Why semiconductor stocks are ‘almost impossible to invest in’ despite record profits amid global shortage

The PHLX SOX semiconductor index,
which hit an all-time high of 4,039.51 on December 27, fell 13% in the first quarter of 2022 and, as of Monday, is down about 24% year-to-date, which places it firmly in bear market territory. The SOX index closed at 2,989.83 on Friday, the first time it has closed below 3,000 since May 19 last year, as previously hot stocks like Nvidia Corp. NVDA,
and Advanced Micro Devices Inc. AMD,
fell by more than 30% in 2022.

This type of sell-off would normally signal a buying opportunity in chip stocks, especially since most analysts are expecting another record quarter of beating and rallying from the sector. But that’s not what Wall Street analysts are saying.

The fundamental fear is that semiconductor companies are poised for a replay of 2018, when the chip sector entered the year on fire across the board, with stocks at record highs and chip prices sagging. increase resulting in record sales. This led to customers buying two or three chips before prices rose even more, leading to a glut when demand stalled and left chipmakers with inventory that took several quarters to run out of. unload as their stocks collapsed.

Evercore ISI analyst CJ Muse recently wrote that investors are waiting for chip executives to predict supply will outpace demand and cut their forecasts. This makes the short-term outlook cloudy or worse, he wrote.

“From an investment perspective, semiconductor stocks are nearly uninvestable today,” Muse wrote in a recent note. “Investors want to buy the ‘cut’, but that ‘cut’ may not happen until 2:22 a.m. at the earliest.”

“So we have to guess whether short-term fundamentals matter (they didn’t for Micron) or whether the market will continue to wait for the next inventory correction,” Muse said. Micron Technology Inc. MU,
shares have fallen more than 15% since late March, when the memory chipmaker reported strong sales driven by data center demand.

“Our feeling is that violent swings will be the new norm (both up and down) until we get a line of sight on whether we’ll see a soft or hard landing,” said declared Muse.

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Raymond James analyst Chris Caso also sees the potential for another 2018 at present, not seeing an end to the shortage as customers continue to order, but a potential for oversupply from l ‘other side.

“Our primary concern is that tight supply conditions and long lead times are disrupting market demand signals, making it difficult for the semi-supply chain to adjust production forecasts and capacity plans if and when demand changes,” Caso said in a recent note.

There are “three ingredients to a cyclical downturn: inventory, excess capacity and a slowdown in demand. We have at least one – inventory,” Caso said.

“We don’t think there’s excess capacity now,” Caso said. “But the capacity is being added and could create a problem in the future. Our main concern is that the current shortages create a strong incentive to build up excess inventory and capacity until customers are sure they don’t need the product.

Even though manufacturers complain that they could make and sell more stuff if they only had the microchips needed to finish those products, not all chips are created equal. If a manufacturer has an advanced processor that goes into a product but cannot get the $1 microprocessor that is also needed to complete it, then chip inventory becomes spotty.

This momentum doesn’t matter much because consumer demand for the finished product has remained high, but that may not be the case anymore, especially for personal computers. A slowdown in PC sales is playing out, after consumers and businesses stocked up on new PCs in the first two years of the COVID-19 pandemic and may not need them. buy more.

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The puzzling setup of the semiconductor sector will be tested this week, with a series of post-close earnings reports expected. Texas Instruments Inc. TXN,
reports Tuesday, Qualcomm Inc. QCOM,
Wednesday, and Intel Corp. INTC,
Thursday, an assortment that should provide a good overview of the chip landscape – Texas Instruments is known for its analog chips, Qualcomm for its chips for mobile devices and Intel for its processors.

Two companies to watch for signals regarding PCs and the rest of the market are Texas Instruments and Intel, Citi Research analyst Christopher Danley wrote in a recent note.

“We expect consensus estimates to rise again in the 1Q22 earnings season given the extended lead times and higher prices,” Danley said. “While we believe the recovery is in the latter innings, we remain positive on the group until we see the timelines decrease.”

“Our main concerns are the impending PC slowdown and a shift in investor sentiment towards a more negative bias, which could keep stocks from hitting new highs until a correction,” Danley said. “We believe the likelihood of a PC slowdown in 2H22 is increasing and would be negative for the group as PCs account for around 30% of semi-demand. We expect forecasts below the season for Intel and Texas Instruments.

Jefferies analyst Mark Lipacis went so far as to say that Texas Instruments “is having a hard time delivering enough coins as desperate customers pay $200 for a $1-2 coin,” but that inventory doesn’t are “not yet a problem” because they “add up”. because OEMs are unable to complete manufacturing kits and manufacture finished products.

Texas Instruments may fare better, according to a recent note from B. of A. Securities analyst Vivek Arya. Arya said while PC weakness is likely already priced into stocks like Intel and AMD, widespread shortages “particularly in the automotive end market” and lean inventory in the types of chips made by Texas Instruments , ON Semiconductor Corp. WE,
NXP Semiconductors SA NXPI,
and Microchip Technology Inc. MCHP,
are “likely to keep the demand outlook strong”.

Arya said this trend was exemplified by Analog Devices Inc. ADI,
raised its outlook earlier in the month.

One of the companies building on this capability is Taiwan Semiconductor Manufacturing Co. TSM,
which reported on April 14, beating Street’s expectations as the third-party fab seeks to clear the backlog of chipmakers in hopes of meeting strong demand.

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American shares of ASML Holding NV ASML,
closed nearly 2% higher last week despite a shortfall after the chip equipment supplier’s CEO Peter Wennink told analysts the company was “operating at maximum capacity” and that it expected “demand to exceed supply until next year”. Shares of Lam Research Corp. LRCX,
also rose nearly 2% last week, attributing its weaker-than-expected earnings and outlook to lingering supply chain issues that escalated in late December amid strong demand. Smaller U.S. rival KLA Corp. KLAC,
is due to report on April 28.

Supply chain issues in the electronics industry have also become as pandemic as COVID-19, which continues to trigger lockdowns in China, further compounding the problems. For example, network equipment and router company Netgear Inc. NTGR,
recently warned that its results will fall short of expectations, directly citing lockdowns in China that have compounded already difficult supply chain issues.

Other expected chip sector revenue includes AMD on May 3, GlobalFoundries Inc. GFS,
– a third-party foundry that went public in October at $47 per share – on May 10, Nvidia is expected to report on May 25 and Broadcom Inc. AVGO,
should report around June 9.

“Perspective remains paramount as we still expect broad beats/ups and while so, most companies’ share prices are down sharply year-to-date, most names in our universe coverage also reached all-time highs ending last year,” said Cowen analyst Matthew Ramsay. told investors.

Weakness in chip stocks has risen to the 24% decline seen so far this year; this time in the last quarter, the sector was already faltering as it fell into a bear market. In comparison, the S&P 500 SPX index,
fell 5% in the first quarter and is down 11% in 2022, while the tech-heavy Nasdaq Composite Index COMP
fell 9.1% in the first quarter and is down 18% since the start of the year.

Garland K. Long