The semiconductor industry is made up of 15 sub-sectors (including 4 for semiconductor equipment) within the Technology sector, which is one of the 16 broad Zacks-categorized sectors.
Similar to the Technology sector, Zacks also breaks down each of the other sectors into groups such that there are a total of 265 sub-sectors or industries. These industries are then ranked based on the average rank of companies comprising the industry.
Therefore the Zacks Industry Rank is a very good indicator of investment opportunities within an industry at any given time. Moreover, because stocks in the same industry have certain common positive or negative factors affecting them, it has been observed that even companies with a neutral Zacks Rank when part of an industry with a “positive” outlook will perform better than similar ranked stocks in industries with “neutral” or “negative” outlooks.
For this purpose, Zacks methodology says that theoutlook for industries positioned #88 or lower is 'Positive,' between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.'
As evident from the table below, seven of the semiconductor segments are now in positive territory, five are neutral and the rest negative.
Note: Stocks mentioned in the “Our Picks” column is based on the individual ranks of stocks. Zacks Rank #1 for individual stocks denotes Strong Buy, #2 is Buy, #3 means Hold, #4 Sell and #5 Strong Sell.
Earnings Trends at a Glance
One of the main factors driving the Zacks Rank for individual stocks is earnings results. Therefore, it makes sense to take a look at how those have been.
From the latest earnings trends report, we see that 14.5% of technology stocks have reported with results trailing the S&P 500. Overall, technology stocks’ earnings were up 14.2% from the year-ago quarter on flattish revenue (down 0.3%). Also, 66.7% beat earnings estimates and an equal percentage beat revenue expectations.
This section can be divided into the current and emerging drivers. But before getting into that, it’s important to understand the backdrop. This includes a shrinking traditional market (mainly PCs) that still consumes the bulk of chips as well as several emerging categories that have extremely strong growth potential. This means that while the industry as a whole may appear sluggish, there are solid opportunities waiting to be picked.
As far as current drivers are concerned, the most significant are cloud computing, big data and artificial intelligence that are increasing demand for servers and data centers exponentially. Intel and NVIDIA (NVDA) are the strongest positioned here, with Intel’s strength mainly on the enterprise side and NVIDIA’s on the HPC side. Intel (INTC) is trying to challenge NVIDIA but that is easier said than done.
HPC is where a lot of the innovation is going on and NVIDIA is set to pick up share of spending because of its lead in machine learning. But of course it won’t be alone here. Intel has plans to get in the game with the technology it acquired through Nervana Systems. Both companies are working on hybrid solutions because GPUs do a better job of processing the huge amounts of data to train a neural network while CPUs do a better job of applying that data to a given situation. Xilinx is another important player working with FPGAs on top of ARM-based chips.
Some disruption is afoot in the enterprise segment as well because of the work done by the Open Compute Project (OCP) that Facebook (FB) founded and continues to feed. The social networking company generates huge volumes of data that it needs to store, manage and process as quickly and cost-efficiently as possible.
Others with similar interest like Apple (AAPL), Microsoft (MSFT) and Google, and differing interest like Intel, HP, Cisco (CSCO) and Juniper are also part of the project. Facebook designs the chip that is then optimized by the OCP so it becomes something members can standardize on.
So far so good. But if the OCP is able to design chips that perform better or comparably with Intel chips, the chip maker’s cloud business can be hurt. This explains why Intel is part of the effort.
But Intel has other challengers too.Google seems to be testing out International Business Machines’ (IBM) new chip designs. It is reportedly the only top chip buyer that doesn’t sell servers but instead builds them for internal use. Therefore, Google’s decisions are significant in the chip consumption context.
Google has done two things in the past that could be viewed as second sourcing or maybe creating leverage against Intel to pressure it into lowering prices. The company has declared that everything it now does also supports IBM’s Power systems and it is also in talks with Qualcomm that could result in its using some of its ARM-based server chips.
Amazon is the leading provider of cloud infrastructure followed by Microsoft, IBM and Google. This is another chip-hungry segment with long-term demand for the devices. This is perhaps the reason that some time back, Amazon started dabbling with low-end ARM-chips. The company looks interested in making its own devices, but it’s still too early to comment on its progress. Meanwhile Google is testing IBM and ARM technology while Microsoft is collaborating with Qualcomm to use ARM technology in its internal servers. It is probably only a matter of time before Intel sees notable competition.
Intel’s only course of action is to innovate around the problem (increasing performance while reducing cost per watt is a way it could do this). After all, it’s hard to convince people that you deserve to make a nice margin. Another significant development is Intel’s decision to license ARM technology perhaps to support its foundry business, or help it speed up its IoT effort, or maybe even to use in some segments of the cloud computing market.
