sector as pricing and inventory conditions continue to improve.

The bank added that NAND memory benefited from Samsung's supply cuts, "with instances of double-digit price increases for September shipments."

"While the pricing strength could be temporary due to excess inventory in the market, the price change could lead to a change in customer inventory behaviour when cycle conditions bottom out," it said.

DRAM chip inventories are also "significantly down" from the third quarter of this year, the bank said.

"We recommend taking advantage of weak periods in the market to build and use time in the market to take advantage," it added. Overall, Morgan Stanley expects shortages to accumulate in the fourth quarter and surge in 2024 - before peaking in 2025.

"The industry continues to produce well below actual demand and we can take comfort that the recovery should last well into 2025."

You can really see the revival here. After the pandemic years when nobody was buying anything because everybody already had everything, we've entered a new cycle. You can see it in the stocks.

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