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Semiconductor Industry Outlook - December 2017

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This year is expected to be robust for the semiconductor industry, not just because of surging demand in some new and existing end markets but also because of supply constraints in key product categories that have led to very strong pricing.

As a result, worldwide company rankings (in terms of sales dollars) are moving around quite a bit. In 2017, IC Insights expects Intel (INTC - Free Report) to relinquish the top position to Samsung for the first time since 1993. S K Hynix, Micron, Broadcom, Qualcomm, Texas Instruments, Toshiba, NVIDIA and NXP are the others making it to the top 10. This means that both Hynix and Micron will jump a couple of spots and NVIDIA will break into the top 10 for the first time.

The integrated circuit market comprised 81.6% of the total semiconductor market in 2016 according to WSTS data, so it bears significant influence on total market performance. Integrated circuits are expected to grow 22.9% this year after negligible growth in 2016, but growth rates will drop off to 7.0% in 2018.

 

As evident from the above chart, the memory category within integrated circuits is making waves this year, although the growth rate isn’t expected to sustain through 2018 as demand-supply imbalances are reduced. For 2017, DRAM ASP growth of 77% will push DRAM market growth of 74%, the highest growth rate since 1994. DRAM will be the single biggest category within semiconductors in 2017. The NAND flash ASP will grow 38%, supporting a 44% increase in the NAND flash market. This will lead to memory market growth of 58% this year, followed by another 11% increase in 2018.

The discrete, optoelectronics and sensor categories are also expected to look up this year. According to IC Insights, discretes will grow 10.3% despite commoditization with power transistors (half of all discretes worldwide) growing 9.0%. The 8.1% growth in optoelectronics will be driven by strong double-digit sales increases in CMOS image sensors (+22%), light sensors (+19%), optical-network laser transmitters (+15%) and infrared devices (+14%). The 17.5% growth in sensor/actuator sales will come on the back of strength in actuators (+20%); pressure sensors, including MEMS microphone chips (+18%); and acceleration/yaw sensors (+17%).

The primary end market driver of growth for these components is IoT, supported by intelligent embedded controls within devices and some inventory replenishment in commodity discretes.

In the Zacks universe, the semiconductor industry is made up of 15 sub-sectors (including 4 for semiconductor equipment) organized under 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 255 sub-sectors or industries. These “X” industries are then grouped in two: the top half (i.e., industries with the best average Zacks Rank) and the bottom half (industries with the worst average Zacks Rank). Over the last 10 years, using a one week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (Click here to know more: About Zacks Industry Rank)

Therefore the Zacks Industry Rank is a good indicator of investment opportunities within an industry at any given time. Moreover, because stocks in the same X industry have certain common positive or negative factors affecting them, it has been observed that there is some positive correlation between them.

The X industries pertaining to semiconductor stocks have been tabulated below. The list clearly displays the kind of industries likely to have more winners. The last column enlists our picks, which are basically Zacks Rank #1 (Strong Buy) or Rank #2 (Buy) stocks within these industries.

 

 

 

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 in the last-reported quarter.

From the latest earnings trends report, we see that 98.4% of technology stocks have reported third quarter results with both top and bottom line averages bettering the S&P 500. Overall, technology stocks’ earnings were up 20.9% from the year-ago quarter on 8.6% revenue growth. This compares with earnings and revenue growth of 17.1% and 7.7%, respectively in the second quarter. Also, 77.0% of technology stocks beat earnings estimates compared to 72.5% for the S&P 500. The beat ratio for revenue was even higher at 85.2% with the S&P 500 averaging much lower at 67.2%.

Primary End Markets

IC Insights has categorized the electronics systems being manufactured globally this year with an estimated total value of $1.49 trillion:

 

The research firm says that while communications and computing are the biggest consumers of electronics systems this year, automotive is the fastest growing part. As a result, automotive ICs are expected to grow 22% in 2017 followed by 16% growth in 2018. The consumer IC market will grow 2.4% in 2017. While computing ICs will grow 25% in 2017, it will be mostly because of higher DRAM and NAND flash prices.

End Market Commentary

The miniaturization and integration of semiconductors has given rise to smaller, lighter and more portable devices like tablets, smartphones and the emerging self-driving and IoT devices. This, along with increased digitization of work and leisure activities, has led to huge data volumes. The creation and analysis of this data has led to artificial intelligence systems that are having an increasing impact on business decisions and consumer experience.

Communication chips are required at every stage of this process, so they are very important and growing component of the semiconductor market. IC Insights expects that electronics systems used in communications activity will grow at a 4.2% CAGR from 2016 through 2021. The Asia/Pac region will grow the strongest this year, producing 69% of all communications chips.

