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3 Promising Picks from the Slowing Semiconductor Industry

·10 min read

Companies in the Semiconductor – General industry are at the forefront of the ongoing technological revolution based on HPC, AI, automated driving, IoT and so forth. These semiconductors also enable the cloud to function and help analyze the data into actionable insights that can be used by companies to operate more efficiently. 
 
The pandemic led companies to ramp up technology investments in order to stay operational when it was unsafe for us to go to work or meet people. But since this meant that a lot of infrastructure was built out in advance, demand was expected to slow down in the near future. But a possible recession in 2023 is further weakening the outlook. Longer-term trends continue to favor digitization, cloud, AI, etc., which will drive strong demand for semiconductors.
 
This is not the best place to invest in right now, but STMicroelectronics. Amtech Systems and Texas Instruments look relatively attractive.

About the Industry

The companies grouped under the Semiconductor – General category produce a broad range of semiconductor devices, both integrated and discrete, like microprocessors, graphics processors, embedded processors, chipsets, motherboards, wireless and wired connectivity products, DLPs and analog, serving multiple end markets. It includes companies like NVIDIA, Texas Instruments, Intel and STMicroelectronics.

According to the latest data from the Semiconductor Industry Association (SIA), global semiconductor sales growth in the second quarter of 2022 decelerated to 13.3%, reaching $152.5 billion. 2021 sales were up 26.2% to the highest-ever annual total. The Americas were the strongest region, growing 29%. All regions were down month-to-month. The 2022 projection of 8.8% growth was not revised. Gartner forecasts 7.4% growth this year.

Major Themes Shaping the Industry

  • The long-term outlook for the industry remains robust because of its being on the building-block side of technology, which makes it crucial for the proliferation of the Internet and the ongoing digitization of every aspect of life. The short-term outlook appears bleak however. The pandemic has accelerated the move toward digitization, but it has created a lot of imbalances in demand and supply. The smartphone market for example (a primary application of semiconductors) is seeing issues on both the demand and the supply sides. Demand is affected by inflation while supply is affected by not only inflation but also geo-political tensions, China shutdowns and ongoing supply chain constraints, according to IDC. This has led the research firm to lower its 2022 forecast to a 3.5% decline (previous 1.6% growth), followed by growth of 5% in 2023. The other major chip consumer is the PC market, where the consumer and education segments had been slowing down following two years of very strong growth. The current macroeconomic weakness is also weakening the outlook for enterprise demand. As a result, IDC expects a 12.8% decline this year followed by a 2.6% decline in 2023 before growth returns in 2024.

 

  • The good news is that some of the weakness in these traditional markets is being made good by strength in emerging areas like AI and machine learning, IoT, and automotive. ReportLinker expects the AI chip market to grow at a CAGR of 29.9% between 2022 and 2030. Driven by Internet connectivity across the developed and developing worlds and supportive technology such as sensor networks and AI adoption, the IoT market is also expected to grow steadily over the next few years. Future Market Insights expects the market to grow at a 5.3% CAGR between 2022 and 2032. Mordor Intelligence expects a stronger 14.7% CAGR between 2022 and 2027. Automotive electronics is another area of evolving needs with increasing electronics (including ADAS), safety enhancements and transition to electrified power trains being important drivers. Grand View Research estimates a 10.7% CAGR through 2025, which it attributes to awareness regarding energy-efficient lighting systems, as well as increasing sales of luxury vehicles that come fitted with navigation and infotainment systems. Automation and robotics, with increasing adoption across industrial operations, are other areas of growth. These strong end markets will drive continued demand for semiconductor components for years to come.

 

  • As the growth potential in emerging markets grows, regulatory (and/or political) issues in China and the U.S., can play an increasingly important role. The government’s strong stance against prime trading partner China has cast a shadow over the space. Semiconductor companies in particular stand to benefit from a truce between the U.S. and China as the Chinese government’s drive to build its own industry requires collaborations with leading semiconductor players. Moreover, commercial sales to China would help fund costly R&D in the U.S. Such a truce seems increasingly unlikely because of ongoing geopolitics. The government is also concerned about IP protection and is trying to delay as far as possible, China’s own technological maturity. Be that as it may, the $52 billion infusion from the CHIPS Act (when adopted) will be a big boost to the domestic semiconductor market.

 

  • Because end devices have to be priced lower to reach more people, the pressure on companies to bring down cost remains. But although companies still find it advantageous to move operations to places where labor may be cheaper or where the proximity to manufacturing facilities can lower transportation and other cost, governments across the world are waking up to the strategic value of onshore chip production. The tensions with China have also increased the importance of diverse supply chains. Industry consolidation should continue however, as larger players add expertise and capacity through acquisitions. There’s also likely to be close collaboration with device makers, facilitating quicker consumption and better inventory management.   

