The semiconductor industry is made up of 11 sub-sectors within the Technology sector, which is one of the 16 broad Zacks sectors.
Similar to the Technology sector, Zacks also breaks down each of the other sectors into groups such that there are a total of 264 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, the majority of semiconductor stocks are now in positive territory with the first eight semiconductor segments being positive and the rest neutral.
Note: The average rank of stocks in each sub-sector is indicated in the last column. 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 94.6% of technology stocks have reported with results notably better than the S&P 500. Overall, technology stocks’ earnings were consistent with the year-ago quarter on revenue that increased 3.0%. Also, 83.6% beat earnings estimates and 72.7% beat revenue expectations. Semiconductor stocks did better than the overall sector with an earnings beat ratio of 87.5%, although the revenue beat ratio wasn’t as strong at 62.5%.
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 is cloud computing, big data and artificial intelligence that are increasing demand for servers and data centers exponentially. Intel and NVIDIA (NVDA - Free Report) are the strongest positioned here, with Intel’s strength mainly on the enterprise side and NVIDIA’s on the HPC side. Intel (INTC - Free Report) is trying to dislodge NVIDIA but that is easier said than done. HPC is where a lot of the innovation is going on.
Some disruption is afoot in the enterprise segment 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 also joined in. 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. IBM (IBM - Free Report) has made some progress in chip design that Google seems to be testing out. Google is reportedly the only top chip buyer that doesn’t sell servers but instead builds them for internal use. And the company is now also seeking growth in the IaaS segment. Therefore, Google’s decisions are extremely significant in the chip consumption context.
Google has done two things in the recent past that could be viewed as second sourcing or maybe creating leverage against Intel to lower prices. The company has declared that everything it now does also supports IBM’s Power systems and it is also hobnobbing with Qualcomm ostensibly to use some of its fledgling 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.
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.
Microsoft seems allied with Intel for now although we don’t know how that story will play out since it’s also a member of the OCP.
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.
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.
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. Semiconductor consumption in this market was worth around $7 billion in 2015, according to Reportlinker.
Primary areas of strength are 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, Freescale, Texas Instruments and Spansion (owned by Cypress) are major players. Analog Devices, with its ADAS technology, is also a beneficiary.
The market, which saw some consolidation last year, is expected to grow 3.7%. Similar to wearables, the auto market also has an emerging adjacent market in the form of autonomous/self-driving cars that will consumer 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.
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 5.2% in the second quarter while IDC estimates that it declined 4.5%).
The encouraging things here are that first, both firms estimate that North America returned to growth last quarter and second, there is a chance of a stronger, Windows 10-driven second half particularly at enterprise customers. The consumer business won’t strengthen as much because consumers are hesitant to spend on upgrades given that they already have many more devices than they need and because Internet and many other conveniences of computers are now easily available on smartphones and tablets.
In either case, it’s very clear that the steady growth seen in previous years is history. IDC expects the PC market to shrink 7.2% this year and 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 chips, 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. 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. In 2016, IoT semiconductor revenue in smart cities will grow 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) expects semiconductor sales to decline 2.4% this year following a flat 2015 despite a second-half rebound. Relatively stronger categories are expected to be discretes, analog and microcontrollers. The SIA also endorsed WSTS data projecting 2.0% growth in 2017 followed by 2.2% growth the following year.
IC Insights expects chip sales growth of 4% in 2016 with total unit shipments growing 5% to more than a trillion. Prices are expected to be stable. Semiconductor capital spending will fall 1% in 2016 with spending on flash memory and within the foundry segment the only areas to grow.
The top semiconductor categories are expected to be cell phone MPUs (up 10% in 2016), signal conversion (up 10%), 32-bit MCU (up 8%), display drivers (up 6%), general purpose logic (up 6%) and NAND flash (up 6%). Wired communications chips (analog and special purpose logic) and wireless communications analog will each grow 6%. Auto and power management chips will be up 5% and PLDs up 3%. Computing logic, app specific analog chips for industrial and chips will grow and server MPUs will grow 2%.
Gartner says that worldwide semiconductor revenue will decline 0.6% in 2016 due to weakened demand for key electronic equipment, elevated inventory levels and the continuing impact of the strong dollar in some regions. The research firm says that weaker estimates for PCs, ultramobiles and smartphones were pulling down demand for semiconductors with IoT and wearables being too small to offset the impact this year.
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.
Confidential from Zacks
Beyond this Industry Outlook, would you like to see Zacks' best recommendations that are not available to the public? Our Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Click to see them now>>