Another important segment for semiconductor companies that is relatively low-key is Industrial. Since semiconductors facilitate increased automation on the factory floor, they are increasingly used to drive efficiency and lower cost. Reportedly, PricewaterhouseCoopers (PwC) expects the industrial semiconductor market to grow at a CAGR (compounded annual growth rate) of 9.7% between 2014 and 2019.
A Global Industry Analysts (GIA) report says that the U.S. is the largest market for industrial semiconductors although the Asia/Pacific is the fastest growing on account of its being a manufacturing hub. The overall market is expected to be worth $60 billion by 2022.
IC Insights estimates that global medical semiconductor sales will grow at a 12.3% CAGR to reach $8.2 billion in 2018. It’s not clear if this estimate includes wearables that are normally considered IoT and therefore included in consumer. Wearables carry an increasing amount of medical information and consume a good number of semiconductor devices.
Databeans attributes continued strength in this vertical to the need to reduce healthcare cost (expected to double from the current $2.5 trillion over the next few years), the need to extend healthcare to underserved areas and convenience/the need to improve overall disease management from the comfort of your own home.
One of the fastest-growing emerging markets for semiconductor devices is automotive, as the consumption of electronic components for safety, infotainment, navigation and fuel efficiency continues to increase. A recent report from MarketsandMarkets says that the automotive semiconductor market will grow at a CAGR of 5.8% from 2016 through 2022.
Power components like MOSFET and IGBT devices are some of the fastest growing because of the increased electrification of vehicles. The growing middle class in several Asian markets like China, India, Thailand, Indonesia and Malaysia is greatly increasing the demand for passenger cars thus accounting for most of the semiconductor shipments into the automotive market.
Semiconductor consumption in this market was worth around $7 billion in 2015, according to Reportlinker. Primary areas of strength were hybrid electric vehicles, telematics and connectivity, and advanced driver assistance systems (ADAS), where the estimated 5-year CAGRs for chip demand are 20%, 19% and 18%, respectively.
Infineon, STMicroelectronics, Renesas (which acquired Intersil), Texas Instruments (TXN), Analog Devices (ADI) and Spansion (owned by Cypress) are important players. Qualcomm, after its acquisition of NXP Semiconductor, which itself acquired Freescale Semiconductor, has become a major player in automotive semiconductors.
Similar to medical devices, the auto market also has an emerging adjacent market in the form of autonomous/self-driving cars that will consume a huge number of semiconductors, particularly the sensors, processors and other technology enabling the vehicles.
Wireless infrastructure builds have been necessitated by increasing data volumes and connectivity issues (network congestion, power reliability, privacy and security) in wireless networks. These builds will require increased investment in semiconductors thus driving sales. New materials (a compound of two or more) are being used in this segment with Galium Nitride gaining share of RF high-power semiconductors, according to ABI Research.
According to Strategy Analytics, the greatest driver of these compound semiconductors is the convergence of voice, video and data networks that is leading to the explosive growth of data traffic across wireless devices, within fixed and wireless networks, in driver assistance systems, in network-centric battlefield philosophies, solid-state lighting and high-power electronics. The firm expects compound semiconductor revenue to grow at a 13% compounded average annual growth rate (CAAGR) to double revenue to $11 billion by 2020.
The PC market still consumes a large number of chips but its importance as a driver continues to decline. That’s because the market itself is shrinking (Gartner estimates that it declined 5.7% in the third quarter while IDC estimates that it declined 3.9%). IDC believes that North America grew for the second straight quarter while Gartner says that sales were consistent with year-ago periods. Both agree on declines in the Asia/Pacific.
Consumers are hesitant to spend on upgrades given that they already have many more devices than they need (developed markets) and because Internet and many other conveniences of computers are now easily available on smartphones and tablets (emerging markets). But gaming enthusiasts demand stronger and faster machines, which is the main driver of PC sales and chips right now.
In either case, it’s very clear that the steady growth seen in yesteryears is history. IDC for one expects the PC market to shrink 2.1% in 2017. So semiconductor players with PC market exposure can at best profit from market share gains, BYOD exposure and increased exposure to the top PC vendors, which are Lenovo, HP, Dell, Asus and Apple according to both IDC and Gartner.
Apple makes its own PCs, software and also a lot of its own processors, relying largely on Intel, Qualcomm and Samsung for its other semiconductor requirements. Microsoft makes software and limited quantities of hardware, relying largely on third-party device makers for chips, PCs and mobile devices. It’s also a major player in the cloud, which makes it an important ally for semiconductor companies like Intel, Qualcomm or NVIDIA. Alphabet’s chromebooks on the other hand are made by a number of hardware makers that use either Intel or ARM technology.