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.

Sheer computing power is a bigger requirement of the data center segment, where cloud computing and HPC are the drivers. The PC market is almost at a standstill, except for gaming PCs and laptops.    

In the data center, Intel flourishes on the enterprise side and NVIDIA (NVDA - Free Report) on the HPC side. Since HPC is required for machine learning that will have a far greater impact across industries, Intel would like a toe hold. So it has recently partnered with long-time rival Advanced Micro Devices (AMD - Free Report) to create a system based on Nervana architecture, marrying computing power with graphics computing power and 3D XPoint memory that it says will be able to match or better NVIDIA solutions. But that is easier said than done since NVIDIA has a huge lead and will do more to expand that lead.

Customer relationships are also an important thing, since the more data a machine learning system processes the better it becomes. Both Intel and NVIDIA 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. With a $16 billion artificial intelligence market (according to marketsandmarkets) by 2020 waiting to be tapped, it’s no wonder that players are going all out to grab their share.

Some disruption is afoot in the enterprise segment as well because of the work done by the Open Compute Project (OCP) that Facebook (FB - Free Report) 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 - Free Report) , Microsoft (MSFT - Free Report) and Google, and differing interest like Intel, HP, Cisco (CSCO - Free Report) and Juniper are also part of the project.

Facebook designs hardware 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. Intel being part of the effort implies that it is working to get its technology in as part of the standard.

Another challenge for traditional semiconductor players includes Google, which is working with International Business Machines’ (IBM - Free Report) 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. Since infrastructure providers need a huge number of chips, each has its own development efforts. Amazon for instance has acquired and hired people for the purpose; Google has announced that it is testing IBM and ARM technology while Microsoft is collaborating with Qualcomm to test ARM designs.

Cost per watt, reliability and low-latency are factors determining purchases and it’s possible that all these efforts will eventually beat Intel. It’s only when (or if) these players take their consumption in house will there be pressure on semiconductor players. In that case, Intel the incumbent will be the worst affected.

Electronic systems used in industrial/medical/other applications will grow 4.6% this year driven by robotics, wearable health and other IoT devices (IC Insights). 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. IHS Markit says that the market grew 3.8% in 2016 to $43.5 billion driven by commercial and military avionics, digital signage, network video surveillance, HVAC, smart meters, PV inverters, LED lighting and various medical electronics.

The U.S. is the biggest spender but improving economic conditions in Europe, China, India and Brazil also drove demand. 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.

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 $321 billion (estimate six months earlier was $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 3%, -5% and -1%. Laptops will grow 2%.

Of the emerging technology categories, ultra 4K HD TVs will grow 59%; wearables will grow 9% (includes fitness activity trackers, other health and fitness devices, hearables, over-the-counter hearing devices and smartwatches); 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 50%; drones will grow 40%, VR 79% and voice-activated digital assistants like Amazon’s Echo 53%. 

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. IC Insights attributes the strength in auto chips to increasing attention focused on self-driving (autonomous) vehicles, vehicle-to-vehicle (V2V) and vehicle-to-infrastructure (V2I) communications, as well as on-board safety, convenience, and environmental features, and growing interest in electric vehicles. It expects this trend to drive demand for analog ICs, MCUs and sensors. The research firm, however, sees pricing pressures on both ICs and electronic systems.

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.

Infineon, STMicroelectronics, Renesas (which acquired Intersil), Texas Instruments (TXN - Free Report) , Analog Devices (ADI - Free Report) and Cypress are important players. Qualcomm, after its acquisition of NXP Semiconductor, which itself acquired Freescale Semiconductor, will become a major player in automotive semiconductors. If Broadcom (AVGO - Free Report) succeeds in its acquisition of Qualcomm with or without NXP, it will become another major player in the segment.

The automotive market has an emerging adjacent market in the form of autonomous/self-driving cars that will consume a huge number of semiconductors, particularly sensors, processors and other technology enabling the vehicles.

Most of the emerging technology categories fall in the group 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 16.2% in 2017 to $21.3 billion and will grow at a CAGR of 14.9% from 2015 to 2020. For the period, semiconductor revenue growth in smart cities of 8.9%, wearables 17.1%, industrial Internet 24.1%, connected homes 21.3% and connected vehicles 32.9%.

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, 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. ARM 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.

Definition

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 up opportunities in the form of chips reducing power consumption, reducing heat dissipation, capturing solar energy, creating more efficient lighting solutions and so forth.

 

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