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While supply constraints impacting some players are likely to continue through much of this year, the strong demand environment is leading to price increases and long-term supply agreements (for some).
The longer-lasting impact of the pandemic is overwhelmingly positive for the industry because it provides the building blocks of technology that everyone is relying on for maintaining social distancing and remote operations.
Moreover, technological advancements in the way we do computing, as well as artificial intelligence, Internet of Things, 5G, driverless cars and a host of other things that will greatly increase our reliance on the digital world are secular drivers for the industry.
Therefore, there are huge prospects in this market and it’s a place we should all be in. Our current picks are Analog Devices, Microchip Technology, Monolithic Power Systems, NXP Semiconductors and ON Semiconductor.
– Zacks
About The Industry
We generally use our electronic gadgets without thinking, expecting them to accurately read our commands, and record, store, retrieve and process the information we throw at them. The complex process that makes this possible is 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). Most electronic gadgets use a combination of these components.
The industry is cyclical and prices are elastic. Given their application across automotive, communications, computing/cloud/data center, industrial, medical, IoT and other markets, these semiconductor suppliers serve multiple markets that offset their individual seasonality.
Factors Driving The Industry
- The increasing use of electronics in vehicles, airplanes and defense equipment; increased factory automation; greater penetration of smartphones, tablets, notebooks, PCs and all manner of personal computing and other personal devices and smart household appliances; communications infrastructure moving to 5G; greater reliance on cloud infrastructure; the advent of artificial intelligence (AI), the Internet of Things (IoT), more advanced medical devices, EVs, self-driving cars etc is leading to unprecedented demand for semiconductor chips. Since we simply aren’t making as many chips as we need, supply chains are being optimized to the maximum. Since the pandemic hit in such a situation, manufacturers had no option but to divert production to things immediately in demand, which in this case were the cloud, household items, personal computing and devices, etc. It helped that automakers cut back orders at around this time in anticipation of a protracted weakness in the market. But when people wanted to move out again, they preferred their own transportation, which increased demand for vehicles. But production diverted to these other things simply couldn’t be redirected at such short notice. And this is the reason behind the global chip shortage. Company chiefs are guessing that the great shortage will continue through most of this year despite considerable effort to redirect some production and also bring new capacity online. This should support continued strength in prices.
- With vaccines rolling out rapidly, many segments of the economy that were only partially operational are expected to open up while not all the work and school that moved home is coming back. This is leading to the hybrid model, where more people move out of their homes more often but not all the time. The expectation is for the return of a certain level of normalcy in the second half of the year, but with flexibility to work from home becoming something that many employers and employees want, the expansion of the overall electronic footprint appears permanent. So, demand for traditional computing equipment like PCs and newer-age tablets should remain strong. Consumer devices incorporating newer technologies to enable more experiences, will add to this demand. The number of semiconductors per device and their complexities will also continue to increase. R&D budgets focused on responding to increased competition and the expanding scope of digitization will therefore also increase.
- Secular drivers for the industry are data center growth (from the continuing shift in workloads to the cloud, which was accelerated by the virus), the advent of artificial intelligence (which is huge because it will permeate every aspect of life and living and is still a market in the making), IoT (which is another market in the making and will tremendously expand the scope of computing) automated vehicles (AVs) and electric vehicles (EVs) (that use many more chips than traditional auto).
- The adoption of 5G communications technology, enabling 10X the data rate as 4G, is another 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. With the economy continuing to open up and the virus looking like it’s on its way to becoming endemic, this segment should only get stronger.
- Industry consolidation continues as the cost and complications of making chips rises in an environment where the adoption of semiconductors in devices of varying value requires prices to decline. Acquisitions are also driven by the need to expand capabilities and acquire of key talent.
- U.S. that government officials worry that none of the most advanced chips are currently manufactured in the country. This is considered to be a national security concern given that semiconductors are playing an increasingly larger role in AI-driven electronic weaponry and surveillance mechanisms. So the government is trying to incentivize companies to build in the U.S. TSM, the main supplier to the U.S. is setting up in the country but the plan is to have this on a much larger scale. How exactly this situation will play out for the industry is unknown. Increasing capacity would depress prices. And U.S. production would increase cost. So much depends on what the government bears.
Zacks Industry Rank Indicates Attractive Prospects
The Zacks Semiconductor – Analog and Mixedindustry is housed within the broader Zacks Computer and Technologysector. It carries a Zacks Industry Rank #36, which places it at the top 14% of more than 250 Zacks-classified industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates attractive 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 top 50% of the Zacks-ranked industries is a result of positive earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions over the past year, it is clear that analysts are optimistic about this group’s earnings growth potential. So 2021 estimates have risen 31.9% over the past year, while 2022 estimates have risen 27.2%.
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.
Stock Market Performance Is Average
The Zacks Semiconductor – Analog and Mixed industry has lagged the broader Zacks Computer and Technology Sector as well as the S&P 500 index though much of the past year. But it has pulled ahead of the broader sector in December.
Overall, the industry added 20.6% to its value over the past year while the broader sector added 18.0% and the S&P 500 24.6%.
One-Year Price Performance
Image Source: Zacks Investment Research
Industry???’s Current Valuation
Although trading at a higher multiple than the S&P 500 on the basis of forward 12-month price-to-earnings (P/E) ratio, it is 7.3% below its own median value over the past year. The S&P 500 is trading at a lower multiple but is only 2.8% below its median level. So now, the industry’s multiple is 23.24X while to the S&P 500’s 21.26X. It is however slightly undervalued compared to the sector’s forward-12-month P/E of 27.13X.
