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.
Some of the leading players in the industry include Analog Devices (ADI) and Maxim Integrated Products (MXIM).
Here are three major themes in the industry:
- The most important theme at this point is the impact of the coronavirus. And this impact is both significant (considering the effect on both the demand and supply sides) and hard to pin (because it’s changing every day). The problem started in China, so it was the supply chain that was impacted initially. But because of channel inventories and seasonal softness in the first quarter, numbers, while being weak, aren’t likely to capture the whole effect. Because in the final weeks of the quarter, the virus spread all over the world, impacting not just supply but also the demand situation. So, because of the opacity surrounding anything Chinese, we don’t really know how badly the supply chain remains impacted, how many workers are really available/alive and on the job and if government workers (the ones passing export orders) are also back. Reports indicate that Asian countries making the chips, packaging, etc are nearing normalcy as far as semiconductor production is concerned. Other reports say that there’s a second outbreak in China. Additionally, the virus has ravaged most of Europe and America and also other parts of the world, which is mostly also in lockdown. So new devices consuming these chips are probably not in high demand at this point. Whether demand picks up, and to what extent it picks up will depend on how quickly economies get back on track. And that is a big unknown.
- At the same time, secular drivers like data center growth (from the continuing shift in workloads to the cloud, which continues in the current situation as well), the advent of artificial intelligence and IoT that expand the scope of computing remains. R&D budgets focused on responding to increased competition and the expanding scope of digitization are likely to see cuts. M&A, which has anyway become more difficult because a significant amount of industry consolidation has already happened, is also likely to come to a grinding halt. So the goals of expanding capabilities and acquisition of key talent could move toward conservatism and thrift. The automotive segment has attracted a lot of investment of late because the level of electronics per car, automation, clean energy, etc. has created increased scope for the industry. This should see a marked slowdown until the situation normalizes. Demand for traditional computing equipment like PCs and even newer-age tablets could be a bit of a bright spot as more work and education is done at home.
- 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. This is also a brighter spot, but a slowdown until the virus impact is clearer seems inevitable.
The challenge of rising cost and complications of fabricating chips remains while their broader adoption across devices of varying value requires prices to decrease.
There’s also a longer term challenge 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 ongoing trade war is increasing uncertainties.
Zacks Industry Rank Indicates Ongoing Concerns
The Zacks Semiconductor – Analog and Mixedindustry is housed within the broader Zacks Computer and Technologysector. It carries a Zacks Industry Rank #172, which places it at the bottom 32% 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 down 32.0% while for 2020, it is down 27.6%.
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 Ahead on Stock Market Performance
The Zacks Semiconductor – Analog and Mixed Industry has trailed both the broader Zacks Computer and Technology Sector and the S&P 500 index over the past year. The industry also appears more volatile, rising a bit more than both the S&P and the sector in stronger periods and falling a bit more in down periods.
Overall, the industry lost 15.0% of its value over this period compared to the broader sector’s decline of 2.6% and S&P 500 index’s decline of 8.0%.
One-Year Price Performance
Industry’s Current Valuation
On the basis of forward 12-month price-to-earnings (P/E) ratio, which is a commonly used multiple for valuing semiconductor companies, we see that the industry is currently trading at 19.2X compared to the S&P 500’s 17.0X. It is however slightly undervalued compared to the sector’s forward-12-month P/E of 19.7X.
The industry is currently trading in the middle of its annual range of 15.9X to 22.8X and close to its median of 19.2X, as the chart below shows.
Forward 12 Month Price-to-Earnings (P/E) Ratio
It is apparent that the current market is not conducive to sales, as the trade tensions between the U.S. and China have given way to the even greater calamity of the coronavirus. There is also cut-throat competition between players in most segments. So discounts, promotions and optimum inventory management typically define their strategies.
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 (StrongBuy). We are also presenting two stocks with a Zacks Rank #3 (Hold) that investors may want to hold on to.
MagnaChip Semiconductor Corp. (MX - Free Report) : Shares of this supplier of analog and mixed-signal semiconductor solutions for high-volume consumer applications have appreciated 43.9% over the past year. Its current Zacks Consensus EPS Estimate for the current fiscal year has increased 4 cents (4.7%) in the last 30 days.
Price and Consensus: MX
MaxLinear Inc. (MXL - Free Report) : This provider of radio-frequency analog and mixed signal semiconductor SoC solutions for broadband communication applications saw its share price decline 43.3% in the past year. Its current Zacks Consensus EPS Estimate is down 4 cents (5.7%) in the last 30 days.
Price and Consensus: MXL
MACOM Technology Solutions Holdings (MTSI - Free Report) : This leading designer and manufacturer of analog and mixed-signal semiconductor products has seen a 30.9% jump in its share price over the past year. Its current Zacks Consensus EPS Estimate has dropped 6 cents (13.0%) the last 30 days.
Price and Consensus: MTSI
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