Zacks Industry Rank Indicates Deteriorating Prospects

The Zacks Semiconductor-General Industry is a stock group within the broader Zacks Computer and Technology Sector. It carries a Zacks Industry Rank #179, which places it in the bottom 28% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates that near-term prospects aren’t too bright. Our research shows that the bottom 50% of the Zacks-ranked industries underperforms the top 50% by a factor of 1:2.

An industry’s positioning in the top 50% of Zacks-ranked industries is normally because the earnings outlook for the constituent companies in aggregate is encouraging. The opposite is true for stocks in the bottom 50% of industries. In this case, the aggregate earnings estimate for 2022 is down 25.9% from the year-ago level. The aggregate earnings estimate for 2023 is down 34.2% from last year. The numbers have deteriorated every month since February.

Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Leads on Stock Market Performance

Tracking the performance of the Zacks Semiconductor – General Industry over the past year shows that the industry has traded higher than both the broader Zacks Computer and Technology Sector and the S&P 500 index up to December 2021. But starting this year, its performance has been choppy and other than the pop in March, it has steadily declined. As of now, it trails both the industry and the S&P 500.

The industry lost 36.3% over the past year compared to the 31.5% loss of the broader sector and the 13.6% loss of the S&P 500 index.

One-Year Price Performance

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Zacks Investment Research


Image Source: Zacks Investment Research

Industry's Current Valuation

On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing semiconductor companies, we see that the industry is currently trading at 21.1X, which is its below its median level of 25.5X over the past year. However, the S&P 500 trades at 16.6X while the sector trades at 19.9X. Therefore, the industry appears overvalued in both these comparisons.

The five-year story is the same. During this time, the industry has traded as high as 34.34X, as low as 12.86X and at the median of 19.26X.

Forward 12 Month Price-to-Earnings (P/E) Ratio

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Zacks Investment Research


Image Source: Zacks Investment Research

3 Stocks Worth Considering

STMicroelectronics N.V. (STM): The company designs, develops, manufactures and markets a broad range of semiconductor integrated circuits and discrete devices used in a wide variety of microelectronic applications, including telecommunications systems, computer systems, consumer products, automotive products and industrial automation and control systems.

STMicroelectronics is seeing strong demand across all segments although the auto market appears to be the strongest.  Favorable mix and strong pricing remain positive for profitability, offsetting the impact of rising input costs. Given its exposure to the automotive market, the replenishment of inventories across the automotive supply chain and the ongoing electrification and digitalization are positives, despite the lower-than-expected number of cars produced.   Industrial, the other significant end market for STMicroelectronics is currently being driven by factory automation, power and energy applications, as well as building and home control. Industrial electrification and digitalization are the main trends accelerating the increase in semiconductor content.

STM beat the Zacks Consensus Estimate by 13.6% in the last quarter. In the last 60 days, the current year EPS estimate of this Zacks Rank #1 (Strong Buy) stock increased 55 cents (16.5%).

The shares of the company are down 20.6% over the past year, sinking along with all other growth, and particularly, technology stocks.

Price & Consensus: STM

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Amtech Systems, Inc. (ASYS): Amtech Systems manufactures and sells capital equipment and related consumables for use in fabricating silicon carbide (SiC), silicon power devices, analog and discrete devices, electronic assemblies and light-emitting diodes (LEDs) worldwide.

While the near-term outlook remains uncertain and China-related shutdowns led to a significant revenue decline in the last quarter, its leading position in consumables positions it for strong growth in the long term.

In the last quarter, Amtech posted a positive surprise of 51.5%. In the last 60 days, the Zacks Consensus Estimate for 2022 has gone from a loss of 32 cents to a profit of 5 cents.

The Zacks Rank #1 stock is down 16.2% in the past year.

Price & Consensus: ASYS

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Texas Instruments, Inc (TXN): Texas Instruments is an original equipment manufacturer of analog, mixed signal and digital signal processing (DSP) integrated circuits.

Texas Instruments has significant exposure to the industrial and automotive markets, where the semiconductor shortage is driving strong demand and pricing strength. But like STM, the company also sees some impact from China’s pandemic-related shutdowns. TI is known for operating a flexible manufacturing model (including its 300mm facilities) that includes both internal capabilities and external sources, thus making it a bit of a defensive play in downcycles. But the secular growth prospects in its served markets coupled with the current chip shortage is driving the company to increase capacity. Those extra costs notwithstanding, Texas Instruments continues to generate solid cash flows. It also returns cash to investors through regular share repurchases and dividends. This is one of the steadiest performing companies and continues to deliver, quarter upon quarter.

In the last quarter, Texas Instruments generated earnings that topped the Zacks Consensus Estimate by 18.4%. The Zacks Consensus Estimate for 2022 is up 57 cents (6.5%) in the last 60 days.

Shares of this Zacks Rank #3 company are down 14.5% over the past year, mainly due to the broad market weakness.

Price & Consensus: TXN

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