Traditionally, the consumer technology market included smartphones, tablets and electronic gadgets like LCD TVs and Blu-ray players. But that is changing as we speak with the Consumer Technology Association (CTA), formerly called Consumer Electronics Association ("CEA") estimating that U.S. consumer technology retail sales will be driven by IoT this year to touch $286.6 billion.
Moreover, these traditional segments are expected to decline this year with their contribution dropping to less than 50% of total sales for the first time next year. Smartphones, tablets and TVs are mature categories with shipments expected to grow a respective 4%, -2% and -1%. Laptops will decline 6% (the estimated growth rate for hybrids, convertibles and detachables wasn’t refreshed, so assuming it remains at 48%.)
Of the emerging technology categories, ultra 4K HD TVs will grow 105%; wearables will grow 39% (fitness trackers up 60%, smart watches up 15%); Smart Home encompassing products like thermostats, smart smoke and CO2 detectors, IP/Wi-Fi cameras, smart locks, smart home systems, and smart switches, dimmers and outlets, will grow 29%; drones will grow 112%, VR 296%, voice-activated digital assistants like Amazon’s Echo 32% and 3D printing 56%.
Most of the emerging technology categories fall in the category more commonly referred to as Internet of Things (IoT). A recent McKinsey report says that the installed base of IoT devices was in the range of 7-10 billion at 2015-end and is expected to increase by about 15-20% annually over the next few years to 26-30 billion units by 2020.
IC Insights estimates that IoT semiconductor sales will increase 19% in 2016 to $18.4 billion and will grow at a CAGR of 19.9% from 2014 to 2020. For 2016, The firm expects IoT semiconductor revenue growth in smart cities of 15% to $11.4 billion, connected vehicles 66% to $787 million, wearables 22% to $2.2 billion, connected homes 26% to $545 million and industrial Internet chip 22% to $3.5 billion.
However, despite the strong revenue prospects, this is still a nascent market with several challenges to its continued growth. These would be security/privacy because of the huge amount of data generated and collected, still-limited availability of consistent standards enabling interoperability, relatively low ROI for chipmakers necessitating the integration of additional technology or the final product by the chipmaker, and the possibility of a growing number of niche products.
Companies are doubling down on these challenges. For instance, Freescale (now part of NXP) is part of the Embedded Microprocessor Benchmarking Consortium (EEMBC) to identify embedded security gaps and set guidelines for IoT manufacturers to make more secure devices.
Also, both Intel and ARM (now acquired by Softbank) have increased focus on security. Intel is working on building chip-level security while also facilitating security in the cloud through the McAfee Data Exchange Layer. In ARM’s case, the company acquired Israeli startup Sansa, which offers both hardware security technology and software for advanced SoCs used in the IoT market. The company will likely build some security features into its designs.
On the standardization front, companies like Intel, IBM, Cisco, GE and AT&T have formed the Industrial Internet Consortium to develop common standards. The process could take time but once available, the standards could generate higher-margin revenue for semiconductor players. There will however be increased scrutiny on privacy considerations.
The Semiconductor Industry Association (SIA) estimates that semiconductor sales in 2016 were up 1.1% from 2015 levels (versus expectations of a 0.1% increase. Logic, memory and micro-ICs were the top three segments, sensors and actuators was the fastest growing segment (up 22.7%), NAND Flash (up 11.0%), DSP (12.5%), diodes 8.7%, small signal transistors 7.3% and analog 5.8%.
Regionally, China was strongest (up 9.2%) followed by Japan (up 3.8%), while Asia Pacific/All Other dropped 1.7%, Europe dropped 4.5% and the Americas were down 4.7%. WSTS data projects 2017 growth of 6.5% (previous 3.3%) driven by sensors, analog and memory. It will be followed by 2.3% growth in 2018.
IC Insights has doubled its 2017 growth forecast to 11% (previous 5%) because of significant upward revisions in DRAM (up 39%) and NAND (up 25%) sales. The increase will be driven by higher prices (37% for DRAM and 22% for NAND).
Gartner estimates that semiconductor capital spending will rise 2.9% in 2017, down from 5.1% growth in 2016. But packaging and assembly equipment will grow 10.7%, wafer level manufacturing equipment will grow 6.0% and wafer fab equipment 5.7%.
The Semiconductor Industry serves as a driver, enabler and indicator of technological progress. Developments in the industry determine the way we work, transport ourselves, communicate, entertain ourselves, defend ourselves and respond to our environment.
The emergence of categories like health monitoring devices and home automation gadgets, and the increased automation on factory floors, automobiles and elsewhere have added a new dimension to the industry. Environmental concerns and the need for judicious use of resources have also opened upopportunities in the form of chipsreducing power consumption, reducing heat dissipation, capturing solar energy, creating more efficient lighting solutions and so forth.
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