The industry is currently trading at its lowest point of 25.08X over the past year. Its highest point over the past year is 26.77X.
Forward 12 Month Price-to-Earnings (P/E) Ratio
Image Source: Zacks Investment Research
5 Promising Stocks Offering Exposure To The Industry
Analog Devices (ADI): The company’s integrated circuits offer small form factor, low-power, radio-frequency (RF) analog and mixed signal semiconductor products including converters, power management products, amplifiers, RF and microwave ICS, accelerometers, gyroscopes and a host of other products, primarily targeted at the industrial, automotive, consumer, instrumentation, aerospace, and communications markets.
Analog Devics has benefited from strength in the industrial and automotive markets, which reached all-time highs in fiscal 2021 (ending October). High-end consumer also delivered strong growth. The Maxim acquisition brought engineering talent and also expanded the product portfolio. Given the level of demand, Analog Devices is adding capacity, which should support its future growth.
Analog Devices beat estimates by 2.4% in the last quarter. Its fiscal 2022 EPS estimate has increased 37 cents (5.2%) in the last 60 days while the 2023 estimate increased 30 cents (3.8%).
Shares of this Zacks Rank #1 (Strong Buy) stock are up 9.0% in the past year.
Price and Consensus: ADI
Image Source: Zacks Investment Research
Microchip Technology Incorporated (MCHP): Microchip develops and manufactures microcontrollers, memory and analog and interface products for embedded control systems, which are small, low-power computers designed to perform specific tasks.
The company’s revenues stagnated through 2020 but have picked up strongly since then. It is currently seeing particular strength in the automotive, industrial and consumer markets, which are seeing above-seasonal strength. Low channel inventories and supply constraints are raising some material and subcontracting costs while high demand is allowing price increases. Despite extension of capacity, the exceptionally high demand is allowing the company to build backlog extending well beyond the current quarter. Moreover, most of the backlog, especially in constrained areas, is coming through its Preferred Supply Program, which further improves visibility. It is also refinancing its debt on more favorable terms while extending maturities. Management continues to increase the dividend.
The company performance in the last quarter was more or less in line with the Zacks Consensus Estimate and the estimate for fiscal 2022 (ending March) increased a couple of cents in the last 60 days. The 2023 estimate increased 6 cents in the same time period.
The shares of this Zacks Rank #2 (Buy) company are up 13.4% over the past year.
Price and Consensus: MCHP
Image Source: Zacks Investment Research
Monolithic Power Systems (MPWR): The company designs, develops, and markets integrated power semiconductor solutions and power delivery architectures for computing and storage, automotive, industrial, communication, and consumer applications markets.
Monolithic Power has not felt any negative impact from the pandemic at all. In fact, being a semiconductor company, it has been one of the enablers of the digital economy that supported the economy during this time. As a result, the company has seen particularly strong revenue growth from the June quarter of 2020. It has also benefited from its long-term customer relationships and share gains, particularly in higher-margin categories. This is helping the company to absorb the rising costs without much impact on its bottom line.
Monolithic Power topped estimates by 3.0% in the last quarter. Its 2021 EPS estimate has increased 10 cents (1.4%) in the last 90 days. Additionally, its 2022 estimate increased 33 cents (4.0%).
Shares of this Zacks Rank #2 stock are up 15.5% over the past year.
Price and Consensus: MPWR
Image Source: Zacks Investment Research
NXP Semiconductors N.V. (NXPI): The company offers microcontrollers, application processors, communication processors, wireless connectivity solutions, analog and interface devices, RF power amplifiers, security controllers, and semiconductor-based environmental and inertial sensors, including pressure, inertial, magnetic, and gyroscopic sensors. Its products are primarily targeted at the automotive, industrial, IoT, mobile and communication infrastructure markets.
The strong demand NXPI is currently seeing is expected given its significant exposure to auto and industrial end markets. The company has prepared to ship higher volumes given the constrained environment and expects the situation to generate additional revenue through this year.
NXP beat estimates by 2.9% in the last quarter. The Zacks Consensus Estimate for 2021 has jumped 27 cents (2.6%) in the last 90 days. The 2022 estimate jumped 55 cents (4.8%) during the same period.
#2 ranked NXP shares are up 30.8% over the past year.
Price and Consensus: NXPI
Image Source: Zacks Investment Research
ON Semiconductor Corporation (ON): The company is an original equipment manufacturer (OEM) of a broad range of discrete and embedded semiconductor components, including power management, logic, signal processing, memory and application specific integrated circuits (ASICs). It also offers foundry services. It serves players in the automotive, industrial, medical, aerospace/defense, communications, networking, wireless, consumer, and computing markets
The company is another beneficiary of the current strength in the automotive and industrial markets, both of which are in the middle of a strong growth phase. Additionally, its highly differentiated power management solutions have enabled it to generate new design wins and market share gains. With auto customers entering into long-term supply agreements, the company stands to benefit from the improving visibility and better asset allocation. On Semi is also well positioned to capitalize on the emerging EV opportunity, as well as the rapidly expanding alternative energy market (mainly solar farms).
ON Semi beat September quarter estimates by 17.6% after which the 2021 estimates for this Zacks Rank #2 company increased 32 cents (12.9%). The 2022 estimate increased 51 cents (18.4%).
The shares are up 80.4% over the past year.
Price and Consensus: ON
Image Source: Zacks Investment Research
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