Chip stocks are having a really good quarter so far, with the typical beat and raise results we would expect in a thriving economy, something like what we had right before the pandemic hit. But while the pandemic has hit several other sectors real bad, this one seems to have come out unscathed. And if you think about it, it’s with good reason.
First of all, semiconductor manufacturing is a highly mechanized process and requiring the cleanest operating environment you could possible arrange for. Even small variances in environmental factors can result in costly changes you weren’t looking for.
The nature of manufacturing in itself requires you to take utmost care in this regard. So it was already optimally set up to deal with the pandemic. Also, it’s relatively simpler to transfer design processes to the home once security measures are set up. This is not the case for most other sectors.
Second, many of the markets driving semiconductor demand, such as cloud and computing, had exceptionally strong quarters, so there was no inventory buildup as would be the consequence of falling demand in these markets.
Third, the end products that use semiconductors come to market long after the semiconductors are actually sold. So sales are driven by the future outlook (and the general perception about the future outlook) for items using them.
So for instance, a company making smartphones would be planning for the fall or the holiday season while a company making TVs, or the different gadgets melting barriers between the traditional TV and digital entertainment would probably plan for the holidays. Then again, companies building 5G infrastructure or boosting AI capabilities, or building out their cloud, or making medical devices (in some categories at least) would be buying for consumption, as the nature of consumption in these markets is on an ongoing basis.
Since consumption for 5G infrastructure, 5G smartphones, AI, computing, medical goods are expected to increase rather than decline irrespective of how the pandemic plays out, and since entertainment has been kind of pulled into the just-concluded quarter because of lockdowns and stay-at-home orders, end market demand for semiconductor devices is expected to remain consistently strong.
Fourth, Huawei has been a bit of an offsetting factor for those that had dealings with it because of government orders and directives. And there were initially some supply chain issues that turned around pretty quickly.
Now for the stocks in question-
Skyworks Solutions, Inc. SWKS
Skyworks’ fiscal third-quarter earnings of $1.25 beat the Zacks Consensus Estimate by 10.6% on revenue of $737 million that beat by 6.8%.
This is basically a 5G story. The quarter’s results were driven by increased adoption of its 5G applications at leading smartphone OEMs and IoT customers all over the world with particular strength in China where 60% of all smartphones sold were 5G-enabled.
Key 5G design wins at Samsung, Motorola, Oppo, Vivo and Xiaomi as well as numerous others across varied end markets (including IoT, which is helping it diversify beyond smartphones) were highlights of the quarter.
Fourth quarter guidance was for earnings of $1.51 on revenue of $840 million (at the mid-point). The Zacks Consensus Estimate has moved up a penny to $1.42, so further revisions may be in cue. 2020 and 2021 estimates are up by a respective 3 cents and 4 cents. The average sales estimate is also much lower than guidance, at around $786 million.
The surprise history has been quite consistent in the last six quarters.
The quarterly dividend was raised 14% to $0.50 a share.
The Zacks Rank #2 (Buy) stock belongs in the Semiconductors - Radio Frequency industry, which is in the top 46% of Zacks-ranked industries. Its VGM Score is B, making it a reasonably good investment for most.
STMicroelectronics N.V. STM
STMicroelectronics’ second quarter earnings of 10 cents were a couple of cents above the Zacks Consensus Estimate. Its revenue of $2.09 billion was above the estimated $2.0 billion.
Nevertheless, STM did see some challenges in the quarter-
These were in imaging, automotive and MEMS markets and were partially offset by strength in microcontrollers, digital, analog and discrete power devices. Saturation charges, including on account of COVID-related operational and logistical issues stemming from government regulations (normalized during the quarter) as well as pricing pressure impacted results.
STM broadly classifies its end markets into automotive, industrial, personal electronics and communications equipment & computing peripherals.
The real long-term opportunity in auto is in electrical, digitization, automation etc and there was no weakness in any of these. Legacy auto had issues and likely bottomed in the last quarter. China’s recovery in Q2 partially offset U.S. and Europe.
Industrial is expected to remain strong with multiple design wins and awards. STM even closed a couple of acquisitions during the quarter to further strengthen its portfolio.
The slowdown in the smartphone market impacted the personal electronics business (design wins including for 5G continued, which bodes well for future quarters). There was strength in accessories, wearables, gaming, as well as continued innovation-driven semiconductors.
Servers and 5G drove demand in comms/comp peripherals.
Year-over-year sales to distribution increased 9.7% while sales to OEMs decreased 9.7%.
The company doesn’t provide earnings guidance. Revenue guidance of $2.45 billion remains below third-quarter 2019, but represents sequential growth of over 17%.
The Zacks Rank #2 stock belongs in the Semiconductor – General industry, which is the top 16% of Zacks-classified industries. The Zacks Consensus Estimate for the September quarter is up 3 cents (21.4%). The estimate for 2020 and 2021 are both up 4 cents in the last seven days. It does appear that the second quarter was the bottom for STM, overall.
Texas Instruments, Inc TXN
Texas Instruments reported earnings of $1.48 cents, thrashing the much-lowered Zacks Consensus Estimate of 88 cents. Earnings came in higher than both the previous and year-ago quarters. Even excluding the one-time tax benefit of 33 cents, it was significantly higher than estimated but down from prior periods.
Revenue of $3.24 billion was lower than the previous and year-ago quarters but easily beat the Zacks Consensus Estimate of $2.96 billion.
Most of the weakness was related to the automotive market, which management said normalized in May as Europe and North America returned to production.
TI has the advantage that it makes long-lived products so by maintaining the greatest flexibility in production, it is able to cater to customer demand within relative short time periods. Management intends to maintain this flexibility to cater to even those customers that are still unable to accurately forecast demand.
Another thing that can prove helpful is the strategy of gradually eliminating distributors to sell directly to customers. This could further reduce lead times and bring more efficient inventory management, especially in times of uncertain demand.
Third, management remains focused on ti.com, where it maintains immediately shippable inventory of more than 40,000 products.
This strategy helped results in the last quarter and should continue to help going forward.
The company continues to pay a quarterly dividend of $0.90 a share and management assured that there’s no threat to it.
Following the strong results, the Zacks Consensus Estimate for the September quarter is up 34 cents (37.4%) while estimates for fiscal 2020 and 2021 are up $1.01 (25%) and 49 cents (10.1%), respectively. Obviously, analysts feel that they’ve grossly underestimated TI’s strengths and they’ve adjusted accordingly.
The Zacks Rank #1 (Strong Buy) stock also belongs in the Semiconductor – General industry, which is the top 16% of Zacks-classified industries. Its VGM Score is B.
While the above results look good, it’s important to remember that a good investment doesn’t just come from good prospects but from good prospects at the right price. That’s why we should also consider the valuation.
Let’s take SWKS first. The stock is trading at 20.73X forward earnings, which is closer to its median value of 18.50X than its six-month high of 25.80X.
STM on the other hand is trading at 27.23X, which is closer to its six-month high of 29.93X than its median value of 20.05X.
TXN on the other hand is trading at 24.89X, which is below its median value of 25.55.
Since the S&P 500 is trading at its six-month high, all the stocks look good in comparison. But TXN looks the best, both in terms of its prospects and in terms of the price to be paid.
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