AI boom not shock-proof; chip shortage and weak pass-through weigh: Report

While the AI boom is supported by strong cash flows, it is not immune to shocks, with chip shortages posing a major risk to the rally, says Nuvama Institutional Equities.

As per the brokerage house, supply shock or a sharp rise in US Federal Reserve interest rates could trigger a turning point in the AI boom, as rising chip costs and stretched valuations expose early signs of excess in the rally.

It noted, higher hardware prices are inflating hyperscalers' capex and squeezing cash flows at a time when monetisation of AI remains limited, potentially forcing a reassessment of investment plans as investor pressure builds.


Additionally, the surge in AI capex and global hardware stocks already shows clear signs of excess, including high valuations (around 10x P/B versus 2-4x in the pre-AI era), a sharp rise in hardware tech stocks even as hyperscalers stagnate, retail euphoria similar to past market peaks in 2000, 2007, and 2021, and a renewed IPO boom.

"A turning point in the AI boom could be triggered by a supply shock or a sharp rise in US Federal Reserve interest rates," it said.

It noted that a chip shortage, with prices up about 2. 5x year-on-year, poses a major risk to the AI boom "as it will further inflate the already high capex bill of hyperscalers when scope for pass-through is limited."

The report said that the technology is still in its early stages of adoption and that global growth, excluding AI, remains weak. It noted that this "will erode hyperscalers' FCF and invoke shareholder dissent (early signs visible)," especially at a time when the US Federal Reserve remains hawkish and focused on price stability and its 2 per cent inflation target.

Semiconductor prices have more than doubled in the past year amid the AI boom, but passing these costs on to end users remains difficult, it noted.

The vulnerability is further heightened as non-AI growth remains weak in the US and globally. Additionally, key risks to the timing of AI mania rolling over emanates from a further supplyside easing in oil and other commodity prices.

"However, we firmly believe that it is post a bust in the capex mania that AI adoption will explode as costs drop dramatically. This is how it has played out in the internet era and we believe this time will be no different," it said.