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Global Chip Shortage a Temporary Problem, But in Extraordinary Times

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Okay, the chip shortage is not exactly a new story; it has been developing over the past year. Ever since the pandemic hit for the first time last spring, we were headed for major inventory imbalances across the supply chain, which often feels like shortages.

A recent Reuters article lays out the causes of the chip shortage rather well, but I’m summarizing it here:

It was actually a chain of events, starting with the pandemic that forced people to operate from home. So suddenly, we had demand for computers and consumer electronics going through the roof. This naturally caused chipmakers to adjust their supply to focus on these markets.

However, as everything opened up, there was still the need for social distancing. So people ended up buying more cars than they normally would (in aggregate). Now, this is where the chip shortage first started showing up because chipmakers couldn’t accommodate them.

Add into that mix a fire at a Renesas factory (supplier of 30% of MCUs used in cars); severe weather in parts of Texas, which limited supply from other major auto chip suppliers Infineon and NXP; chip-guzzling 5G devices that launched during this time; new game consoles from Microsoft and Sony that also launched during this time; record bitcoin mining; and U.S. sanctions on China, which led to stockpiling by China and troubled the entire Asia supply chain, which is highly integrated across a number of Asian economies, including South Korea, China, Japan, Malaysia, Singapore, Philippines, Taiwan, Thailand and Vietnam.

What we have as a result of all this is inventory shortage at manufacturers of automobiles as well as a range of consumer electronics products, including smartphones, refrigerators and microwaves. 

A report from IHS Markit offers hope for the auto industry. The research firm expects the MCU shortage to recover gradually, with supply improving in the second quarter, meeting demand in the second and recovering first-half shortfalls in the fourth quarter.

While all players will be impacted, Japanese manufacturers are likely to be somewhat insulated because of inventories at their distributors. Overall auto output forecast was maintained at 84.6 million units, although the situation remains dynamic and could change as we move forward.

The Chip Market Reinvents Itself

Even as all these tensions continue, major changes are afoot on the manufacturing side.

Intel’s (INTC - Free Report) new CEO surprised some of us folks with the announcement that it would continue its internal manufacturing (including 2 new fabs by 2024). However, it will use outside foundries when required and also offer foundry services as a separate business unit.

So Intel appears to be playing nice with the government while it also tries to generate the volumes necessary to maintain such a model. As American technology companies are being encouraged to use locally produced components, Intel’s supply should have some takers in Apple, NVIDIA (NVDA - Free Report) , Microsoft, Facebook, Alphabet and the like.

Not to be outdone, Taiwan Semiconductor Manufacturing Co (TSM) announced last week that it would invest $100 billion over the next three years to scale up its manufacturing operations and fund the development of new chip technologies. “TSMC is working closely with our customers to address their needs in a sustainable manner,” the company said, in a response to local media reports.

According to CEO C.C. Wei, despite running its fabs at over 100% utilization over the past year, TSM is unable to meet demand. It remains on a major hiring spree, has new fabs under construction and has decided to suspend wafer price reductions for a year beginning in 2022. This is hardly surprising since it caters to companies like Intel rival Advanced Micro Devices (AMD - Free Report) , Apple and NVIDIA.

Samsung, the other major semiconductor manufacturer, that’s planning to move beyond memory chips, expects to spend $116 billion over 10 years (from 2019).

The Steel Mills of the Future

The only concern, if you can call it that is the possibility of an inventory glut three to four years down the line. In this context, it’s worth noting that competition has reached entirely new levels as the U.S. attempts to regain some of its lost territory. The Semiconductor Industry Association, (SIA) recently said that semiconductor manufacturing in the country had gone from 37% of global chip supply in 1990 to just 12% in 2020. The industry group urged the government to take appropriate measures to rectify the situation.

In this scenario, it would be disastrous to miss a design cycle and get cut out of all the new products that will launch at an accelerated pace in the next few years. Absorbing losses from weaker pricing seems like a lesser evil. So everyone is likely to go full throttle.

Without a doubt, semiconductor fabs are the steel mills of the future, considering their role in AI. Semiconductors will increasingly be embedded into every conceivable device and also into our own bodies by the end of decade.

But for now, the markets into which they’ve already made their way are screaming out for them. So it’s a good time to invest in chip stocks, as long as you’re following tried and tested strategies.

So look for Zacks Ranks of #1 (Strong Buy) or #2 (Buy) and check out the specific sub-industry. Remember, not all players are made the same, nor will they all fare the same way in the same situation, nor will all their valuations be attractive.

So here’s a list that I would recommend-

AMAT and ASML are obvious beneficiaries of these trends, but their rich valuations keep me on the sidelines. Formfactor (FORM - Free Report) looks like a safer bet.

Himax Technologies (HIMX - Free Report) , Micron (MU - Free Report) , Texas Instruments (TXN), Xilinx (XLNX - Free Report) and STMicroelectronics (STM - Free Report) are also looking good.

Stocks with extremely attractive valuations (based on their performance over the past year) are AMD and NVDA, so they are also worth snapping up.

There are also some attractive stocks in the analog/mixed signal group: Max Linear (MXL - Free Report) , MACOM Technology Solutions (MTSI - Free Report) and NXP Semiconductors (NXPI - Free Report) are examples.

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