We generally use our electronic gadgets without thinking, expecting them to understand our operating environment, read our commands correctly and store, retrieve and process the information we throw at them.
But what goes on behind the process is complicated, and enabled by semiconductor technology, whether analog (enabling the recording and measurement of real-world information), digital (processing information available in machine-readable language) or mixed signal (enabling conversion of analog signals to digital or digital to analog among other things). So most electronic gadgets use a combination of these semiconductor devices.
The industry is cyclical, making for periods of expanding capacity and supply that outpace demand followed by periods during which the growing demand matches then exceeds supply. So there is a certain elasticity in prices. Moreover, these semiconductor components have wide application across automotive, communications, computing/cloud/data center, industrial, medical and other markets, so players can serve multiple markets that offset their individual seasonality.
According to IC Insights’ 2018 McClean Report, analog products (both general purpose and application-specific) will increase by a compound annual growth rate (CAGR) of 6.6% to $74.8 billion in 2022 from $54.5 billion in 2017. Signal conversion components (data converters, mixed-signal devices, etc.) are forecast to record double-digit sales gains in three of the next five years.
Here are the three major themes in the industry:
First, while most experts agree that the semiconductor growth rate won’t be as exciting this year as it was in 2017, the analog and mixed-signal parts will be decent, supporting the thesis that the current semiconductor cycle continues to stretch out. The primary drivers of this cycle extension are the data center that is growing exponentially because of the continuing shift in workloads to the cloud and the advent of artificial intelligence, and IoT, both of which are expanding the scope of computing.
Second, while companies’ current R&D budgets are still largely focused on the computing segment, demand for traditional computing equipment like PCs and even newer-age tablets are sluggish and high penetration rates mean that replacement sales are the main driver (except some strength in developing markets). So M&A with the goal of expanding capabilities and acquiring key talent remains a top priority for companies. Additionally, budgets continue to be reallocated to areas like automotive, where increased electronics per car and automation are driving current sales, with future growth prospects remaining very bright because of the drive to implement clean energy and reduce auto emissions, and the adoption of semi to fully autonomous (level 3-5) driving capabilities.
Third, the adoption of 5G communications technology, enabling 10X the data rate as 4G, will be a huge boost to analog-mixed signal sales both in base stations and end devices. Because of the multiple input (MI) and multiple output (MO) streams the technology will enable in base stations, demand for sensors and power management analog including envelope tracking chips (to manage excess power flow and thus reduce heating), as well as gallium nitride (GaN) materials will increase. Moreover, since 5G is only involved in short range signals, it will not totally replace 4G but will supplement it. So it will be additive in terms of component demand.
The greatest challenge in all this is cost because the cost and complications of fabricating chips continue to increase while their broader adoption across devices of varying value requires prices to decrease.
The longer-term challenge is with respect to China, which is bringing new fabs online. The increased supply will bring down prices and dampen sales for American players, likely in 2020 and beyond. The outcome of the current trade war remains unclear.
Zacks Industry Rank Indicates Gloomy Prospects
The Zacks Semiconductor – Analog and Mixed industry is housed within the broader Zacks Computer and Technology sector. It carries a Zacks Industry Rank #203, which places it at the bottom 21% 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 bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are losing confidence in this group’s earnings growth potential. In the past year, the industry’s earnings estimate for the current year is a mere 1.1% while for 2019, it is down 0.1%
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 Lags on Stock Market Performance
The Zacks Semiconductor – Analog and Mixed Industry has lagged the broader Zacks Computer and Technology Sector as well as the S&P 500 index over the past year.
The industry has declined 26.6% over this period compared to the S&P 500 index’s increase of 3.2% and broader sector’s decline of 0.7%.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing semiconductor companies, the industry is currently trading at 12.3X compared to the S&P 500’s 15.7X and the Zacks Tech sector's 17.5X.
In fact, the industry is currently trading at the low end of its annual range of 18.86X to 12.33X and therefore, also below the median of 17.70X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
The analog semiconductor market should continue to see secular growth because the underlying drivers are strong and a significant amount of product differentiation is required in the design process, which insulates players to a certain extent. The current sluggishness is tied to weakness in its largest volume business (PCs) and the inability to quickly transfer resources elsewhere to adapt to changing market scenarios. So growth may actually slow down or turn negative until the necessary adjustments are substantially completed.
So it’s perhaps not surprising that just one of the stocks in the Zacks Semiconductor – Analog and Mixed market currently holds a Zacks Rank #1 (Strong Buy). We are also presenting two stocks with a Zacks Rank #3 (Hold) that investors may want to hold on to.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Semtech Corporation(SMTC): Shares of this supplier of analog and mixed-signal semiconductors for high-end consumer, enterprise computing, communications and industrial equipment have appreciated 11.6% over the past year. Its current Zacks Consensus EPS Estimate has remained stable over the last 30 days.
Price and Consensus: SMTC
Analog Devices (ADI): This leading provider of a broad portfolio of high performance analog, mixed-signal, and digital signal processing chips used in virtually all types of electronic devices has seen a 12.7% erosion in its share price over the past year. Its current Zacks Consensus EPS Estimate has remained stable over the last 30 days.
Price and Consensus: ADI
NXP Semiconductors N.V. (NXPI): This provider of high performance mixed-signal semiconductors saw its share price drop 36.7% in the past year. Its current Zacks Consensus EPS Estimate has appreciated substantially since the company last reported earnings.
Price and Consensus: NXPI
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