Fitch Ratings has assigned SK hynix Inc.'s (BBB/Stable) proposed US dollar senior unsecured notes a rating of 'BBB'.

The proposed notes are rated at the same level as SK hynix's senior unsecured rating, as they represent its direct, unconditional, unsecured and unsubordinated obligations. Net proceeds from the proposed notes will be used for general corporate purposes, including refinancing of existing debt.

SK hynix's ratings reflect its position as the second-largest maker of dynamic random-access memory (DRAM) and NAND memory semiconductors, strong technological capability and high entry barriers. The ratings also reflect the memory industry's need for large capex and its high cash-flow volatility, as prices of commoditised DRAM and NAND fluctuate due to demand-supply mismatches.

We believe that SK hynix continues to have adequate financial flexibility, as it is able to moderate capex and shareholder returns in cyclical downturns. We assess SK hynix based on its average metrics through the 2023-2025 industry cycle.

Key Rating Drivers

Entering Memory Upcycle: Fitch expects the memory semiconductor market to continue recovering from 2023's severe downturn as inventory levels normalise and consumer demand rises from end-markets, such as personal computers (PCs), smartphones and servers. The fast-growing generative artificial intelligence (AI) chip market has resulted in a stronger DRAM market rebound than previously expected. The NAND market remains clouded by uncertainty over end-market demand, but we expect its recovery to have become more apparent from 4Q23 when the benefit of production cuts kick in.

Profitability Swings to Positive: We expect SK hynix's operating performance to improve meaningfully in the memory upcycle. The company is also well positioned to take advantage of its dominant market share in the high-end chip segment, including high-bandwidth memory chips (HBM) and DDR5 (fifth-generation DRAM).

We forecast SK hynix's 2024 revenue to increase by more than 30%, led by higher memory demand and recovery in average selling prices (ASPs), with the Fitch-adjusted EBITDA margin improving to 40%-50% (2023: below 20%; 2022: 46%) driven by higher ASPs and improvement in product mix.

Strong Technology Capabilities: We expect the company to focus on upgrading its technological capabilities, to reduce its unit cost and expand gross profit margin. We anticipate mid-cycle capex/revenue of around 30% as SK hynix invests in technology upgrades and expands its fabs in Yongin and Cheongju in Korea.

Leverage to Improve in 2024: We assess SK hynix's financial structure to remain strong on a through-the-cycle basis, given its long-term target of debt/EBITDA of below 1.5x, strong financial flexibility and high EBITDA profitability that supports positive free cash flow (FCF) generation. The company has a record of maintaining EBITDA leverage of around 1.0x in the last five years. We forecast its EBITDA leverage to have deteriorated significantly during the industry downturn to over 5.0x in 2023, before improving to around 1.0x-1.5x in 2024-2025, led by a recovery in product prices.

Solid Market Position: SK hynix's strong market position and industry growth potential in a consolidated industry support its business profile; SK hynix is the second-largest memory semiconductor supplier. Its global market share in DRAM in 3Q23 rose to about 34%, from 30% in 2Q23 and 25% in 1Q23. Robust sales of its HBM products to Nvidia drove the gain. It also strengthened its position by acquiring Intel Corporation's (A-/Negative) NAND business in 2021. This improved revenue diversity, with DRAM and NAND contributing 64% and 32%, respectively, of 2022 revenue (2021: 71% and 24%).

Highly Cyclical Industry: SK hynix's rating is constrained by the high cyclicality of the memory semiconductor business. The impact of the industry downturn, which started in 1H22, is compounded by geopolitical tensions and subdued smartphone and PC demand, following a surge in demand during the Covid-19 pandemic. The US government's initiatives to attract semiconductor investments may also create structural inefficiencies in the short term, despite the consolidated nature of the industry.

Derivation Summary

SK hynix's credit profile is comparable with that of Micron Technology Inc. (BBB/Stable). SK hynix's scale and market share in DRAM and NAND are larger than that of Micron. The technological capabilities are similar, but Micron has better end-sector diversification with higher exposure to the automotive business. However, SK hynix's financial structure is slightly weaker than that of Micron, as the latter has maintained a better balance sheet with a net cash position historically as it focused on organic growth.

Microchip Technology Inc.'s (BBB/Positive) credit profile is slightly stronger than that of SK hynix. The latter's larger scale and better market position is more than offset by Microchip's lower volatility in demand and product prices. We expect Microchip to gain market share and solidify its position among the top three microcontroller producers globally, with strong operating performance benefiting from rising electronic content in diversified markets.

The Positive Outlook on Microchip's Issuer Default Rating reflects its strengthening financial profile with strong EBITDA profitability, which supports stable FCF margins of around 20%-30% that are used for debt reduction and for shareholder returns to maintain a long-term EBITDA net leverage target of 1.5x.

SK hynix's credit profile is weaker than that of NXP Semiconductor N.V. (BBB+/Stable). NXP has relatively small scale and market share in the microcontroller market, but this is offset by exposure to the auto and industrial sectors, which are experiencing secular growth and significant end-market diversification.

NXP has better cash-flow visibility than SK hynix because its products do not face the wild price swings of memory products. This keeps NXP's EBITDA leverage ratio at around 2.0x, whereas we forecast SK hynix's leverage ratio to have exceeded 5.0x in 2023, before recovering to around 1.5x in 2024. NXP also generates higher FCF margins of 15%-20% due to its lower capex/revenue requirement of 8%-10%.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer:

Revenue to decline by 25%-30% to around KRW30 trillion-32 trillion in 2023, driven by weak demand, excess inventory and severe pricing pressures, before steep recovery in 2024;

SK hynix to report an operating loss in 2023, given our expectation of a significant decline in ASPs and then swing back to profit in 2024;

Capex to have declined to around KRW7 trillion-8 trillion in 2023, in line with management's guidance of over a 50% reduction in capex from KRW19 trillion in 2022. Capex/revenue will return to 28%-30% from 2024;

SK hynix to distribute about KRW1,200 per share, in line with the company's policy;

R&D as percentage of sales of around 10%;

No major M&A in 2024 other than the USD2.2 billion remaining payment to Intel by March 2025.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

EBITDA leverage below 1.5x and cash flow from operations (CFO)-capex/total debt in excess of 20% on average through the cycle;

Improvements in market share in the DRAM and NAND market;

FCF margins in the mid- to high-single digits through the cycle.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

EBITDA leverage above 2.5x and CFO-capex/total debt below 15% on average through the cycle;

Sustained negative FCF on high capex intensity and/or shareholder returns;

Significant loss of market share on rising geopolitical risks.

Liquidity and Debt Structure

Adequate Liquidity: SK hynix has cash, cash equivalent and short-term investments of KRW8.5 trillion compared to short-term obligations of KRW11.2 trillion, including USD1.7 billion of exchangeable bonds. The exchangeable bonds will not affect the company's liquidity, as they only involve equity conversion. We believe SK hynix's liquidity remains adequate on our expectation of positive FCF from 2024, which will support medium-term liquidity. The company has solid access to capital markets and local banks.

Issuer Profile

SK hynix, based in South Korea, is the second-largest memory semiconductor company in the world. It designs, manufactures and sells memory chips such as DRAM and NAND flash. SK Square owns a 20.07% stake in the company.

Date of Relevant Committee

12 April 2023

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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